Endogenous Leadership in Tax Competition: A Combination of the Effects of Market Power and Strategic Interaction

Abstract

This paper extends Kempf and Rota-Graziosi (2010, “Endogenizing Leadership in Tax Competition.” Journal of Public Economics 94 (9):768–776) and Hindriks and Nishimura (2015, “A Note on Equilibrium Leadership in Tax Competition Models.” Journal of Public Economics 121:66–68) by jointly considering the effects of market power and strategic interaction in tax competition. We depict the regional asymmetry as different slopes and different vertical intercepts of the inverse demand for capital. In our setup, the risk-dominant equilibrium in which the large region leads is regained. Moreover, dissimilar to Kempf and Rota-Graziosi (2010, “Endogenizing Leadership in Tax Competition.” Journal of Public Economics 94 (9):768–776) and Hindriks and Nishimura (2015, “A Note on Equilibrium Leadership in Tax Competition Models.” Journal of Public Economics 121:66–68), we show that with a large market demand and a low capital endowment, the leadership by the large region can still be Pareto-dominant even if the asymmetry is very small.