DISTRIBUTION OF FACTOR ENDOWMENTS AND TAX COMPETITION

This paper analyzes a Nash tax competition between two heterogeneous regions that differ in their endowments of production factors: mobile capital and immobile labor. Each region uses a unit tax on capital to finance local public service. The effects of the differences in the factor endowments on the equilibrium tax rates, relative utility levels, and the efficiency of the public service provision are analyzed. When the income effect on the public service is zero, the poor large region chooses a higher tax rate and has a lower utility than its rival, but the poor small region may choose a lower tax rate and attain a higher utility. When the public service is a normal good, the poor large region may choose a lower tax rate and has a higher utility than the rival if its share of labor endowment is not very high. The rich region with a higher tax rate under-provides the public service, but the poor region may provide an efficient level of the public service.