Tax competition and club goods

We augment the traditional model of tax competition with spillovers in public good provision. In our model, identical countries compete for mobile capital. A subset of these countries can coordinate their taxes and provide a public good that generates international spillovers. This subset forms a club of high taxes. Adopting a utility function that is linear for the public good and a quadratic production function, we calculate the equilibrium tax rates and capital allocation. The partial tax equilibrium is analogous to size differences. We show that the utility of both club and non-club countries increases with the number of participating members. We also demonstrate that an increase in the degree of spillovers benefits all, including countries outside the club, even though outsiders do not directly benefit from the spillovers. We show that in a world with many tax competitors, spillovers can restore the stability of cooperation and compensate for incentives to exit the club to win the tax competition.