Economic competition among jurisdictions: efficiency enhancing or distortion inducing?

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Abstract

This paper explores the normative implications of competition among ‘local’ jurisdictions to attract new industry and income. Within a neoclassical framework, we examine how local officials set two policy variables, a tax (or subsidy) rate on mobile capital and a standard for local environmental quality, to induce more capital to enter the jurisdiction in order to raise wages. The analysis suggests that, for jurisdictions homogeneous in workers, local choices under simple-majority rule will be socially optimal; such jurisdictions select a zero tax rate on capital and set a standard for local environmental quality such that marginal willingness-to-pay equals the marginal social costs of a cleaner environment. However, in cases where jurisdictions are not homogeneous or where, for various reasons, they set a positive tax rate on capital, distortions arise not only in local fiscal decisions, but also in local environmental choices.

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Oates is also a member of the Bureau of Business and Economic Research, University of Maryland. Both authors were visiting scholars at Resources for the Future while much of this research was done. We are grateful to the National Science Foundation, the Sloan Foundation, and Resources for the Future for their support of this research. For helpful comments on an earlier draft, we thank William Baumol, Paul Courant, William Fischel, Marvin Frankel, Edward Gramlich, Bruce Hamilton, Robert Lee, Michael Luger, Therese McGuire, Peter Mieszkowski, Peter Murrell, Arvind Panigariya, Paul Portney, John Quigley, Daniel Rubinfeld, John Wilson, George Zodrow, the participants in the Sloan Workshop in Urban Public Economics at the University of Maryland and two anonymous referees.

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