A Simple Model of Commodity Taxation and Cross-border Shopping

This paper sets up a simple model of commodity taxation and cross-border shopping. Two countries, differing in geographical extent, engage in tax competition originating in the opportunities for cross-border shopping. Both tax competition and various coordination initiatives are examined. Then follow two extensions: (i) inclusion of costs of transportation for goods; (ii) inclusion of border inspection. These extensions allow us to conclude that both a drop in transportation costs and abolishment of border control intensify commodity tax competition and lower tax rates and revenues. The qualitative results for coordination measures also hold for the extended versions of our model.