The literature on political endogeneity of policies shows how policies change when interest groups and political responses are taken into account (Hillman 1989;
Grossman and Helpman, 2002). I have shown how political endogeneity of policies changes the conclusions regarding integration of capital markets. My results are consistent with the empirical evidence that CMI may raise or lower capital taxes. I have shown how the extent of the tax competition among countries affects the political influence of capitalists, which can reverse conventional results. If tax competition is intense, then the political pressure from the capitalists to reduce the tax rate will only be slight, or they may even seek to increase the tax rate because most of the tax burden is shifted to the workers. As a result, capitalists' lobbying mitigates the underprovision of the public good, and may enhance efficiency. A related result is that the level of the public goods increases with the number of countries, which is different from the finding in Hoyt (1991). My conclusions can be caste in terms of a comparison between centralized and decentralized government.25
I have highlighted the effect of the extent of tax competition on lobbies’
incentives. Although more intense tax competition is characterized by a smaller market share of each competing country in this paper, I believe that my conclusions can be sustained in other situations resulting in more intense tax competition between countries, such as a reduction in capital mobility costs.
25 I have not discussed the effect of capital mobility on the amount of political contributions. Since this problem is somewhat complicated, I consider the simplest case in which only the capitalists lobby.
Following Grossman and Helpman (1994), we obtain that the capitalists' political contribution is proportionate to the distortion that the equilibrium tax rate imposes on the economy. Specifically, the capitalists' contribution is given bym=(1/θ)[W(t*j)−W(tˆj)], j∈{c,o}, wherej=c refers to the closed economy, andj=o refers to the open economy. The effect of capital mobility on the amount of political contributions is generally ambiguous. Suppose that the capitalists do not benefit from the public good. In this case, the capitalists would intensively lobby for a lower tax rate in the closed economy, and are willing to provide a large amount of political contributions. By contrast, in the open economy, they would offer a small amount of contribution ifsis small. As a result, we expect that the amount of political contributions will decrease with the capital mobility in this case.
In this paper, the policymakers are exogenously determined. Then a question arises: where do the policymakers come from? A more satisfactory setting is to endogenize the determination of the policymakers (e.g., Besley and Coate, 2001).
This issue, I believe, merits further research.
Acknowledgements
I thank the editor Professor Arye L. Hillman and two anonymous referees for valuable comments. The remaining errors are the author's sole responsibility. Financial support from the National Science Council [Grant NSC 98-2410-H-004-043-MY2] and National Chengchi University is gratefully acknowledged.
Appendix
A. The proof of Lemma 1:
Proof. Let ϕo and ϕc denote ∂Wκ /∂t in the open economy equilibrium and closed economy equilibrium, respectively. Then we can verify that
(1 )( )( )
o c l l
s κ κ K
ϕ −ϕ = − α γ +α γ φ , which is unambiguously positive, for all s that are less than unity. This implies that either 0 >ϕo>ϕcor ϕo> 0 >ϕc. In both cases, the capitalists' downward political pressure on t is reduced as a result of CMI.
B. The derivation of (43):
The zero-profit condition defines a negatively-sloped factor-price frontier:
);
(ρ ϖ
ϖ = ϖ ρ′( )= −K L= − (46) κ. Then the policymaker's problem is to maximize the following Lagrangian:
L = +(1 θ)Wκ +Wl+λ τ κ[( +t )L−Nz]. (47) Differentiating the above equation with respect to z gives λ=φH ′. With this relationship, the first-order condition for t is given by
(1 ) ( )
r Wl w K L w
K H K t t
t θ t w t φ t τ κ w t
∂∂ = + ∂∂ +∂∂ ∂∂ + ′ + ∂∂ + + ∂ ∂∂ ∂ L
(1 sθ)K φH′{[1 (1 s) ]ε K (τ κt )(1 s)κL′} 0
= − + + − − − + − = (48)
where we apply the relationships ∂Wl /∂ =w L and ∂ ∂ = ∂ ∂ = − −w t ϖ t (1 s) .κ Rearranging (48) gives (43).
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