Optimal International Tax Coordination and Economic Integration: A Game-Theoretic Framework

The scope for optimal international coordination of indirect taxes is examined in a macroeconomic game-theoretic framework which encompasses two regionally integrated economies, which have a single goods market. In each country there are tax-financed non-tradeable public goods, while labor is immobile internationally. The analysis of both fixed and flexible wage versions of the model identifies a much wider spectrum of cooperative tax policies than has been previously recognized. In relation to non-cooperative Nash equilibria, cooperative Pareto-improving tax changes can entail not only uni-directional increases or decreases in rates, but also asymmetric directional changes. In particular, the constellation of such welfare improving tax changes is shown to depend critically on the countries'' relative preferences for private and public goods consumption, savings, as well as demand elasticity values relative to unit elasticity.