The Gains from Preferential Tax Regimes Reconsidered

The EU policy against harmful tax competition aims at eliminating tax policies targeted at attracting the internationally mobile tax base. We examine this issue by considering two countries which decide their corporate tax rates their tax regimes (discriminatory or non-discriminatory tax policy). Firms produce under imperfect competition and trade between countries is costly. The endogenous spatial allocation of mobile firms depends upon different parameters of the economy while the distribution of immobile firms is exogenous. We show that countries discriminate against immobile firms when trade costs are high. Trade integration makes imposing the same tax on all firms more appealing such that, at low trade costs, the unique Nash equilibrium is characterized by uniform corporate taxes being set by both governments. However, when trade costs reach intermediates values, fiscal competition may lead to tax discrimination while uniform taxation is socially preferred