Endogenizing governments' objectives in tax competition

• Endogenous determination of governments' objectives under strategic interdependence
• Revenue (welfare) maximization restricts (accelerates) race-to-bottom in tax rates.
• It is optimal to commit for revenue maximizing fiscal policies in most of the cases.
• Only the leader should not deviate from ultimate goal, in interregional competition.
• Results are robust: asymmetric regions, two-dimensional competition, timing of move

In this paper we endogenize objective functions of the regions in case the of tax competition for foreign owned mobile capital. First, considering symmetric regions and simultaneous move tax competition, we demonstrate that the competing regions can restrict ‘race-to-the-bottom’ in tax rates by deviating away from social welfare to net tax revenue. Moreover, it is optimal for a region to be fully revenue oriented even if that region's ultimate goal is to maximize social welfare, irrespective of whether the rival region is concerned about social welfare or net tax revenue. Next, we show that these results go through under production asymmetry and under sequential/simultaneous choice of public investment and tax rate in the case of two-dimensional competition. However, in the case of Stackelberg type competition, it is optimal for the leader region not to deviate from its ultimate goal, while the follower region always gains from being fully revenue oriented.