Tax Competition, Local Infrastructure, and Business Taxation: A Comparison of Different Tax Instruments

Abstract:

Most of the tax competition literature focuses on the provision of local public services to households. However, a number of papers, dating back to Zodrow and Mieszkowski (1986), analyze tax competition when capital taxes are used to finance local public services provided to businesses, examining the conditions under which such services are provided efficiently, under-provided, or overprovided. In addition, several prominent observers have noted that “benefit-related” business taxation is desirable on both efficiency and equity grounds and argued that such taxation should take the form of a tax based on production, such as an origin-based value-added tax. We evaluate this contention in this paper, comparing within the context of a standard model of interjurisdictional competition the relative efficiency properties of these alternative business taxes. Our simulation results suggest that under many circumstances it is more efficient to finance business public services with an origin-based production tax rather than a source-based capital tax. We also relate our results to others found in the existing literature on capital tax competition when public services are provided to businesses.