Public expenditure spillovers: an explanation for heterogeneous tax reaction functions

Abstract

In this article, we show that spillovers may provide an alternative explanation for the heterogeneity of tax reaction functions under tax competition. In particular, we assume the existence of $$n\ge 2$$ n ≥ 2 jurisdictions, which compete to attract mobile capital in a context where public expenditure produces spillovers. We show that the latter can lead to asymmetric responses. For instance, jurisdiction i may react positively to a change in the tax rate of jurisdiction j and negatively to the change in jurisdiction z. From a policy point of view, these findings are helpful to understand the mixed results found by the empirical literature, and to analyse the tax reaction functions of city centres and suburban jurisdictions.