Social insurance and the completion of the internal market

With the completion of the internal market in the EU pressures may arise to diminish social insurance budgets. In a two-country model with an (imperfectly) integrated consumer goods market it is shown that competitive member states use the social insurance tax rate as an instrument to tax consumers abroad which buy imported goods or to improve employment and competitiveness of home-based firms. As a result, there is tax competition. If the number of firms is fixed, social insurance levels will be inefficiently high. If there is free entry and exit social insurance levels could be inefficiently low. This could be prevented by coordination of social insurance policies. In addition, it is shown that reductions of trade barriers have a downward effect on the size of social insurance budgets in the long run.