Fiscal Competition, Unemployment, and the Provision of Productive Infrastructure

This paper examines efficiency in an international tax competition setting with governmental provision of productive infrastructure subject to congestion and with unemployment due to wage rigidities in the competing jurisdictions. In the non-cooperative equilibrium with head and source-based capital taxes, the level of the capital tax rate and both the provision and utilisation levels of the infrastructure facility remain ambiguous due to countervailing externalities from employment and congestion. If the governments' toolkit of instruments is enriched with a user fee for firms, the non-cooperative equilibrium will be second-best efficient as user fees alleviate the inefficiency arising from congestion and are used to manipulate infrastructure utilisation appropriately to stimulate employment. However, also in an extension of the framework with an absence of head taxes, the decentralised equilibrium cannot be expected to be efficient.