Tax Competition and the Efficiency of 'Benefit-Related' Business Taxes

Abstract

We consider a model in which business public services must be financed with either a sourcebased tax on mobile capital, such as a property tax, or a tax on production, such as an originbased VAT and assess which of the two tax instruments is more efficient. In general, both a capital tax and a production tax are inefficient. However, the production tax is efficient if the production function belongs to the knife-edge case between log sub-and log supermodularity with respect to capital and public services (e.g., a Cobb-Douglas production function), while the capital tax results in underprovision of public services in this case. Similarly, if the production function is log submodular with respect to capital and public services (e.g., a CES production function with an elasticity of substitution greater than 1), a production tax is again less inefficient than a capital tax, although both taxes result in underprovision of the public service. Finally, if the production function is log supermodular (e.g., a CES production function with an elasticity of substitution smaller than 1), a production tax results in overprovision of the public service, while the e¤ects of a capital tax -and thus the relative efficiency properties of the two taxes -are theoretically ambiguous.

Local Policy Choice: Theory and Empirics

“…For example, Bucovetsky and Wilson (1991) analyzes labor and capital taxes in a variant of the ZM W model that includes labor-leisure decisions, and Gugl and Zodrow (2019) analyze source-based capital taxes and taxes on production in a model where the public service enters the production function. But these papers still do not consider the full range of possible tax instruments, including head taxes.…”

The impressive contribution of Canadian economists to fiscal federalism theory and policy

“…Over‐provision of public inputs might also arise if there are scale economies (Bucovetsky ). Finally, given that businesses benefit directly from such public services, a tax on production can mimic a benefit‐related tax and therefore, can result in more efficient provision of public services than with a tax on capital (Gugl and Zodrow ).…”

“…Firms' capital investments are far from homogenous and such heterogeneity can give rise to preferential tax treatments. Preferentially treatment would be granted to the types of capital that can move more easily (Gugl and Zodrow 2004). Preferential tax regimes might discriminate based on the ownership of capital (i.e., by residents or non-residents) given that foreign-owned capital might be more mobile (Mongrain and Wilson 2014), or they might discriminate on some other characteristic of capital that relates to its ability to move.…”