How Much are the Poor Losing from Tax Competition: The Welfare Effects of Fiscal Dumping in Europe

This paper quantifies the welfare effects of tax competition in an union where individuals can respond to taxation through migration. I derive the optimal linear and non-linear tax and transfer schedules in a free mobility union composed by symmetric countries that can either compete or set a federal tax rate. I show how in the competition union, the mobility-responses to taxation affect the redistributive capacity of governments through several mechanisms. I then use empirical earnings’ distribution and estimated migration elasticities to implement numerical calibrations and simulations. I use my formulas to quantify the welfare gains and losses of being in a tax competition union instead of a federal union, and show how these welfare effects vary along the earnings distribution. I show that the bottom fifty percent always loses from tax competition, and that being in a competition union rather than in a federal union could decrease poorer individuals welfare up to -20 percent