Unilateral tax reform under the restricted origin principle

The paper analyzes the effects of general commodity taxation under the restricted origin principle when the union countries are small relative to the rest of the world and trade deflection can be controlled by tax authorities. A change in the tax rate of one union country leads to two fiscal externalities, an intra-union terms of trade effect and a change in national tax bases. While the direction of terms of trade effects depends on the specific trade pattern assumed the tax base effect is always negative for the country which raises the domestic tax rate. This suggests that a process of downward tax competition between union members can take place under the restricted origin principle.