Cross-border casino competition, Externalities and Optimal Tax Policy: A Unified Theory with Quantitative Analysis

We develop a framework on cross-border competition in markets for goods with negative externalities and provide evidence for optimal fiscal policy with a special focus on taxation. We build the case of two bordering casinos with city governments setting taxes to maximize social welfare. Analytically, we show that cross-border casino gambling makes aggregate casino demand more elastic. By calibrating the model to fit the Detroit-Windsor market, our welfare analysis shows that cross-border competition induces both cities to lower casino taxes, while the optimal tax mix features a shift from the casino revenue tax to the good and service surcharge on gambling in Detroit but a reversed shift in Windsor. We also find a casino buy-out deal to not be credible because Windsor's willingness to pay Detroit to ban Michigan casinos is far below Detroit's willingness to accept giving up its casinos.