Factor mobility and fiscal policy in the EU: policy issues and analytical approaches

increased integration of labour and capital markets creates significant cha llenges for the welfare states of modern Europe. laxation of capital and la bour that finances extensive Programmes of cash and in-kind redistribution creates incentives for capital owners and workers to locate in regions wher e they obtain favourable fiscal treatment. Competition among countries for mobile resources constrains their ability to alter the distribution of inco me and may lead to reductions in the size and scope of redistributive polic ies. Mobility of labour and capital is imperfect, however Recent trends ind icate that labour and capital are neither perfectly mobile nor perfectly im mobile, but rather adjust gradually to market conditions and economic polic ies. This paper presents an explicitly dynamic analysis showing that govern ments can achieve some redistribution when it is costly for factors of prod uction to relocate. As the costs of factor mobility fall, however, the effe ctiveness of redistributive policies ir more limited, and governments have weaker incentives to pursue them. Liberalized immigration policies, EU enla rgement, and other steps that promote integration of the factors markets of Western Europe with those of surrounding regions thus present a challenge to policy-makers if they also wish to maintain fiscal systems with extensiv e redistribution.