Capital Tax Competition and Returns to Scale

Abstract

There is a gap between the predictions of capital tax competition models and the reality they purport to describe. In a standard capital-tax model, with head taxes, capital-importing regions tax capital and capital-exporting regions subsidize capital. In the real-world, competing regions appear to subsidize capital whether or not they are capital importers. We show that by relaxing the standard assumption of constant returns to scale symmetric regions in a Nash equilibrium may all subsidize capital.We also prove that any ine¢ciencies in a non-symmetric Nash equilibria arise entirely from regions’ incentives to manipulate the terms of trade, and not from increasing returns.We also compare our results to those in captial tax competition models without head taxes.