Public Expenditure Spillovers: An Explanation for Heterogeneous Tax Reaction Functions

This article provides an explanation for the heterogeneity of reaction functions under tax competition. Using a three-jurisdiction model, we show that competing players may have asymmetric responses, due to spillover effects. Namely, jurisdiction i may react positively to changes in jurisdiction j's tax rate and negatively to the same change in jurisdiction z. This theoretical result helps us to both interpret the mixed results found by the empirical literature and explain the lack of tax tax rate convergence among jurisdictions.