Do EU15 countries compete over labour taxes?

Empirical research on international tax competition has mainly considered cor- porate taxation. Because of the limited international mobility of labour, labour tax competition tends to be overlooked. This may be unjusti?ed. The tax base in labour taxation is the wage mass that depends on employment. While labour is largely in- ternationally immobile, jobs are certainly not because of the international mobility of goods. Given the higher share of labour tax in government revenues, labour tax competition could also have more important welfare consequences than corporate tax competition. We model the possibility of labour tax competition using a standard Dixit-Stiglitz two-country model with immobile ?rms and workers and transportation costs in exporting goods. The model is extended with the assumptions of non-clearing labour markets and income redistribution by the government, ?nanced by a labour tax. The model results in an empirical speci?cation of the labour tax reaction function in the form of a spatial lag panel. The tax reaction function is then estimated for the EU15 member states using an instrumental variable approach. Our results point to the presence of small, but signi?cant labour tax competition within the EU15.