Public Good Differentiation and the Intensity of Tax Competition

We show that, in a setting where tax competition promotes effciency, variation in the extent to which firms can use public goods to reduce costs brings about a reduction in the intensity of tax competition. This in turn brings about a loss of effciency. In this environment, a ‘minimum tax’ counters the reduction in the intensity of tax competition, thereby enhancing effciency. ‘Split-the-difference’ tax harmonization also potentially enhances effciency but would not be agreed upon by governments because it lowers the payoff to at least one of them. This paper also presents an explanation for how traditionally high-tax countries have continued to set taxes at a relatively high rate even as markets have become more integrated.