TAX COMPETITION WITH 2 TAX INSTRUMENTS

Models of tax competition among local or regional governments typically assume that only a source-based tax on capital income is available. This paper presents a model where a wage tax is also available and shows that small regions choose not to tax capital income, given that it can only be taxed on a source basis. However, the model also yields the conclusion from previous tax competition models that local public goods are underprovided. In contrast, government use of the available tax instruments is efficient when both source- and residence-based capital taxes are available, even in the absence of wage taxation.