Staff Report 348

Comment on Mendoza and Tesar’s “Why Hasn’t Tax Competition Triggered a Race to the Bottom? Some Quantitative Lessons from the EU”

Ellen R. McGrattan | Consultant

Published October 1, 2004

With a monetary union in place, many European countries are now debating if and how to coordinate their tax policies. Of particular interest to EU ministers is taxation of mobile factors like capital. Mendoza and Tesar (MT) use a game-theoretic approach to address the question, What is the outcome of tax competition and tax coordination when countries choose the tax on capital income and adjust other tax rates to keep revenues constant? MT predict very large welfare gains (losses) to tax competition for European countries that had high (low) tax rates prior to financial integration. In particular they predict a large gain for the United Kingdom and a large loss for countries in continental Europe. A second finding is that the welfare gains of tax coordination relative to that of tax competition are small. I discuss these findings in light of current policy debates and possible future extensions of this work.

Published In: Journal of Monetary Economics (Vol. 52, No. 1, January 2005, pp. 205-211)

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