This paper explores the implications of consumption externalities for capital mobility, the distribution of firms and tax competition. In the absence of tax competition, the country with higher consumption externality attracts more capital/firms. In contrast, under tax competition, because the country with higher consumption externality will impose a higher tax rate on capital, due to the strong negative effect of taxation, the country with lower externality attracts more capital. Besides, as trade openness increases, capital agglomerates in the country with lower consumption externality. We also show that there may exist an efficiency‐enhancing role for tax competition.