Optimal Level of Taxes and Public Goods PDF

Optimal level of taxes and public goods Regional governments levy a source-based capital tax. Tax revenues tk are used to provide a local public good g, 1 unit of tax tk = g. 1 unit of public good > - revenue = The government chooses t = arg max u(wl + rk, tk) Efficiency requires: C - will be reache...

Optimal level of taxes and public goods Regional governments levy a source-based capital tax. Tax revenues tk are used to provide a local public good g, 1 unit of tax tk = g. 1 unit of public good > - revenue = The government chooses t = arg max u(wl + rk, tk) Efficiency requires: C - will be reached with symmetric Production efficiency: fki = fkj , ug uc i 6= j. ~ marginal utility of c Allocative efficiency: = 1 where @u/@c ⌘ uc and @u/@g ⌘ ug , respectively. When we reduce public good MRS = MRT ↑ private consumption by 1 unit , we can produce one unit of 31 / 43 Equilibrium tax policy ~ of immobile factor Applying the Euler theorem rental income can be rewritten as wl = f (k) fk k. Therefore, private consumption is given by what output c = f (k) is paid capital fk k + rk. = to ~ difference In endowment h w > - and K -- E fixed capital Call individuals the says where you invested samel (7) how much The local government sets t and, thereby, g, taking the reaction of the interest rate (4) and regional capital demand (5) into account. It behaves as a Nash competitor towards other regions, i.e. it takes the tax rates of other regions as given. Thus, it solves max t S What's the choosen by u f (k) fk k + rk, tk - s.t. (4) and (5) E optimal t government 32 / 43 Equilibrium tax policy The first-order condition is: (t) : uc ✓ ◆ ✓ ◆ @k @r @k fkk k + k + ug k + t = 0. @t @t @t because all attract the same a mount of (8) capital (same tax ratel At a symmetric equilibrium (k = k), the f.o.c. (8) reduces to substitute equ (1) :. e uc ✓✓ ◆ ◆ ✓ ◆ @k k + ug k + t = 0, @t ✓ ◆ @k uc ( k) + ug k + t = 0. @t @k @r fkk + @t @t Inserting Eqs. (4) and (5) and rearranging yields: marginal rate of substitution ug 1 = uc 1 + ✏k,t give's distortion with ✏k,t := The bigger E @k t < 0. @t k 49 = (9) 33 / 43 FOC n : [t-t- ~ + k) only + r because ug(k + + I is fixed =) = 0 (S) Interpretation: have assumed it to be ug 1 = uc 1 + ✏k,t one with ✏k,t := @k t < 0. @t k The LHS gives the marginal rate of substitution, i.e. the marginal willingness to pay for public consumption. The RHS depicts the marginal cost of public funds (henceforth MCPF). MCPF measures how much private consumption has to be sacrificed in order to raise one additional unit of tax revenues. ✏k,t is the tax base elasticity which in absolute value is positively related to the MCPF. 34 / 43 Result: ug uc > 1 ) public good provision is inefficiently low! t will not be 0 at equilibrum The higher |✏k,t |, the more severe the underprovision tendency (“race to the bottom”) & t will not positive be zero at but there's equilibrium , it will be underprovision Proposition 2 Symmetric tax competition with source-based capital taxes leads to inefficiently low capital tax rates and levels of public good supply in each country, relative to a situation where taxes are coordinated (Zodrow and Mieszkowski, 1986). ↳ governments * shift of * shocks have other instruments to provide g : taxes 35 / 43 Asymmetric countries 36 / 43 Tax competition with asymmetric countries Model based on Bucovetsky (1991) Two countries 2 {A, B} with di↵erent population size Each household in either country supplies k ⇤ units of capital (e.g. k ⇤ is the avg. capital-labor ratio) Per capita level of capital invested in country i: k i (may di↵er from k ⇤ ) Exogenous share of country i in world population: si where sie sA + sB = 1 SA LA =population inconty _ 0 00 Production: f (k i ) where f (k i ) > 0, f (k i ) < 0 37 / 43 World L ht = + 4 = ga da. + 943 1 : - (1 si ) < 0. si )f 00 (k i ) + si f 00 (k j ) for all humerator denumerator weg. countries larger for negative (12) - - but smaller effect larger for smaller countries countries : (positive for all 38 / 43 Implicity differentiating equ f E- Analog for = B. (11) : f change 2 : substitute equ (10) Result: i Tax elasticity of capital higher for smaller country: | @k | @ti decreases with si. Smaller country faces larger reduction in capital stock following a domestic tax increase ! smaller country will engage more aggressively in tax competition. Proposition 3 If two countries di↵er only in size, then the smaller country levies the lower capital tax rate and has the higher per capita utility level in the asymmetric Nash equilibrium (Bucovetsky , 1991). It can be shown that there exists a certain population distribution for which the smaller country has a higher per capita utility in the non-coordinated equilibrium than under always profitable coordinates capital tax rates. zusammenbrechen the small country deviate from equ * , bc. to > - If there's a player small enough relative to other players It's coord coordinated. for. * equilibrium 39 / 43 Advantage of smallness Z ! The small country (B) will charge a lower tax, employ more capital per unit of labor k B > k A and its residents will be better of than those of the large country. 40 / 43 Further Considerations: Not only taxes are important for investors’ allocation decisions but public infrastructure, legal systems or the protection of property rights matter, too. Investors will accept taxes if they are seen as the price that must be paid for the publicly provided infrastructure (benefit taxation). In theory, overprovision of infrastructure may arise if capital is more responsive to public inputs than to taxes. (genters Agglomeration externalities give rise to rents that may be taxed (Baldwin, Krugman, 2004). production function not only utility 41 / 43 Yardstick competition: Voters use other jurisdictions as a yardstick against which they evaluate the fiscal performance of their own government (Besley and Case, 1995). ! Whether the tax base externality or the yardstick spillovers dominate depends on the initial conditions and remains an empirical question. ! Mobility-based competition (standard tax competition) vs. information-based competition (yardstick competition). > - Hier fehlen zwei Folien ! 42 / 43 Bruelhart and Jametti (2019) test whether ”tax competition tames the Leviathan” using Swiss data Theory prediction: small (large) jurisidiction internalizes less (more) the externality it creates on the tax base of the other jurisdiction. Small (large) jurisdiction engage more (less) aggressive in tax competition. Smallness exacerbates externalities. If smallness is positively correlated with the tax rates in jurisdictions with relatively benevolent governments and this relationship (smallness and local tax rates) turns negative for relatively less benevolent governments (leviathan) then tax competition is welfare improving. 43 / 43