Scenario: Contiguous States Often Use Tax Policy to Attract Residents

question 168

Multiple Choice

Scenario: 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. The first number in a cell is the payoff to New Jersey; the second number is the payoff to Pennsylvania.

(Source: John Greenwald, "A No-Win War Between the States," Time, April 8, 1996, 44-45.
-Refer to the scenario above.Does New Jersey have a dominant strategy?

• A) No.
• B) Yes. Regardless of whether Pennsylvania decides to lower its sales tax rate, New Jersey will always gain more revenue by lowering their sales tax rate to 3 percent.
• C) Yes. Regardless of whether Pennsylvania decides to lower its sales tax rate, New Jersey will always gain more revenue by maintaining their sales tax rate at 7 percent.
• D) Not enough information is provided to answer the question.

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