Fiscal Competition and the Efficiency of Public Input Provision with Asymmetic Jurisdictions

This paper analyses the efficiency of public input provision in a model with large and asymmetric jurisdictions and international capital mobility, where governments provide local public consumption goods and public inputs. Our main result is that the efficiency of public input depends on the set of available tax instruments. If a lump-sum tax is the only available policy instrument, the provision of public inputs will be distorted as governments use the public input to strategically influence the interest rate in the world capital market. In contrast, if a source based capital tax is available, the distortion of public input provision vanishes. This does not imply, however, that a first best equilibrium is attained. The allocation of capital across jurisdictions is inefficient due to differing capital tax rates.