The Influence of Altruistic Preferences on the Race to the Bottom of Welfare States

Common tax competition models suggest that welfare states will
undercut each other's tax rate to attract taxpayers and keep
welfare recipients at bay. This will lead to a zero-taxation
outcome in the absence of migration costs or other barriers to
migration. This paper develops a two-country framework with mobile
altruistic taxpayers and immobile welfare recipients. It shows that
under the assumption of taxpayers motivated by warm glow altruism,
tax competition leads to unique pure strategy Nash equilibria in
taxation which are different from zero given sufficiently strong
altruistic preferences. If countries are asymmetric with respect to
the number of welfare recipients, pure altruism and inequity
aversion preferences support additional unique pure strategy Nash
equilibria in which the country with the fewer poor attracts more
taxpayers and sets higher taxes. This implies that rich countries
may benefit from tax competition.