Endogenizing government’s objectives in tax competition with capital ownership

See Wilson and Wildasin (2004) for a review on the advantages and disadvantages of capital tax competition.

As another thread of studies on strategic delegation in tax competition, we can list (Persson and Tabellini 1992; Ihori and Yang 2009; Ogawa and Susa 2017). In these studies, it is assumed that the power to set a capital tax rate is delegated to a citizen elected as the policy-maker from heterogeneous citizens through majority voting, allowing the policy-maker to be self-serving, which is called the all-citizen-candidate model. On the other hand, in Pal and Sharma (2013) and in this study, the power is delegated from the welfare-maximizing central authority to a risk-neutral manager. The significant difference between these two threads is whether they focus on the formation of political systems or the behavior of a welfare-maximizing government in the globalized world. In other words, the former examines election itself and who becomes the policy-maker in each country, while the latter attempts to tell a story about how governments implement tax policy after elections.

They extend the baseline model to incorporate production asymmetries, sequential-move structure, and competition in public investment and show that maximizing welfare rather than maximizing tax revenue is the dominant strategy, at least, in one country in the sequential-move game.

The basic settings, that is, preferences and technologies, follow the works of Bucovetsky (2009), Pal and Sharma (2013), and Eichner (2014), among others.

\(\gamma \) can also be interpreted as the marginal cost of public funds in the country. See Cardarelli et al. (2002), Bucovetsky (2009), Keen and Konrad (2013), and Eichner (2014). If \(\gamma =0\), then the model would reduce to the one in which tax revenues will be returned to the residents in a lump sum manner.

The assumption of the ultimate goal of governments is simply justified by the fact that they are representatives elected through voting by citizens of a country that is under the regime of democracy. If they deviate from the ultimate goal, then they will not be chosen in the next election.

The Leviathan-type government, first proposed by Brennan and Buchanan (1977, 1980), maximizes the fiscal surplus that consists of tax revenue minus cost for providing public goods. However, since the results do not change, we here simply follow Kanbur and Keen (1993), Ohsawa (1999), Wang (1999), and Kanbur and Keen (1993) to assume that the objective of the Leviathan is tax revenue maximization.

Appendix A provides details of derivations referred to throughout the text.

In the first two subsections, \(\delta =1\) is also assumed to present our argument most clearly. In the following two subsections, we do not limit our analysis to \(\delta =1\) so that we can better see the impact of the magnitude of \(\delta \) on the results.

Appendix B provides details of the derivation process of the equilibrium of this game.

Appendix C provides details of the derivation process of the equilibrium of this game.

Appendix D provides details of the derivation process of the equilibrium of this game.

Similar results can be derived, even in the case where there are two policy instruments—capital tax and public investment.

Appendix E provides details of the derivation process of the equilibrium of this game.