Endogenous timing in tax competition: The effect of asymmetric information

• Published date: 01 June 2023
• Author: Takaaki Hamada
• Date: 01 June 2023
• DOI: http://doi.org/10.1111/jpet.12631

Received: 10 January 2022

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Accepted: 1 October 2022

DOI: 10.1111/jpet.12631

ORIGINAL ARTICLE

Endogenous timing in tax competition:

The effect of asymmetric information

Takaaki Hamada

Faculty of Economics, Toyo University,

Tokyo, Japan

Correspondence

Takaaki Hamada, Faculty of Economics,

Toyo University, 5‐28‐20, Hakusan,

Bunkyo‐Ku, Tokyo 112‐8606, Japan.

Email: t.hamada.econ@gmail.com

Funding information

Japan Society for the Promotion of

Science, Grant/Award Number:

17J07819; Toyo University

Abstract

This study explores the effects of asymmetric informa-

tion on endogenous leadership in a simple tax

competition environment. The study models a two‐

country economy where one country is informed about

its own and opponent's productivity of private goods,

while the other country only knows its productivity.

The results show that each type of informed country

has an incentive to pretend to be the other type, which

leads to a Stackelberg outcome endogenously, while

the simultaneous move is the unique outcome under

complete information. Under the Stackelberg outcome,

the uninformed country moves first and the informed

country moves second. Moreover, ex‐post social

welfare under asymmetric information can become

larger than that under complete information, because

the uninformed country chooses a less aggressive tax

rate under asymmetric information. These results

depend on the type of uncertainty, and capital

ownership and share.

1|INTRODUCTION

Recently, there have been studies on endogenous timing in tax competition models. In the

simple tax competition environment and Hamilton and Slutsky's (1990) observable delay

manner, the equilibrium outcomes are characterized by production technology, capital

ownership, and the distribution of the capital across regions (Hindriks & Nishimura, 2017,2021;

Kempf & Rota‐Graziosi, 2010,2015; Ogawa, 2013).

In a two‐country economy, assuming the absence of capital ownership, Kempf and Rota‐

Graziosi (2010) conclude that the subgame perfect equilibrium (SPE) yields two sequential‐move

J Public Econ Theory. 2023;25:570–614.wileyonlinelibrary.com/journal/jpet570

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© 2022 Wiley Periodicals LLC.

outcomes. Ogawa (2013) shows that the simultaneous move is the unique SPE outcome in

economies with nonabsentee capital ownership and an equal capital share between two countries.

Moreover, Kempf and Rota‐Graziosi (2015) characterize the equilibrium outcome in the

nonabsentee capital ownership model, which allows an unequal share of the capital, and Hindriks

and Nishimura (2017) develop more flexible capital ownership models. These studies have

adequately addressed the timing decisions of fiscal authorities in complete information

environments.

This study provides a new perspective on endogenous leadership in a simple tax

competition by introducing asymmetric information. Using Ogawa's (2013) setting, the study

analyzes information asymmetry regarding a country's productivity level of private goods in a

two‐country economy, where one country is informed about its own and opponent's

productivity, while the other country only knows its productivity. The results show that a

Stackelberg outcome emerges endogenously, while the simultaneous move is the unique

outcome under complete information. Moreover, we find that ex post social welfare under

asymmetric information can become larger than that under complete information.

In Ogawa's (2013) setting, information asymmetry can provide each type of the informed

country with a novel incentive of pretending to be the other type, which leads to a pooling

equilibrium. The mechanism behind that is as follows. In Ogawa (2013), as the capital is fully

owned by the residents in the two countries and their productivity levels are heterogeneous,

one country becomes a capital importer and the other becomes an exporter. The capital

importer strategically chooses its tax rate to decrease the price of capital, while the exporter

chooses a tax rate to increase it. Now, suppose the uninformed country does not know whether

its opponent has higher or lower productivity than itself, which implies that the country is

unaware of whether it is a capital importer or exporter. The informed country with higher

productivity (henceforth, high type) wants the uninformed country to choose a tax rate that

decreases the capital price, because it is a capital importer given its higher productivity. If the

uninformed country incorrectly expects itself to be a capital importer (i.e., to be more

productive than the opponent), then it will lower the capital price, which will actually benefit

high type. In this situation, high type has no incentive to resolve the uncertainty. Similarly, low

type also has an incentive to use the uncertainty such that the uninformed country is misled

into increasing the capital price.

These two‐way concealment incentives can make each type choose the same choice of

timing and the same tax rate such that information on its productivity level is not given to the

uninformed country. Such incentives consequently lead to a Stackelberg outcome endogen-

ously in which the uninformed country moves first and both types of the informed country

move second, while the simultaneous move is the unique outcome under complete

information.

These concealment incentives depend on the assumption of the type of uncertainty, and

capital ownership and share. First, it is essential that the uninformed country does not know

whether its opponent has a higher or lower productivity level than itself. Unlike this

assumption, we can consider a different type of uncertainty such that the uninformed country

knows that its opponent has a higher or lower productivity level than itself but does not

understand the degree of the gap. In such a case, the uninformed country is aware of its actual

role in the capital trade, and either type of the informed country wants to differentiate itself

from the other type, contributing to a separating equilibrium. Second, in the case of no‐capital

ownership (Kempf & Rota‐Graziosi, 2010) or in some cases of unequal capital share across

countries (Kempf & Rota‐Graziosi, 2015), two‐way concealment incentives disappear and the

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pooling equilibrium cannot emerge. The results in this study can be brought when the

incentives for manipulating the capital price differ between the two types.

1

Some examples of information asymmetry in this study include some exogenous events,

such as productivity shocks or disasters. After a country experiences an exogenous shock, it

may hold more information on itself than others, even though most of the information had

been gathered until then. Theoretical studies incorporating the risk of disasters include

Wildasin (2011) and Goodspeed and Haughwout (2012).

2

Especially, Wildasin (2011) considers

a similar situation with two regions: one region (Coast) is exposed to the risk of disasters, while

the other (Inland) is not exposed. Unlike this study, they do not focus on the information

asymmetry between jurisdictions.

The examples above may seem limited to a specific scenario. Nevertheless, this model is

worth analyzing for several reasons. First, this model suggests that the informed country is

willing to use the uncertainty to pretend to be the other type. This implies that each country

may have an incentive to “create”uncertainty by manipulating or concealing information.

3

Thus, our environment may be realized not only through some exogenous shocks but also

through countries' decisions endogenously. Moreover, this study shows that such incentives

significantly change the equilibrium outcome compared with that under complete information,

which suggests that information asymmetry may also have nonnegligible effects in related

works. The driving mechanism in this study is helpful in introducing information asymmetry to

others' studies.

Second, the study finds that social welfare in the equilibrium under asymmetric

information can become larger than that under complete information, where social welfare

is defined as the sum of ex post utilities. The positive effect of information asymmetry on

welfare is also shown in the analysis with a fixed timing structure. This occurs because the

uncertainty makes the uninformed country choose less aggressive tax rates toward both types.

This finding contributes to uncovering the mechanisms behind the positive effects of

information asymmetry on social welfare,

4

and, to my best knowledge, this is the first study to

show welfare improvement by asymmetric information in endogenous timing models.

However, the study does not detect a Pareto improvement by asymmetric information. Under

our setup, while each type of the informed country can improve its utility by pretending to be

the other type, the uninformed country suffers a loss because such a country may choose a tax

rate with misperceptions of the actual capital flows.

Finally, our model presents some interesting points from the game theoretical aspect. The

first point is about the signaling game. A signaling game in our model with continuous action

space (tax choice) does not satisfy the commonly used single‐crossing property, but holds the

double‐crossing. In the game, we find that there uniquely exists a pooling equilibrium (or

hybrid equilibrium) outcome (Lemma 1). Interestingly, the study does not use refinement

1

In other words, one type wants to lower the capital price, while the other wants to raise the price.

2

See the survey of Goodspeed (2013).

3

This has an opposite implication for the information sharing among governments (Bacchetta & Espinosa, 1995,2000;

Huizinga & Nielsen, 2003).

4

As examples of welfare improvement by asymmetric information, the notable work by Morris and Shin (2002) shows

that more (public) information can decrease welfare in game theoretical situations. In other examples, in the insurance

market models with asymmetric information, de Garidel‐Thoron (2005) finds that sharing information about past

accidents among insurers decreases welfare in dynamic environments. Koufopoulos and Kozhan (2014) show that an

increase in ambiguity about the probability of an accident can lead to a Pareto improvement. The mechanism behind

welfare improvement in our model is different from that in these studies.

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