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Rethinking Tax Competition Based on Endogenous Equilibrium

Based on Dixit-Stiglitz framework of exogenous equilibrium, the basic tax competition model is developed introducing agglomeration forces. However, the short-run dynamic micro-foundation to reach such equilibrium has long been ignored in the new economic-geography tax competition literature. In this paper, we uncover the black box and explain the supply dynamics behind the market equilibrium. It is shown that the long-run market clearing condition can be endogenously realized due to individual firm's dynamic optimization behavior. Within this endogenous equilibrium context, we cast new insights on the relationship between trade integration and international tax competition assuming asymmetric factor distribution. Besides, the tax race is argued on the industry level concerning different market structures.