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Nash Equilibrium in Tax and Public Investment Competition

Sharma, Ajay and Pal, Rupayan (2019): Nash Equilibrium in Tax and Public Investment Competition. Forthcoming in: International Review of Economics and Finance (17 March 2019)

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Abstract

We analyze Nash equilibrium in fiscal competition with tax and public investment between symmetric regions. We show that given the opposite strategic nature of tax (strategic complement) and public investment (strategic substitute), there is possibility of multiple equilibria. We find that if strategic substitute effect dominates strategic complement effect, then both regions have first mover advantage in a timing game and simultaneous move Nash equilibrium (early, early) emerges; otherwise sequential move equilibria-(early, late) and (late, early) emerges. Also, sequential move Nash equilibria are Pareto improving than simultaneous move outcome. Lastly, race-to-the-bottom in taxes is restricted in sequential move equilibria.

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