A presentation about the paper working ifo paper: TAX PRINCIPLES AND TAX HARMONIZATION UNDER IMPERFECT COMPETITION: A CAUTIONARY EXAMPLE from 2001

1. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Tax principles and tax harmonization
under imperfect competition
Timo Grote
November 28, 2013
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

2. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
1 Introduction
2 Destination-based commoditiy Taxes
3 Origin based comodity taxes
4 Conclusion
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

3. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Motivation
The ifo institute
Releases quarter of all economic articles in Germany
Releases the ifo Buisness Climate index
Recently in the media for revealing Target-2 balances
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

4. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Conclusion
Content
This paper is about:
Discussion about the origin and destination based taxes in
the EU
Welfare impacts of a tax rate harmonization
Imperfect competition of taxation among countries
Timo Grote
Tax principles and tax harmonization under imperfect competition

5. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Conclusion
Assumptions
Definition: Destination-based commodity Taxes are taxes on
commodities that are raised in the country in which the
product is sold.
The model of Keen and Lahiri (1993) consists of:
Market: imperfect competition, one homogenous good
A second commodity is traded internationally (it is used
as a numeraire)
Production: international immobile, Constant Returns
Two Countries: Home and Foreign, Preferences may differ
One Consumer
Timo Grote
Tax principles and tax harmonization under imperfect competition

6. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
The Model
1
Utility Home: W (P, Y ) = β ∗ P 2 − αP + Y ,
2
1
∗
∗
∗
Utility Foreign: W (P , Y ) = β ∗ (P ∗ )2 − α∗ P ∗ + Y ∗
2
Demand Functions:D = α − βP and D ∗ = α∗ − β ∗ P
Market Clearing condition: D + D ∗ = X + X ∗
∗
If a tax is introduced: P − td = P ∗ − td = Pw
The two firms have the profit functions:
Π = (Pw − c)X − F and Π∗ = (Pw − c ∗ )X ∗ − F ∗
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

7. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Solution of the game
The equilibrium is determined in a two-stage game
stage one:Goverment sets taxes to maximize welfare of
agents
Maximized welfare: W = CS + Π + td D
stage two: Two firms behave optimally under tax rate
Backward induction is used to solve the game with the
∗ −2X ∗
D−2X
∗
resulting tax rates:td = 2β+3β ∗ and td = D ∗ +3β
2β
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

8. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Perspectives of both countries
Tax rate of the exporting country is affected by:
Terms of Trade (positively)
The Demand (positively)
Therefore the optimal tax is negative (subsidy)
Tax rate of the importing country is affected by:
Terms of Trade(positively)
Monopoly distortion(negatively)
Therefore tax rate depends on the dominating effect
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

9. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
The welfare effects of harmonization
To gain from a harmonization the condition is:
∗
H = λtd + (1 − λ)td with λ (0, 1)
∗
∗
The results are dtd = δ(H − td ) and dtd = δ(H − td )
So that H the weighted average is
β
The welfare optimizing case with λ = β+β ∗ is:
N
N∗
d(W + W ∗ ) = δββ ∗ b(td − td )2 > 0
Implication: The firms can profit from the condition if
they pay compensations
Conditions: The optimal exporter tax is lower than the
importer tax
Conditions: Each country taxes import goods more
strongly than export goods and tax rates are positive
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

10. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Conclusion
Welfare effects of harmonization
Welfare of the (foreign) exporting country:
Is effected as an envelope property by home country tax
Beneficial terms of trade effect (D ⇑→ Pw ⇑)
Expansion of foreign countries output (Pw > c ∗ )
Contraction of domestic demand (through price changes
the value of domestic goods is higher)
In perspective of the home country only the foreign countries
tax rate is important:
Consumption increases in home country if px < W (X )
The home country profits if td > 0
Timo Grote
Tax principles and tax harmonization under imperfect competition

11. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Model of Origin based taxes
Definition: Origin based taxes are raised in the country of
production.
The same model assumptions as before, but
P = Pw = P ∗
so that Π = (Pw − t0 − c)X − F and
∗
Π∗ = (Pw − c ∗ − t0 )X ∗ − F ∗
As the same game-theoretic model is applied
The Nash tax rates are:
b(D ∗ + X ∗ )
N∗
t0 =
2
b(D + X )
N
t0 =
2
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion

12. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Conclusion
Implications
Substituting these values into welfare functions
∗
2dW = (X − D)dt0 and 2dW ∗ = (X ∗ − D ∗ )dt0
The situation can only lead to a Pareto-improvement if the
low tax country imports the taxed good:
Because td ⇑ in the country
The country sets a low tax rate to keep its industry
competitive
The country sets a low tax rate to gain a high consumer
surplus
N
N∗
As t0 − t0 = c − c ∗ it must hold that the low cost country
has lower taxes
Timo Grote
Tax principles and tax harmonization under imperfect competition

13. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
Conclusion
Intuitive Interpretation
Raising a higher tax on the inefficient firm is welfare
improving:
A Marshallian subsidy is given to the more efficient firm
An overall welfare improvement can be acquired through
redistribution of the higher production efficiency
The Welfare improving situation can only be realized
when the two countries cooperate
Timo Grote
Tax principles and tax harmonization under imperfect competition

14. Introduction
Destination-based commoditiy Taxes
Origin based comodity taxes
What do the results show us
Destination and Origin-based taxes and Harmonization
can not be seperately discussed
Harmonization can have positive implications for
destination based policies
Harmonization can alleviate the inefficiency in
international allocation of consumption
Harmonization is bad for origin based policies
Pareto improvements can be obtained by allocation
movements towards more productive countries
The results show the possibility of welfare gains but the
conditions are difficult to fullfill
Timo Grote
Tax principles and tax harmonization under imperfect competition
Conclusion