Three Essays on Fiscal Competition and Public Policy

This dissertation consists of three essays examining issues related to fiscal competition. The first essay investigates the Stackelberg equilibrium for public input competition and compares it with the non-cooperative Nash equilibrium. Given two asymmetric regions, I show that under the Nash equilibrium, the more productive region tends to spend more on public input, which results in this region attracting more capital than the less productive region. The comparison of the two equilibria reveals that the leader region obtains a first mover advantage under the Stackelberg setting. This suggests that if regions interact with each other sequentially as in the Stackelberg equilibrium, then the regional disparity that is due to the heterogeneity of productivity is likely to be mitigated or enlarged, depending on which region performs the leadership role in the competition process. This second essay examines how a fiscal equalization system affects the disciplining effect of competition for capital among heterogeneous regions in a decentralized economy. I build a model in which regions that are heterogeneous in initial endowments try to attract capital by competing public input that enhances the productivity of capital; meanwhile, a fiscal equalization system is imposed by the central government to reduce regional disparities in fiscal capacity. The key prediction, borne out in data from the German equalization system, is that while competition for capital strengthens discipline in the well-endowed regions, it weakens discipline in the poorly endowed regions. However, a conventional equalization transfer scheme, common to many countries, can be effective in correcting the distortion driven by the heterogeneity of initial endowments across competing regions. This third essay aims to provide empirical evidence on the extent and possible channels of tax competition among provincial governments in China. Using a panel of provincial level data for 1993-2007, I find strong evidence of strategic tax interaction among provincial governments. Tax policy is approximated by average effective tax rates on foreign investment, taking into account the tax incentives available to foreign investors. In line with the predictions of the theoretical tax competition literature, I also highlight the impact of each province\u27s characteristics (including its size and level of industrialization) on the strategic interaction with its neighbors. Finally, I explicitly identify the establishment of development zones as an important conduit for tax competition among provinces