Abstract

In the public economics literature, fiscal competition for mobile production factors (e.g. mobile capital) may provide an incentive for policy makers to choose inefficiently low tax rates and public good provision levels in a non-cooperative environment. As a potential reason for underprovision, fiscal externalities resulting from international capital mobility are identified. Recent research stresses that the implications of fiscal competition depend to a significant degree on the institutional setting of the competing jurisdictions' labour markets. This is because, assuming imperfect labour markets, the representative government needs not only to account for the effects that a variation of available fiscal policy parameters may have on the amount of capital invested in the jurisdiction, but also on the level of employment. A potential inefficiency in the non-cooperative equilibrium can then be attributed to the fact that the change in employment arising from a region's choice of tax and/or expenditure levels creates an additional incentive for regional governments to deviate from public good provision levels according to the first-best provision rule, where the marginal utility of public good provision equals the marginal cost. The project aims to derive equilibrium (capital-) tax rates and provision levels of public goods in the presence of unemployment. We aim to introduce a wide range of fiscal policy instruments available for policy makers such as (source-based) capital taxes, taxes on labour, or governmental provision of public inputs. In a theoretical framework, we intend to test the implications of various institutional settings on the labour market (fixed-wage approach, right-to-manage approach, monopolistic union) on the outcome for public good provision levels and the optimal tax policy in the regions. With respect to public good provision, the project distinguishes further between governmental provision of public consumption goods and public inputs. Using comparative static analysis, the project investigates the impacts of fiscal policy measures on the capital endowment and the employment levels in the regions. In addition, we apply numerical analysis to test for the robustness of results.