Unemployment and Endogenous Choice on Tax Instruments in a Tax Competition Model: Unit Tax versus Ad Valorem Tax

This paper examines the endogenous choice of the government’s tax instrument between the unit and ad valorem taxes under tax competition with unemployment. Governments seek to maximize their objective functions that are the weighted sum of employment and revenue levels. Considering the tax competition model, a high fixed wage rate generates not only unemployment but also employment externalities. This effect can be either positive or negative because of the presence of capital freely mobile among regions. Without unemployment, the revenue-maximizing governments choose unit tax as their tax instruments to avoid revenue loss from intense tax competition under ad valorem taxes. However, with unemployment, positive employment externalities generate additional benefits to use ad valorem taxes for stimulating employment. Therefore, the present study shows that one region chooses an ad valorem tax and the other selects a unit tax, or both governments use ad valorem taxes depending on employment externalities.
Japanese translation: http://hdl.handle.net/2237/0002003769