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Economic Integration and the Optimal Corporate Tax Structure with Heterogeneous Firms

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  • Christian Josef Bauer
  • Ronald B. Davies
  • Andreas Haufler

Abstract

We study the optimal combination of corporate tax rate and tax base in a model of a small open economy with heterogeneous firms. We show that it is optimal for the small country’s government to effectively subsidize capital inputs by granting a tax allowance in excess of the true costs of capital. Economic integration reduces the optimal capital subsidy and drives low-productivity firms from the small country’s home market, replacing them with high-productivity exporters from abroad. This endogenous policy response creates a selection effect that increases the average productivity of home firms when trade barriers fall, in addition to the well-known direct effects.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3566.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3566

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Keywords: corporate tax reform; trade liberalization; firm heterogeneity;

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Cited by:
  1. Langenmayr, Dominika & Haufler, Andreas & Bauer, Christian J., 2012. "Should tax policy favor high- or low-productivity firms?," Discussion Papers in Economics 14277, University of Munich, Department of Economics.
  2. Peter Egger & Horst Raff, 2011. "Tax Rate and Tax Base Competition for Foreign Direct Investment," CESifo Working Paper Series 3596, CESifo Group Munich.

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