“How Much are the Poor Losing from Tax Competition?”

How much are European citizens losing from tax competition? Would they be better-off if European countries were able to have a common fiscal tool? In this paper, Mathilde Muñoz examines the welfare effects of tax competition in a free mobility union composed by perfectly symmetric countries where individuals can respond to taxation through migration. When countries of a free mobility union set their tax rates separately (tax competition), the optimal level of taxes and transfers is lowered because individuals can change their residence in response to taxes. By contrast, if countries are constrained to set a uniform tax rate at the union level (federal union), individuals’ location decisions are no longer affected by taxes, leading to more redistribution at the optimum. The difference in the level of taxes and transfers between the competition and the federal union depends of how responsive migration responses are to taxes.

Figure : Distribution of Welfare Gains and Losses from Tax Competition 

How to read it: In the absence of uniform federal taxation, the bottom twenty percent loses up to 20 percent of its welfare. The top ten percent gains between 15 and 20 percent of welfare because of lower tax rates in tax competition.