Dynamic Capital Tax Competition under the Source Principle

We explore the short- and long-run implications of tax competition between jurisdictions, where governments can only tax capital at source. We do this in the context of a neoclassical growth model under commitment and capital mobility. We provide a new theoretical perspective on the dynamic capital-tax externalities that emerge in this model. Numerically, we show that the net capital-tax externality is positive in the short run but converges to zero in the long run. We also find that non-cooperative source-based capital taxes are initially positive and slowly decline towards zero. Coordinated capital tax rates are higher than non-cooperative ones in the short run, lower in the medium run, and the same in the long run. This stands in contrast to common beliefs and results from static and two-period models, which have informed policy debates in the European Union and elsewhere.