Redistribution, Fiscal Competition, and the Politics of Economic Integration

Abstract

The paper examines the consequences of the economic integration of factor markets in a model with two countries that redistribute income among their residents. The social benefits in each country are financed by a source based tax on capital which is democratically chosen by its inhabitants. If either capital or labour is internationally mobile, the countries engage in fiscal competition and the partial integration of capital or labour markets is detrimental to the countries' redistributive ability. A move from partial to full integration, however, may alleviate rather than intensify fiscal competition, particularly, if the two countries face sufficiently similar economic and political conditions. In such a situation, for example, tax competition for mobile capital is softened as the labour market becomes more integrated and even vanishes if both factors are fully mobile. As a result, there is more redistribution in equilibrium and a majority of the population * This paper has benefitted from comments by Jan Brueckner, Ig Horstmann, Dave Wildasin, and various participants of seminars at Bonn, Heidelberg, Konstanz, Mannheim, the

Why is mobile capital taxed?

“…19 There is a large literature on voting on capital taxation with heterogeneous capital ownership (for example, Persson and Tabellini 1992; Kessler et al 2002). However, their focus differs and do not consider why mobile capital is taxed even if non-distortionary taxes are available.…”

Efficiency of capital taxation in an open economy: tax competition versus tax exportation

“…A further reason why tax competition may become less attractive due to labor mobility is that the higher perceived benefits it creates for a country (in terms of higher wages and/or social transfers) tend to increase immigration. Since domestic residents then have to share the benefits with the immigrants, they may vote against lower taxes (Kessler, Lülfesmann, Myers 2002).…”

Tax incidence, majority voting and capital market integration

“…A final related paper here is Kessler, Lulfesmann and Myers (2002). In that model, agents differ only with respect to their capital endowment, and capital taxes fund a lump-sum transfer to all residents.…”

“…An assumption sufficient to rule this out was made by Zodrow and Mieszkowski(1986) in their original paper, so they also found under-taxation with an infrastructure public good. is detrimental to a majority" (Kessler, Lulfesmann and Myers(2002)). So, both the result and the reasoning behind it are rather different to our paper.…”