Tax Competition And Tax On Agglomeration Rent

Due to fiscal decentralization, local govemments in China are possessed with many resources for economic development. Thus local governments may compete for the mobile factor by offering various tax incentives leading to the tax competition between local governments. In New Economic Geography models, since trading goods is costly and firms operate under increasing returns to scale, firms prefer to locate in a market with a greater number of consumers and to export elsewhere. The NEG literature argues that firms obtain rents because of agglomeration forces, which allows agglomeration-hosting govemments to set a high corporate tax rate without triggering an immediate capital outflow even if capital is highly mobile.This research examines the tax rate decisions of local governments. The sample consists of252255micro-enterprise unbalanced panel data at the county level and above in Zhejiang Province from1998to2008. The results indicate that both urbanization economies and localization economies exert a positive impact on the tax rate decision of local govemments. Finally, based on the empirical findings, this research proposes some practical policy advice.