The role of relocation mobility in tax and subsidy competition

Abstract

In this paper, we analyse the role of relocation mobility in tax and subsidy competition. Our primary result is that increasing mobility of firms leads to increasing ‘net’ tax revenues under plausible assumptions. While enhanced relocation mobility intensifies tax competition, it weakens subsidy competition. The resulting fall in government subsidy payments can overcompensate the decline in tax revenues, leading to a rise in net tax revenues. Interestingly, the opportunity costs of subsidy competition can rise along with net tax revenues. We derive these conclusions in a model in which two governments are first engaged in subsidy competition and thereafter in tax competition, and firms locate and potentially relocate in response to successive policy choices on taxes and subsidies.