Department of Economics and Business Economics

Globalization, tax distortions and public sector retrenchment

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  • Wp10 09

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  • School of Economics and Management
It is widely perceived that globalization is a threat to tax financed public sector activities. The argument
is that public activities (public consumption and transfers) financed by income taxes distort labour markets
and cause higher wages and thus a loss of competitiveness. Since this link is strengthened by globalization,
it is inferred that the marginal costs of public funds increase and a retrenchment of the public sector follows.
We challenge whether these conclusions have support in a general equilibrium model featuring standard effects
from open macroeconomics and trade theory. Even though income taxation unambiguously worsens wage
competitiveness, it does not follow that marginal costs of public funds increase with product market integration
due to gains from trade. Moreover, non-cooperative fiscal policies do not have a race-to-the-bottom bias despite
that taxes harm competitiveness. In fact we identify an expansionary bias in …scal policies that is likely to
increase with globalization when taxes finance either public consumption or transfers.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages35
Publication statusPublished - 2010

    Research areas

  • labour taxation, open economy, policy spill-over, marginal costs of public funds

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