Lobbying and Tax Competition in an Oligopolistic Industry: A Reverse Home Market Effect
JEL Classification codes : F15, F22, H20
This paper studies tax competition between two asymmetric countries for an oligopolistic industry with many firms. Each government sets its tax rate strategically to maximize the weighted sum of residents’ welfare and political contributions by owners of firms. It is shown that, if the governments care deeply about contributions and trade costs are low, the small country attracts a more than proportionate share of firms by setting a lower tax rate. The well-known home market effect, which states that countries with a larger market attract a more than proportionate share of firms, may be reversed as a result of tax competition by politically-interested governments.