Using Taxes to Attract the Creative Class in the Presence of a Region-Specific Rent

We analyze interregional competition between two regions A and B that use taxes to attract a representative creative class member (the entrepreneur). This entrepreneur establishes a firm in either region A or B, which guarantees her profit. However, if the entrepreneur locates in region A, she also obtains a stochastic, location-specific rent that is either high with positive probability or low with positive complementary probability. In this setting, we accomplish three tasks. First, given the values of the two tax rates, we determine the payoff to the entrepreneur in the two regions for the two possible values of the location-specific rent in A. Second, we ascertain when the entrepreneur will locate in A for both the rent values and when she will locate in B. Finally, we compute the tax rate that B will set and then specify a condition which ensures that the entrepreneur locates in B.