Capital Tax Competition and Wage Inequality

ABSTRACT This paper builds general equilibrium models to explore the influence of capital tax competition on the disparity between skilled and unskilled wages. In an ideal labor market scenario, as competition among jurisdictions intensifies, the capital tax rate decreases, resulting in wage growth. The direction of inequality, however, depends on the relative capital intensities across different sectors. Additionally, this paper incorporates the impact of labor market frictions through informality and minimum wage policies. The situations of regime switching, rural–urban migration, and a dynamic modeling framework are also taken into consideration. The main findings are contingent upon the capital intensities specific to each sector and the frictions inherent in the labor market. Besides, the empirical results using panel data in China from 2010 to 2019 and the results from numerical simulations strongly testify to our findings predicted by the theoretical models. The analysis reveals the bidirectional relationship between tax competition and inequality, highlighting the nuanced implications that arise when taking labor market dynamics into account alongside the traditional tax competition literature. By examining the intersection between capital and labor markets within the context of tax competition, this paper provides novel insights into the dynamics of inequality.