Fiscal Competition, Unemployment, and the Provision of Productive Infrastructure

Abstract

This paper examines efficiency in the provision and utilisation of productive infrastructure in an international tax competition setting with employment and congestion externalities. In a framework where infrastructure quality and infrastructure utilisation enhance production, the approach derives the conditions for constrainedand first-best efficiency in environments with and without unemployment from rigid wages. For a basic tax competition setting with head and source-based capital taxes, the level of the equilibrium capital tax rates and of the infrastructure provision and utilisation levels are ambiguous and depend on the magnitude of both externalities. If the governments’ toolkit of fiscal instruments is enriched with a user charge for firms both the employment of capital and the utilisation of infrastructure may be subsidised in the non-cooperative equilibrium. In such a policy framework, the noncooperative equilibrium can be shown to be constrained efficient as user charges alleviate the inefficiency arising from congestion, and are used to manipulate infrastructure utilisation appropriately to stimulate employment.