Is a Dynamic Approach to Tax Games Relevant?

In this paper we argue that static models provide an incomplete analysis of interjurisdictional tax competition. According to Wilson (1987) a static tax competition model might predict the long-run outcomes of government decision making in a dynamic setting. We show that this conjecture is only true when policymakers commit to a tax path at the start of the game without future updates (open-loop behavior), with the proviso that they are time-indifferent and/or capital is perfectly mobile. Static models however never predict future outcomes when policymarkers continuously update their tax rates (Markovian behavior). In particular, we address the following aspects. How do long-run outcomes in a dynamic setting change relative to static games? How does social welfare change accordingly? If policymakers have the choice, which strategical behavior (Markovian or open-loop) should they adopt? In light of this, which one confers the highest social advantage?