And the tax winner is … A note on endogenous timing in the commodity taxation race

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Working paper
Hubert Kempf and Grégoire Rota-Graziosi
Issue number: 
Centre d’Economie de la Sorbonne
This note investigates the endogenous choice of leadership in commodity tax competition. We apply an endogenous timing game, where jurisdictions commit themselves to lead or to follow, to the Kanbur and Keen (1993) model. We show that the Subgame Perfect Nash Equilibria (SPNE) correspond to the two Stackelberg situations, yielding to a coordination issue. Selecting an equilibrium by means of the risk-dominance criterion, we prove that the smaller country has to lead. If asymmetry among countries is sufficient, Pareto-dominance reinforces risk-dominance in selecting the same SPE. We deduce two important results for the literature of tax competition: when countries differ sufficiently by their size, the “big-country-higher-tax” rule does not hold anymore; when countries are close in size, tax harmonization through a unique tax rate among countries occurs without any international agreement.
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