Income distribution and tax competition

Abstract

The literature on international tax competition has shown how increased international mobility of the tax base may create a downward pressure on tax rates and give rise to increased inequality in disposable income. This paper endogenises the mobility of the tax base, explaining mobility as a function of the pre-tax income distribution. We show that increased pre-tax income inequality may reduce the ability of governments to carry out redistributive policies. Moreover, increased inequality in one country may also negatively affect the ability of other countries to carry out such policies. The mechanisms suggested here provide one explanation of the empirical observation that countries with an egalitarian pre-tax income structure typically have a more redistributive tax system than more inegalitarian countries.