Effects of dual networks on tax strategies: geography and transaction
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Economics and Complex Networks
Effects of dual networks on tax strategies: geography and transaction Ryo Itoh1 · Zonghui Li1 Received: 26 May 2020 / Revised: 15 October 2020 / Accepted: 16 October 2020 © The Author(s) 2020
Abstract This study investigates how a revenue-maximizing tax strategy of local and central governments incorporates dual networks, namely, an inter-firm transaction network and an inter-country geography network. We assume a two-stage game in which governments propose discriminatory tax levels for firms, whereas each firm has an incentive to invest in a country near the foreign branch office of its transaction partner. In our model, the centrality index of the Kronecker product of the two networks describes the interplay among the location choices and tax strategies in the equilibrium. A stronger linkage within each network generally increases demand for investment and in turn raises overall tax levels to exploit the high demand. Although more central firms in the inter-firm network are likely to be levied higher taxes because of their high demand for investment, firms in the highest tax bracket differ among countries depending on their geographical location. Finally, we show that a uniform tax in which firms are not discriminated and networks do not matter is the socially optimal tax, which incorporates all inter-country externalities. We also investigate decentralized tax strategies based on the rule of non-discriminatory (uniform) taxation and show, by comparing social welfare under discriminatory and uniform tax regimes, that restricting tax discrimination improves social welfare. Keywords Geography · Inter-firm transaction · Tax strategy · Katz-Bonacich centrality · Tax discrimination
1 Introduction Transaction networks play an important role in influencing firms’ location choice and policy-making. Foreign direct investments involve transactions with local firms in destination markets, sometimes leading to various problems such as the mismatch of product design and quality and delivery systems (e.g., Reid 1995). Hence, some * Ryo Itoh [email protected] 1
Tohoku University, Aramaki aza aoba 3‑6‑09, Aoba‑Ku, Sendai 980‑8579, Japan
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The Japanese Economic Review
firms choose to make joint investments with their trading partners to replicate the current transaction partnership in a new investment destination (Hackett and Srinivasan 1998). Itoh (2014) introduced such transaction network effects in firms’ location choice into a two-country tax competition model to show how governments impose different tax rates on firms depending on their position in the network. Moreover, not all location spillovers remain within the region, because affiliates trade across countries and may even form regional supply networks (e.g., Baldwin and Okubo 2014).1 At this time, as described by Anderson and van Wincoop (2004), because the trade costs have a large impact on international trade, it is essential for research to consider the geographical structure among regions a
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