Part 1 - AL-Tax

International Taxation Handbooktheir nature and magnitude will depend on the constellation of tax (and broadereconomic) systems with which the domestic economy competes.3.3 A stylized theoretical model of capital-taxcompetitionWe leverage Persson and Tabellini’s (2000, Chapter 12) formal–theoretical modelto demonstrate further that tax competition implies spatial interdependence. Themodel’s essential elements are as follows. In two jurisdictions (i.e. countries), denotethe domestic and foreign capital-tax rates as τ k and τ * k. Individuals can invest ineither country, but foreign investment incurs mobility costs. Taxation follows thesource (not the residence) principle. Governments use revenues from taxes levied oncapital and labor to fund a fixed amount of spending. 4 Individuals differ in theirrelative labor-to-capital endowment, denoted e i , and make labor-leisure, l and x, andsavings-investment, s k f (k domestic; f foreign), decisions to maximizequasi-linear utility, ω U(c 1 ) c 2 V(x), over leisure and consumption and inthe model’s two periods, c 1 and c 2 , subject to a time constraint, 1 e i l x,and budget constraints in each period, 1 e i c 1 k f c 1 s and c 2 (1 τ k )k (1 τ * k)f M(f ) (1 τ l )l.The equilibrium economic choices of citizens i in this model are as follows:s S( τ ) 1 U1 ( 1τ)k c k(3.1)f F( ττ , * ) M1( τ τ* )k k f k k(3.2)k K( ττ ,*) S( τ ) F( ττ ,*).k k k k k(3.3)With labor, L(τ l ), leisure, x, and consumption, c 1 , c 2 , implicitly given by theseconditions, this leaves individuals with indirect utility, W, defined over the policyvariables, tax rates, of:W( ττ l, k) U{ 1S( τk)} ( 1τk) S( τk) ( τ*k τk) F(τk, τ* k) MF { ( τk, τ*k)}( 1 ττ) L( ) V{ 1 L( τ )}.l l l(3.4)Facing an electorate with these preferences over taxes, using a Besley–Coate(1997) citizen-candidate model wherein running for office is costly and citizenschoose whether to enter the race by an expected-utility calculation, some citizen50