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This paper provides a challenging view to the tax harmonization issue. The literature often proposes tax harmonization to avoid free-riding behaviors in free-trade areas, and more particularly in monetary unions. Countries may decrease their tax rates in order to develop tax competitive advantage and attract capital. Without tax harmonization, tax autonomy may lead to a race to the bottom. The model proposed here uses a game-theoretical approach to analyze this question. It shows that tax competition may lead to stability. The mechanism leading to this outcome rests upon the impact of the signal given by both players. If a country gives the signal that friendly taxation behavior is not its priority, the result can be a race to the bottom. Conversely, if both countries signal their ability to conduct such a war, this war will not occur, and the stability of the system will be ensured.

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Thierry Warin

Andr Fourans

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