The Impact of Economic (Dis)integration on Tax and Trade Policies
In contrast to the multilateral process of economic integration, the disintegration of a country involves a unilateral exit from a multilaterally formed economic union. To dissect the effects of this partial disintegration on tax and trade policies, we set up a multi-country, multi-sector general equilibrium trade model with governments competing for a continuum of internationally mobile firms.
We address the key dimensions of economic disintegration, such as trade costs, the harmonization of production standards and regulations, as well as household migration. Their effects on tax policies vary not only by countries but also by these dimensions. The model predicts that the
leaving country's business tax rate declines.
We document asymmetric effects on tax rates inside the remaining union. Third countries' ability to tax improves. When trade policy is endogenous, we predict that the countries inside the union integrate more with each other. That triggers additional downward pressure on the leaving country's tax rate.