TAX COMPETITION IN IMPERFECTLY COMPETITIVE MARKETS

The literature on strategic trade policy has shown that in imperfectly competitive markets governments have an incentive to subsidize export s of their own firms. Yet the consequence of the departure from laisse z-faire is a wasteful subsidy race. In contrast, this paper shows that even in imperfectly competitive markets there is a strong tendency fo r laissez-faire to prevail. The driving force is the firms' willingnes s to exploit tax or subsidy differentials by relocating production. A small tax differential induces firms to change their place of producti on. The change in market structure has a negligible effect on the olig opoly equilibrium, but a non-negligible impact on government revenues. When tax policy is non-discriminatory, governments gain (lose) by att racting all firms when production is taxed (subsidized). Hence, laisse z-faire is the only equilibrium. Since, from the point of view of the two producing countries, laissez-faire (nondiscrimination) Pareto domi nates the intervention equilibrium (discrimination), nondiscrimination is a simple device to result in a mutual beneficial outcome. (C) 1998 Elsevier Science B.V.