Globalization, Tax Distortions and Public Sector Retrenchment

Univ. of Aarhus Working Paper No. 2010-9

37 Pages Posted: 27 Jun 2010

See all articles by Torben M. Andersen

Torben M. Andersen

University of Aarhus - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Allan Sorensen

Aarhus University, Economics and Business

Date Written: June 24, 2010

Abstract

It is widely perceived that globalization is a threat to tax financed public sector activities. The argument is that public activities (public consumption and transfers) financed by income taxes distort labour markets and cause higher wages and thus a loss of competitiveness. Since this link is strengthened by globalization, it is inferred that the marginal costs of public funds increase and a retrenchment of the public sector follows. We challenge whether these conclusions have support in a general equilibrium model featuring standard effects from open macroeconomics and trade theory. Even though income taxation unambiguously worsens wage competitiveness, it does not follow that marginal costs of public funds increase with product market integration due to gains from trade. Moreover, non-cooperative …fiscal policies do not have a race-to-the-bottom bias despite that taxes harm competitiveness. In fact we identify an expansionary bias in fiscal policies that is likely to increase with globalization when taxes finance either public consumption or transfers.

Keywords: labour taxation, open economy, policy spill-over, marginal costs of public funds

JEL Classification: H2, F1, J22

Suggested Citation

Andersen, Torben M. and Sorensen, Allan, Globalization, Tax Distortions and Public Sector Retrenchment (June 24, 2010). Univ. of Aarhus Working Paper No. 2010-9, Available at SSRN: https://ssrn.com/abstract=1629669 or http://dx.doi.org/10.2139/ssrn.1629669

Torben M. Andersen

University of Aarhus - Department of Economics ( email )

University Park
Building 322
DK-8000 Aarhus C
Denmark
+45 8 942 1609 (Phone)
+45 8 613 6334 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Allan Sorensen (Contact Author)

Aarhus University, Economics and Business ( email )

Fuglesangsalle 4
Aarhus V, 8210
Denmark

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