This paper argues that increased factor mobility incurs the risk of dismantling the welfare state, even though this state may have useful allocative functions. It will be difficult to finance the welfare state with taxes on capital and it may even be necessary to subsidize this factor in the sense that some of the infrastructure it uses will have to be covered by taxes on other factors. In general, redistribution activities are underprovided since they provide other countries with positive policy externalities. To overcome these difficulties and to make competition among welfare states workable, the paper suggests taxing capital income on a cash flow basis and other incomes on the basis of a nationality principle.