Skip to main content
SpringerLink
Log in

Unemployment and endogenous choice on tax instruments in a tax competition model: unit tax versus ad valorem tax

International Tax and Public Finance Aims and scope Submit manuscript

Cite this article

Abstract

This paper examines the endogenous choice of unit and ad valorem taxes in a model of tax competition with unemployment. Governments maximize objective functions that are a weighted sum of regional welfare and revenue. In the tax competition model, a high fixed wage rate generates unemployment and employment externalities. This effect can be either positive or negative because of freely mobile capital among regions. Without unemployment, revenue-maximizing governments choose unit taxes as their tax instrument to avoid revenue losses from intense tax competition under ad valorem taxes. However, with unemployment, positive employment externalities generate additional benefits for using ad valorem taxes to stimulate employment. Therefore, the present study shows that one region chooses an ad valorem tax, whereas the other chooses a unit tax, or that both governments use ad valorem taxes depending on employment externalities.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1

Data availability

The data used for the numerical analysis of this study are available from the corresponding author upon request.

Notes

  1. For a general overview of the broad tax competition literature, see Zodrow (2010), Keen and Konrad (2013), and Agrawal et al. (2022).

  2. Morita et al. (2020) focused on imperfect labor markets in the context of subsidy competition.

  3. See Sato (2009) and Lee (2021) for the matching and search frictions model, and Eichner and Upmann (2012) and Exbrayat et al. (2012) for the labor union model.

  4. Several studies have found empirical evidence supporting the effect of taxes on employment (e.g., Feld and Kirchgassner, 2003; Harden and Hoyt, 2003; Bettendorf et al., 2009; Felix, 2009; Feldmann, 2011; Zirgulis and Šarapovas, 2017). Almost all related studies discovered a negative relationship between employment and tax rates, implying positive employment externalities. By contrast, Feldmann (2011) showed empirical evidence that higher corporate taxes might lower the unemployment rate, resulting in a negative employment externality. Section 4 discusses the possibility of negative employment externalities.

  5. Several recent studies have examined the nature of tax competition equilibrium with unemployment assuming a fixed wages (e.g., Gillet and Pauser, 2018; Kikuchi and Tamai, 2019; Tamai and Myles, 2022).

  6. Agrawal and Trandel (2019), which studied the dynamics of policy diffusion, derived the conditions for asymmetric policies.

  7. Focusing on tariff war, Lockwood and Wong (2000) showed that the country switching from a specific tariff to an ad valorem tax has an incentive to lower its tariff.

  8. Previous studies made several assumptions about labor market imperfections. For example, Yellen’s (1984) efficiency wage model is the simplest way to justify our model.

  9. This specified production function is a generalized version of that used in the earlier studies by Wildasin (1991), Brueckner (2004), and Akai et al. (2011). To ensure well-behaved factor demand functions, we impose \({A}_{i}{B}_{i}>{\gamma }_{i}^{2}\) (i.e., \({f}_{KK}^{i}{f}_{LL}^{i}-{\left({f}_{KL}^{i}\right)}^{2}={A}_{i}{B}_{i}-{\gamma }_{i}^{2}>0\)).

  10. We provide a discussion about the government’s objective function in Sect. 4.

  11. bK > σ requires that the employment externality be sufficiently small to ensure positive values of Gi. This condition and Assumption 1 lead to a > σ

  12. See Appendix C. For instance, Eq. (C1) is positive if Assumption 3 holds.

  13. According to Frey and Osborne (2017), approximately 47% of the total US employment is in the high-risk category, meaning that jobs could be automated relatively soon.

References

  • Agrawal, D. R., Hoyt, W. H., & Wilson, J. D. (2022). Local policy choice: Theory and empirics. Journal of Economic Literature, 60(4), 1378–1455.

    Article  Google Scholar 

  • Agrawal, D. R., & Trandel, G. A. (2019). Dynamics of policy adoption with state dependence. Regional Science and Urban Economics, 79, 103471.

    Article  Google Scholar 

  • Aiura, H., & Ogawa, H. (2013). Unit tax versus ad valorem tax: A tax competition model with cross-border shopping. Journal of Public Economics, 105, 30–38.

    Article  Google Scholar 

  • Aiura, H., & Ogawa, H. (2019). Indirect taxes in a cross-border shopping model: A monopolistic competition approach. Journal of Economics, 128, 147–175.

    Article  Google Scholar 

  • Akai, N., Ogawa, H., & Ogawa, Y. (2011). Endogenous choice on tax instruments in a tax competition model: Unit tax versus ad valorem tax. International Tax and Public Finance, 18(5), 495–506.

    Article  Google Scholar 

  • Autor, D. H., Levy, F., & Murnane, R. J. (2003). The skill content of recent technological change: An empirical exploration. Quarterly Journal of Economics, 118(4), 1279–1333.

    Article  Google Scholar 

  • Bettendorf, L., Horst, A. V. D., & De Mooij, R. A. (2009). Corporate tax policy and unemployment in Europe: An applied general equilibrium analysis. World Economy, 32(9), 1319–1347.

    Article  Google Scholar 

  • Edwards, J., & Keen, M. (1996). Tax competition and Leviathan. European Economic Review, 40(1), 113–134.

    Article  Google Scholar 

  • Eichner, T., & Upmann, T. (2012). Labor markets and capital tax competition. International Tax and Public Finance, 19(2), 203–215.

    Article  Google Scholar 

  • Exbrayat, N., Gaigné, C., & Riou, S. (2012). The effects of labour unions on international capital tax competition. Canadian Journal of Economics, 45(4), 1480–1503.

    Article  Google Scholar 

  • Feld, L., & Kirchgassner, G. (2003). The impact of corporate and personal income taxes on the location of firms and on employment: Some panel evidence for the Swiss cantons. Journal of Public Economics, 87(1), 129–155.

    Article  Google Scholar 

  • Feldmann, H. (2011). The unemployment puzzle of corporate taxation. Public Finance Review, 39(6), 743–769.

    Article  Google Scholar 

  • Felix, R. A. (2009). Do state corporate income taxes reduce wages?, Economic Review federal reserve bank of Kansas. City, 94(2), 77–102.

    Google Scholar 

  • Frey, C.B. and M.A. Osborne (2017), The future of employment: how susceptible are jobs to computerisation?, Technological Forecasting and Social Change, 114 (C), 254–280.

  • Gillet, H., & Pauser, J. (2018). Public input provision in asymmetric regions with labor market imperfections. German Economic Review, 19(4), 466–492.

    Article  Google Scholar 

  • Hoffmann, M., & Runkel, M. (2016). A welfare comparison of ad valorem and unit tax regimes. International Tax and Public Finance, 23(1), 140–157.

    Article  Google Scholar 

  • Kawachi, K., Ogawa, H., & Susa, T. (2019). Endogenizing governments objectives in tax competition with capital ownership. International Tax and Public Finance, 26(3), 571–594.

    Article  Google Scholar 

  • Keen, M., & Konrad, K. A. (2013). The theory of international tax competition and coordination. In A. J. Auerbach, R. Chetty, M. Feldstein, & E. Saez (Eds.), Handbook of Public Economics, 5 (pp. 257–328). Amsterdam.

    Chapter  Google Scholar 

  • Kempf, H., & Rota-Graziosi, G. (2010). Endogenizing leadership in tax competition. Journal of Public Economics, 94(9–10), 768–776.

    Article  Google Scholar 

  • Kikuchi, Y., & Tamai, T. (2019). Tax competition unemployment and intergovernmental transfers. International Tax and Public Finance, 26(4), 899–918.

    Article  Google Scholar 

  • Lee, K. (2021). Labor market frictions capital taxes and employment. International Tax and Public Finance, 28(6), 1329–1359.

    Article  Google Scholar 

  • Lockwood, B. (2004), Competition in unit vs. ad valorem taxes, International Tax and Public Finance, 11 (6), 763–772.

  • Lockwood, B., & Wong, K. (2000). Specific and ad valorem tariffs are not equivalent in trade wars. Journal of International Economics, 52(1), 183–195.

    Article  Google Scholar 

  • Morita, T., Sawada, Y., & Yamamoto, K. (2020). Subsidy competition and imperfect labor markets. Journal of Public Economic Theory, 22(3), 698–728.

    Article  Google Scholar 

  • Ogawa, H. (2013). Further analysis on leadership in tax competition: The role of capital ownership. International Tax and Public Finance, 20(3), 474–484.

    Article  Google Scholar 

  • Ogawa, H. (2016). When ad valorem tax prevails in international tax competition. International Review of Economics and Finance, 46, 1–9.

    Article  Google Scholar 

  • Ogawa, H., Sato, Y., & Tamai, T. (2006). A note on unemployment and capital tax competition. Journal of Urban Economics, 60(2), 350–356.

    Article  Google Scholar 

  • Pal, R., & Sharma, A. (2013). Endogenizing government’s objectives in tax competition. Regional Science and Urban Economics, 43(4), 570–578.

    Article  Google Scholar 

  • Sato, Y. (2009). Capital tax competition and search unemployment. Papers in Regional Science, 88(4), 749–764.

    Article  Google Scholar 

  • Tamai, T., & Myles, G. (2022). Unemployment tax competition and tax transfer policy. Journal of Public Economic Theory, 24(3), 407–503.

    Article  Google Scholar 

  • Wildasin, D. E. (1989). Interjurisdictional capital mobility: Fiscal externality and a corrective subsidy. Journal of Urban Economics, 25(2), 193–212.

    Article  Google Scholar 

  • Wildasin, D. E. (1991). Some rudimetary duopolity theory. Regional Science and Urban Economics, 21(3), 393–421.

    Article  Google Scholar 

  • Wilson, J. D. (1986). A theory of inter-regional tax competition. Journal of Urban Economics, 19(3), 296–315.

    Article  Google Scholar 

  • Wrede, M. (1998). Household mobility end the moderate Leviathan: Efficiency end decentralization. Regional Science and Urban Economics, 28(3), 315–328.

    Article  Google Scholar 

  • Yellen, J. L. (1984). Efficiency wage models of unemployment. American Economic Review, 74(2), 200–205.

    Google Scholar 

  • Zirgulis, A., & Šarapovas, T. (2017). Impact of corporate taxation on unemployment. Journal of Business Economics and Management, 18(3), 412–426.

    Article  Google Scholar 

  • Zodrow, G. R. (2010). Capital mobility and capital tax competition. National Tax Journal, 63(4), 865–902.

    Article  Google Scholar 

  • Zodrow, G. R., & Mieszkowski, P. (1986). Pigou Tiebout property taxation and the underprovision of local public goods. Journal of Urban Economics, 19(3), 356–370.

    Article  Google Scholar 

Download references

Acknowledgements

The authors would like to thank Nobuo Akai, Mutsumi Matsumoto, Tadashi Morita, and the participants of 2022 Spring Meeting of Japan Association for Applied Economics and Nagoya International Economics Study Group Workshop at Hokkaido University and Tuesday Workshop at Nagoya City University for their constructive comments. We also thank the editor, David Agrawal, and two anonymous reviewers for their helpful comments and valuable suggestions.

Funding

This work was supported by JSPS KAKENHI (Grant Numbers: 20H01492; 22H00841; 22K20174).

Author information

Authors and Affiliations

  1. College of Business Administration and Information Science, Chubu University, Matsumoto-Cho 1200, Kasugai, Aichi, 487-8501, Japan

    Yuya Kikuchi

  2. Graduate School of Economics, Nagoya University, Furo-Cho, Chikusa-Ku, Nagoya, Aichi, 464-8601, Japan

    Toshiki Tamai

Authors
  1. Yuya Kikuchi
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Toshiki Tamai
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Toshiki Tamai.

Ethics declarations

Conflicts of interest

No conflict of interest to disclose. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of the authors’ institutions and funders.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Supplementary Information

Below is the link to the electronic supplementary material.

Supplementary file1 (DOCX 58 kb)

Rights and permissions

Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.

Reprints and Permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Kikuchi, Y., Tamai, T. Unemployment and endogenous choice on tax instruments in a tax competition model: unit tax versus ad valorem tax. Int Tax Public Finance (2023). https://doi.org/10.1007/s10797-023-09785-x

Download citation

  • Accepted:

  • Published:

  • DOI: https://doi.org/10.1007/s10797-023-09785-x

Keywords

JEL classification

search

Navigation