When Do Small Countries Win Tax Wars?

Abstract

This article analyzes the conditions under which the smaller of two otherwise iden- tical countries prefers the noncooperative Nash equilibrium to a situation of fully harmonized tax rates. A standard two-country model of capital tax competition is extended by allowing for transaction costs, additional countries, and additional tax instruments The effects of introducing either mobility costs or a wage tax instru ment are theoretically ambiguous because they lower both the costs and the benefits of noncooperation from the perspective of the small country. Numerical simulations indicate, however, that for a wide range of parameter values, all model extensions considered reduce the possibility that the small country gains from tax competition.