Labor Taxes, Productivity and Tax Competition

Why are taxes higher in Europe than in the US? We propose that it stems from lesser competition across jurisdictions within Europe. We embed self-interested governments and tax competition into a standard neoclassical growth model with public goods. While greater jurisdictional competition reduces taxes it also reduces societal investment in public capital and thus often ends up reducing total factor productivity. We show that despite this deleterious e¤ect on the level of productive public capital, tax competition ends up raising per capita output and welfare. We show evidence to support both our baseline assumption of lesser mobility in Europe relative to the US as well as for our predictions on productivity di¤erences between the two.