By Paul Gomme
How should governments choose tax rates when they face competition from other jurisdictions? This questions is answered by solving for the Nash equilibrium of the game played between Ramsey planners in a two good, two country open economy macroeconomic model. It is shown, analytically, that the planers do not tax capital income in the long run. Short term results, obtained computationally, reveal that the government of the larger country manages the path of the real exchange rate in order to manipulates its smaller rival’s choice of tax rates. Tax competition does not lead to a “race to the bottom.”
Paper full of insights about international tax competition and “currency manipulation.” It is particularly interesting for tax havens that struggle with the movements (or levels) of their exchange rate.