Wages and International Tax Competition

Firms generating larger surpluses on average pay higher wages. To account for this, we develop a tax competition model with rent‑sharing between firms and workers. In our model, firms in a large country can shift profits to a tax haven to reduce their tax bill. Workers, who bargain with firm owners, can detect some but not the entire surplus shifted. Thus, profit shifting implies an additional gain for firms as it allows them to reduce their wage bill. We find that the introduction of rent‑sharing reduces the own‑tax elasticity of revenues of the large country, thereby reducing the competitive pressure on its tax setting. Whether this translates into a higher or lower equilibrium tax rate of the large country depends on the ability of workers to detect shifted profits. If this detection ability is strong, the equilibrium tax rate increases, if it is weak, the equilibrium tax rate decreases.