Competition for firms in an oligopolistic industry. Do firms or countries have to pay? CESifo Working Paper No

Economic integration has led to falling rates of corporate taxation, but tax competition has fallen short of delivering zero tax rates. Moreover, small and large countries seem to have followed different paths of policy adjustments. To understand these developments we set up a model of generalised oligopoly where two countries of different size compete for an exogenous, but variable, number of identical firms. The model combines a desire by national governments to attract internationally mobile firms with the existence of location rents that arise even in a symmetric equilibrium where firms are dispersed. As economic integration proceeds, equilibrium taxes initially decline, but then rise again as trade costs fall even further. A range of trade costs is identified where economic integration raises the welfare of the small country, but lowers welfare in the large country