Abstract

We examine a two-jurisdiction tax competition environment where local governments can only imperfectly monitor where agents pay taxes and risk-averse individuals may choose to cross borders to pay lower taxes in a neighboring location.

In a game between local authorities, we find that, when communities differ in size, in equilibrium the smaller community sets lower taxes and attracts agents from the larger jurisdiction. With identical communities, tax rates must be equal.

Finally, we examine the incentives of jurisdictions to harmonize tax rates and find that, whenever the smaller community benefits from tax harmonization, the larger jurisdiction will benefit also.