Part 1 - AL-Tax

Chapter 4AbstractThis chapter provides a model of nonlinear income taxation in a context of internationalmobility. We consider two identical countries, in which each government chooses noncooperativelya redistributive taxation. If both governments are Rawlsian, the mobility ofunskilled workers has no influence on the income tax equilibrium. The mobility of skilledworkers reduces the redistribution of income: At optimum, by decreasing income tax, a governmentattracts skilled workers and thus increases its total tax revenue. If we consider moregeneral welfare functions, the mobility of unskilled workers matters. Finally, if the costs tomove are low, at equilibrium, labor supplies are not distorted.4.1 IntroductionConventional wisdom suggests that mobility across countries leads to a ‘race tothe bottom’: Generous countries will see their low-skilled population increase andat the same time their more skilled workers emigrate to escape high tax rates. Thiswill make redistribution and social programs more difficult as any economic integrationwould cause reductions in social programs, or less progressive tax schedules.In such a situation one would conclude that free migration constrains theshape of possible redistribution schemes for each government. This effect of internationalcompetition with a mobile factor has already been studied in the literature(for a more detailed survey, see Cremer et al., 1996; Wilson, 1999), especiallyfor capital income taxation. The primary objective of the current chapter is to providea model of income tax competition between two countries for the case ofmobile workers. Since most papers on income tax competition focus on linearincome taxes (e.g. Gordon, 1983; Wildasin, 1991, 1994), our work will considernonlinear income taxes.Optimal nonlinear taxation usually consists of transferring income from therich to the poor. In this context, Bertrand competition between governments leadsto an unsatisfactory equilibrium: Trying to attract skilled workers in order toincrease tax revenue, each government has an incentive to reduce the tax rate onhigh wages. If there is no restriction on mobility, the laissez-faire is the only outcomeof the competition game. Using Swiss data, Kirchgässner and Pommerehne(1996) showed that fiscal competition has an empirical impact. Their resultsstrongly suggest that high income earners choose their place of residence dependingon the amount of income tax they have to pay. But they have also shown thateven if fiscal competition matters, there is no ‘race to the bottom’ – neighboringregions exhibit very different taxation policies. In the remainder of this chapter,we will consider different restrictions on mobility and their consequences on the75