Border zones with reduced commodity taxes

Economics

Speaker:Søren Bo Nielsen, Copenhagen Business School
Date: Friday 2 December 2011
Time: 16.15
Location: STC/D

Further details

This paper investigates whether a high-commodity-tax country can benefit from reducing its commodity tax in a zone at the border with a low-commodity-tax neighbor. We find in a simple model with a given foreign tax that this will be the case, and solve for optimal tax rates as well as the optimal width of the border zone.

In addition, we contemplate strategic interaction between countries when such border zones with reduced rates are possible. It turns out that there is no Nash equilibrium (in pure strategies), whereas there is a Stackelberg equilibrium with the foreign country as the leader. From this we conclude that if the foreign country can anticipate the home country's implementation of the border zone, commodity tax competition will intensify and both countries will lose revenue.

We also explore the consequences of a border zone with welfare rather than tax revenue maximization and find qualitatively similar results. Finally, we address the technical complications associated with deriving the Stackelberg border zone tax equilibrium with the home country as the leader.