Taxation, public expenditure and agglomeration

Recently, issues of international taxation have also been analysed from a New Economic Geography perspective. These discussions show that adding agglomerative forces can change the results considerably. In our paper, we introduce a public sector into a Footloose Capital model: Capital income is taxed according to the residence principle and any tax revenue is spent for providing a public commodity. Thus, public policy changes the sectoral split of total expenditures, which is central for determining international factor rewards and thus for factor mobility. We modeled this factor mobility process - along the lines of a replicator dynamics - in discrete time and studied its local and global properties. We showed that multiple equilibria are possible, involving cyclical and chaotic attractors; and that the basins of attraction may exhibit a highly complex structure. In that environment, the long run outcome of the dynamics process may depended highly sensitive to initial conditions and/or parameters. Public policy trying to attract industrial capital to one country may trigger a dynamic process actually leading to agglomeration in the other country