Tax competition and governmental efficiency: Theory and evidence ∗

The focus of this paper is on the tax competition between the governments, which are different in their efficiency- one of the gov-ernments is able to produce more public good out of the same amount of tax revenue. The main result of the paper is that in equilibrium the more efficient government sets higher income tax. Two assump-tions are needed for this result to hold: the profit function of a firm should be sufficiently concave in public good, and the governments should be sufficiently different in their efficiency. The empirical ev-idence from developed countries, which is analyzed in the paper, in general, supports the conclusions of the model