Double Bertrand tax competition: a fiscal game with governments acting as middlemen

In a common market with costless mobility of all factors regional governmen ts can attract mobile firms by granting subsidies which they must finance o ut of wage taxes on mobile labour. Firms locate where subsidies are highest and workers settle where taxes are lowest, forcing government 'in the spli ts' (double Bertrand-type tax competition). Initially, there is unemploymen t in the economy. Regional governments then behave Like middlemen in the la bour market, and the fiscal game takes the form of competition among strate gic intermediaries. Results from the theory of intermediation are applied t o this framework. It is shown that government size may increase rather than decline in a fiscal competition, that industrial clustering may emerge fro m tax competition, and that tax competition may alleviate the unemployment problem. (C) 2001 Elsevier Science B.V. All rights reserved.