19
Table 4: Tax Competition between Countries of Different Budget Constraints
Country Types
Tax System Chosen by Country:
A B C
A
B
C
11
11
31
.23 | .33
.24 | .33
.36 | .47
11
11
21
.24 | .34
.25 | .34
.35 | .44
11
11
11
.26 | .35
.28 | .35
.31 | .36
11
21
31
.26 | .34
.27 | .43
.36 | .46
11
21
21
.26 | .34
.35 | .44
.35 | .44
11
31
31
.23 | .33
.36 | .47
.36 | .47
14
14
34
.25 | .26
.26 | .27
.41 | .43
14
14
24
.25 | .26
.26 | .27
.40 | .41
14
14
14
.28 | .30
.29 | .31
.33 | .34
14
24
34
.30 | .30
.39 | .40
.40 | .42
14
24
24
.30 | .31
.39 | .40
.39 | .41
14
34
34
.30 | .30
.40 | .42
.40 | .42
Mirroring the results of variations in fairness norms, tax competition becomes
more severe when (at least) two governments are unrestricted by budget con-
straints.
15
Both governments greatly cut their tax rates on mobile capital, while the
more constrained government cannot follow. In other words, unrestricted gov-
ernments set competitively low tax rates on mobile capital to attract the mobile
capital base of the more restricted country. If there is much to compete for, the
least constrained governments can trade off budget deficits and violations of fair-
ness norms to attract the internationally mobile capital. In comparison, when gov-
ernments in all countries are unrestricted, little amounts of mobile capital actually
change the jurisdiction. Thus, heterogeneity of political constraints matters.
Finally, the tax structure of the least constraint country depends to a larger extent
on the heterogeneity of competing countries than the tax structure of the con-
strained countries. The constrained countries reduce tax rates on mobile capital as
far as possible given the domestic constraints, while the less constrained countries
reduce it as far as necessary to become the low tax country.
15
This result qualifies a hypothesis formulated by Basinger and Hallerberg (2004: 266). Analyz-
ing tax competition between two heterogeneous countries they conclude that the probability of
one country undertaking tax cuts increases in the number of low cost countries (where low
(high) cost denotes a low (large) number of veto-players in their analysis). Our model suggests
that the country with the second lowest costs (to rely on Basinger and Hallerberg’s terminol-
ogy) determines the intensity of tax competition. However, we observe separating Markov
equilibria. It could therefore well be that the high-cost country increases its taxes on mobile
capital when the number of low-cost countries increases.
Convention