Dynamic fiscal competition: A political economy theory

Abstract

I develop a political economy theory of dynamic fiscal competition via public spending and debt. With internationally mobile capital, strategic policies generate two cross-border externalities that voters in each country fail to internalize: (1) an increase in public spending that bolsters capital accumulation but also (2) a race to the top in public debt which crowds out capital. The relative size of these two externalities varies with the number of financially integrated countries and interacts with the domestic political conflict between young and old voters. Despite residence based taxation, capital tax rates are lower under strategic policies than under coordination. Furthermore, they may decline with financial integration. Strategic policies lead to lower long run output and welfare relative to coordination but are preferred by subsequent generations of voters if the number of financially integrated countries is low or the political weight of the young is high.

Local Policy Choice: Theory and Empirics

“…The desirability of restricting the use of government debt depends on political economy 27 Arcalean (2018) shows that with mobile capital, strategic policies generate two cross-border externalities that voters fail to internalize: (1) an increase in public spending can spur capital accumulation, but also (2) increase interest rates, which crowds out capital. The latter of these channels arises because decit spending yields a negative pecuniary externality (an increase in the interest rate), as governments ignore the crowding out eect in other countries.…”

Residence- and source-based capital taxation in open economies with infinitely-lived consumers

“…when capital taxes distort both the intertemporal savings margin as well as the allocation of capital across countries. A few papers employ a formally dynamic model, but make specific functional-form assumptions so that capital taxes do not affect the savings decision, as for instance in Köthenbürger and Lockwood (2010) and Arcalean (2018). Lejour and Verbon (1998) only analyze steady states without taking into account the transition.…”

Dynamic Tax Competition, Home Bias and the gain from Non-preferential Taxation Regimes: A case for unilateral commitment

“…The primary harmful effect motivating such agreements appears to be the erosion of tax revenues and the loss of economic efficiency due to the movement of capital between jurisdictions solely to evade tax payments. 1 Email: kaushal@iiserb.ac.in. Ph: +917496088192.…”

“…Therefore, we have 𝑀 / 𝐺 6 (𝑀 / − 𝐹) − (𝑚 / + 𝐹)𝐺 6 (𝑚 / ) − (𝑚 / + 𝐹)𝐺 6 (𝑚 / + 𝐹) ≥ 0.The above inequality implies 𝑀 / 𝐺 6 (𝑀 / − 𝐹) − (𝑚 / + 𝐹)𝐺 6 (𝑚 / ) ≥ 0.Note that 𝑚 / + 𝐹 ≤ 𝑀 / ≤ 1. Therefore, using step(1) we can state that 𝛱 / ž (𝑀 / − 𝐹, 𝐺 6 ) − 𝛱 / ž (𝑚 / , 𝐺 6 ) ≥ 0. Therefore, we have 0 ≥ 𝛱 / (𝑀 / − 𝐹, 𝐺 6 ) − 𝛱 / (𝑚 / , 𝐺 6 ) ≥ 𝛱 / • (𝑀 / − 𝐹, 𝐺 6 ) − 𝛱 / • (𝑚 / , 𝐺 6 ) or, (M − F)𝐺 6 (𝑀 / − 2𝐹) − 𝑚 / 𝐺 6 (𝑚 / − 𝐹) ≤ 0.…”