Games within borders: are geographically differentiated taxes optimal?
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The discontinuous tax treatment of sales at borders creates incentives for individuals to cross-border shop. This paper addresses whether it is optimal for a state composed of multiple regions to levy differentiated commodity tax rates across the regions. In a model where states maximize social welfare, a state’s optimal commodity tax system is almost always geographically differentiated. The optimal pattern of geographic differentiation critically depends on fundamental parameters as well as whether the state has a preference for high or low taxes. Under the assumption that utility is linear in consumption and that the elasticity of cross-border shopping is less than unity in absolute value, high-tax states will find it optimal to set a tax rate that is lower in the border region than in the periphery region and low-tax states will find it optimal to set a tax rate that is higher in the border region than in the periphery region. Optimizing high-tax states will set a higher tax rate in the border region if the social welfare measure is sufficiently redistributive. With welfare maximization, it is possible for taxes to be higher in the region near the state border—an outcome that cannot arise when the government cares only about total tax revenue.
KeywordsCommodity taxation Cross-border shopping Tax competition Preferential tax rates
JEL ClassificationH21 H25 H73 H77 R12
I am especially grateful to my dissertation committee chair Joel Slemrod along with the members of my committee—David Albouy, Robert Franzese and James Hines. I also wish to thank Paul Courant, Lucas Davis, Charles de Bartolomé, Dhammika Dharmapala, Reid Dorsey-Palmateer, Marcel Gérard (discussant), Michael Gideon, Makoto Hasegawa, Ravi Kanbur, Sebastian Kessing, Michael Lovenheim (discussant), Byron Lutz (discussant), Søren Bo Nielsen, Ben Niu, Stephen Salant, Nathan Seegert, Jeff Smith, Caroline Weber, and David Wildasin for helpful suggestions and discussions. Suggestions from conference participants at the 2011 International Institute of Public Finance Annual Congress, the 2011 Association of Public Economic Theory Conference and the Michigan Tax Invitational contributed to the paper. Two anonymous referees and the editor, Ruud de Mooij, improved the paper. Any remaining errors are my own.
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