Competitive Nonlinear Income Taxation Revisited∗

In the current literature on competitive nonlinear income taxation, competition is usually modeled as a game in which different tax authorities compete in tax schedules. An undesirable feature of this traditional approach is that the resource constraint is required only on the equilibrium path: following a deviation by one state, the resource constraints in other competing states are typically unbalanced. We propose a new approach in which the tax authorities compete in marginal tax rates, with the poll subsidies adjusting to satisfy budget balance. We show that our new approach in general leads to an equilibrium outcome different from the traditional approach. In cases where high-income workers are at least as mobile as low-income workers, the new approach leads to increased competition, reducing the amount of income redistribution from high-income to low-income workers.