Mergers and tax competition

With increased mobility of labor and capital, Europe is currently struggling with tax competition that keeps taxes lower than is deemed healthy, in particular because of some small entities trying to poach on larger ones by attracting the larger tax payers. A response to this problem would be to merge fiscal authorities so as to reduce competition and thus get higher taxes and also allow a fairer distribution of the tax burden across jurisdictions. While this is not (yet) feasible at the European level (there is no talk of a European tax), there is plenty of evidence of within country mergers. What are they expected to bring?

Marie-Laure Breuillé and Skerdilajda Zanaj note that mergers have not only an impact on regional tax rates, but on local ones as well. Mergers are expected to a) reduce tax competition, b) increase tax bases and c) take into account tax externalities of cities. The impact on tax rates differs, however, by level: regional taxes increase, while local ones decrease. That seems like a trivial results, as mergers are suppose to reduce the influence of local jurisdictions. The tax changes are direct consequences of effects a) and b), but c) counteracts it, and an ambiguity may arise. But it turns out from the Nash equilibrium of the game the regions play, c) is always smaller than a) and b). The impact on welfare, though, is difficult to establish before first saying something about public goods and tax distortions. Indeed, some level of tax competition is not always bad.