Globalization, Asymmetric Tax Competition, and Fiscal Equalization

Trade integration and the increasing mobility of firms have raised the need for international coordination in corporate tax. In this paper, we study the ability of fiscal equalization to avoid the misallocation of capital across asymmetric countries arising from tax competition. Such a reform respects the principle according to which the tax decision is entirely left up to the nation and links nations engaged in strategic tax policy by transfers. We use a model of trade and location where firms produce under imperfect competition. Our analysis suggests that falling trade costs increase the distortion created by tax competition in the international allocation of production. However, we show that fiscal equalization based on differences in tax revenues or tax base can implement a more efficient tax wedge and spatial allocation of the tax base