In the transitional phase towards full economic integration, European countries have the possibility of re-shaping the continental geography of specialization. We use an Economic Geography model of industrial agglomeration to show how fiscal incentives can be critical in this phase. Differently from other work we concentrate on the role of indirect taxation, and sector specific state-aid, still important in the EU but little studied. While it is obvious that tax incentives could be used to attract some industries, it is not obvious that, in a general equilibrium analysis, such use of taxes is welfare improving. In the paper, we show that the optimal policy is to levy asymmetric taxes on the two sectors only during the phase of intermediate transport costs, when such a measure induces welfare improving agglomerations.
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