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Corporate Tax Competition and the Decline of Public Investment

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  • Pedro Gomes
  • Francois Pouget
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    Abstract

    The government’s choices of the corporate tax rate and public investment are interdependent. In particular, they both respond positively to the other. Therefore, international tax competition not only drives corporate tax rates to lower levels but might also affect negatively the stock of public capital. We build a general equilibrium model that illustrates the relation between the two variables. We then add an element of international tax competition. Our simulations show that when international tax competition drives the statutory tax rate down from 45% to 30%, public investment is reduced by 0.4% of output at the steady state. The short run effect is three times higher. The second part of our study displays an empirical analysis that corroborates the main outcome of the model. We estimate two policy functions for 21 OECD countries and find that corporate tax rate and public investment are endogenous. More precisely, a decline of 15% in the corporate tax rate reduces public investment by 0.6% to 1.1% of GDP. We also find evidence that international competition operates on both policy tools.

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    Bibliographic Info

    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2384.

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    Date of creation: 2008
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    Handle: RePEc:ces:ceswps:_2384

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    Related research

    Keywords: tax competition; corporate tax; public investment; public capital;

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    References

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    1. Aaron Mehrotra & Timo Välilä, 2006. "Public Investment in Europe: Evolution and Determinants in perspective," Fiscal Studies, Institute for Fiscal Studies, Institute for Fiscal Studies, vol. 27(4), pages 443-471, December.
    2. Fabrizio Balassone & Daniele Franco, 2000. "Public investment, the Stability Pact and the ‘golden rule’," Fiscal Studies, Institute for Fiscal Studies, Institute for Fiscal Studies, vol. 21(2), pages 207-229, June.
    3. Devereux, Michael P & Lockwood, Ben & Redoano, Michela, 2002. "Do Countries Compete over Corporate Tax Rates?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3400, C.E.P.R. Discussion Papers.
    4. Duarte Bom, P.R. & Ligthart, J.E., 2008. "How Productive is Public Capital? A Meta-Analysis," Discussion Paper, Tilburg University, Center for Economic Research 2008-10, Tilburg University, Center for Economic Research.
    5. Martin Kolmar & Andreas Wagener, 2007. "Tax Competition with Formula Apportionment: The Interaction between Tax Base and Sharing Mechanism," CESifo Working Paper Series 2097, CESifo Group Munich.
    6. Alfons Weichenrieder, 2009. "Profit shifting in the EU: evidence from Germany," International Tax and Public Finance, Springer, Springer, vol. 16(3), pages 281-297, June.
    7. Hans Jarle Kind & Helene Midelfart & Guttorm Schjelderup, 2004. "Corporate Tax Systems, Multinational Enterprises, and Economic Integration," CESifo Working Paper Series 1241, CESifo Group Munich.
    8. KEEN, Michael & MARCHAND, Maurice, 1996. "Fiscal Competition and the Pattern of Public Spending," CORE Discussion Papers, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) 1996001, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    9. Elitzur, Ramy & Mintz, Jack, 1996. "Transfer pricing rules and corporate tax competition," Journal of Public Economics, Elsevier, Elsevier, vol. 60(3), pages 401-422, June.
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    Cited by:
    1. Neumann, Rebecca & Holman, Jill & Alm, James, 2009. "Globalization and tax policy," The North American Journal of Economics and Finance, Elsevier, Elsevier, vol. 20(2), pages 193-211, August.

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