Strategic Responses to International Tax Competition: Fiscal (De) Centralization versus Partial Tax Harmonization

Abstract

This paper analyzes a country’s optimal fiscal strategy among centralization, decentralization, and partial tax harmonization. Countries are asymmetric in productivity levels and characterized by multi-level government such that there is both horizontal and vertical tax competition. The main result from the analysis is that partial tax harmonization is more difficult to achieve in fiscally decentralized economies with high levels of productivity and low labor taxation. This result is confirmed by recent data from the OECD and explains the observed difficulties in achieving capital tax harmonization in the European Union. JEL Classification Numbers: F15, F38, H20, H87 Key Words: Centralization; Decentralization; Fiscal Competition; Partial Tax Harmonization.