Question

(3) Contiguous states often use tax policy to attract residents, firms, and economic activity. These "tax competitions" between states can be modeled with game theory. Suppose New Jersey currently has a state sales tax of 7 percent and Pennsylvania has a state sales tax of 6 percent. The game shown below models the effect of a reduction in each state's sales tax rate to 3 percent on each state's sales tax revenue. Assume the motivation of each state is to maximize tax revenue and the payoff is shown below. Source: John Greenwald, "A No-Win War Between the States," Time, April 8, 1996, 44—45. State Tax Competition (NJ Tax Revenues, PA Tax Revenues) New Jersey Lower to 3% (NJ) Maintain Sales Tax Pennsylvania (PA) Lower to 3% Maintain Sales Tax PA: $16 M PA: $14M NJ: $20 M NJ: $26M PA: $22M PA: $20 M NJ: $18 M NJ: $24M a. Does New Jersey have a dominant strategy? Does Pennsylvania have a dominant strategy? Why or why not? b. What is the Nash equilibrium? c. Is there a set of payoffs that is superior to the payoffs realized at the dominant strategy equilibrium? Why is this outcome not sustainable?

Answer 1

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