The dark side of tax breaks for foreigners
Alain Trannoy  1@  , Laurent Simula  2@  
1 : Aix-Marseille School of Economics  (AMSE)  -  Website
Ecole des Hautes Etudes en Sciences Sociales (EHESS), Centre national de la recherche scientifique (CNRS)
GREQAM, Centre de la Charité, 2 rue de la Charité, 13236 Marseille Cedex 02 -  France
2 : Grenoble Alpes University  (UGA)
Université Grenoble Alpes

Following Mirrlees (1982), the literature has focused on tax competition between Nation States, considering that, in a given country, all tax residents face the same income tax schedule (see, e.g., Blumkin, Sadka, Shem-Tov, 2014; Simula and Trannoy, 2010 and 2012; as well as Lehmann, Simula and Trannoy, 2015). We in contrast allow for the possibility of tax differentiation based on citizenship, in each country, and investigate the impact on well-being from a national as well as from an international perspective. Can it be optimal to rely on such a tax differentiation? Or should it be avoided? To investigate this issue, we use a world consisting of two (non-necessarily symmetric) countries. Individuals differ with respect to three dimensions of heterogeneity: native country, skill and cost of migration. The distribution of types is common knowledge. However, the skill and migration cost of a given individual are private information. In each country, a benevolent policymaker aims at redistributing incomes from the rich to the poor people. Following Mirrlees (1971), the government is unable to observe the skill nor the cost of migration of a given individual. In addition, the latter can only levy taxes on residents. However, contrary to Lehmann, Simula and Trannoy (2014) and the previous literature, it is not constrained to treat natives and foreigners in the same way. Some form of “tagging” (Akerlof, 1978), based on citizenship, is thus allowed. This radically changes the problem each government faces. Indeed, given these circumstances, each policymaker designs two income tax schedules, one for the native residents and one for the resident expatriates. We first characterize the tax schedules of each country in a Nash equilibrium, assuming that skills (but not migration costs) can be observed. This intermediary situation, referred to as the “Tiebout best” in Lehmann, Simula and Trannoy (2014), will give us insights into the second best, in which skills as well as migration costs are private information. We then turn to the characterization of the second best. We contrast the equilibrium schedules and profiles of well-being with those obtained when each country is not allowed to implement tax breaks for foreigners. Numerical illustrations, calibrated using US and Danish data, are then provided, to quantify the reduction in social welfare resulting from the introduction of tax breaks for foreigners.


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