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Tax Rate and Tax Base Competition for Foreign Direct Investment

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  • Peter Egger
  • Horst Raff

Abstract

This paper argues that the large reduction in corporate tax rates and only gradual widening of tax bases in many countries over the last decades are consistent with tougher international competition for foreign direct investment (FDI). To make this point we develop a model in which governments compete for FDI using corporate tax rates and tax bases. The model’s predictions regarding the slope of policy reaction functions and the response of equilibrium tax parameters to trade costs and market size are shown to be consistent with panel data for 43 developed countries and emerging markets. Using estimated policy reaction functions we simulate the effect of regional trade integration and find that this integration has contributed significantly to the observed fall in corporate tax rates.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2011/wp-cesifo-2011-09/cesifo1_wp3596.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3596.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3596

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Keywords: corporate taxes; tax competition; foreign direct investment; multinational firms; free-trade areas; regional integration;

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References

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  1. Christian Bauer & Ronald B. Davies & Andreas Haufler, 2011. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Working Papers 1114, Oxford University Centre for Business Taxation.
  2. Keen, Michael, 2001. "Preferential Regimes Can Make Tax Competition Less Harmful," National Tax Journal, National Tax Association, vol. 54(n. 4), pages 757-62, December.
  3. Bjorvatn, Kjetil & Eckel, Carsten, 2006. "Policy competition for foreign direct investment between asymmetric countries," European Economic Review, Elsevier, vol. 50(7), pages 1891-1907, October.
  4. Mervyn A. King & Don Fullerton, 1984. "Introduction to "The Taxation of Income from Capital: A Comparative Study of the United States, the United Kingdom, Sweden, and Germany"," NBER Chapters, in: The Taxation of Income from Capital: A Comparative Study of the United States, the United Kingdom, Sweden, and Germany, pages 1-6 National Bureau of Economic Research, Inc.
  5. Devereux, Michael P. & Lockwood, Ben & Redoano, Michela, 2008. "Do countries compete over corporate tax rates?," Journal of Public Economics, Elsevier, vol. 92(5-6), pages 1210-1235, June.
  6. Haufler, Andreas & Wooton, Ian, 1999. "Country size and tax competition for foreign direct investment," Munich Reprints in Economics 20408, University of Munich, Department of Economics.
  7. David L. Carr & James R. Markusen & Keith E. Maskus, 1998. "Estimating the Knowledge-Capital Model of the Multinational Enterprise," NBER Working Papers 6773, National Bureau of Economic Research, Inc.
  8. Ronald B. Davies & Christopher J. Ellis, 2001. "Competition in Taxes and Performance Requirements for Foreign Direct Investment," University of Oregon Economics Department Working Papers 2001-4, University of Oregon Economics Department, revised 01 Jun 2001.
  9. James R. Markusen & Keith E. Maskus, 1999. "Discriminating Among Alternative Theories of the Multinational Enterprise," NBER Working Papers 7164, National Bureau of Economic Research, Inc.
  10. Johannes Becker & Clemens Fuest, 2009. "Optimal tax policy when firms are internationallly mobile," Working Papers 0907, Oxford University Centre for Business Taxation.
  11. Roger H. Gordon & James R. Hines Jr., 2002. "International Taxation," NBER Working Papers 8854, National Bureau of Economic Research, Inc.
  12. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 269-304, June.
  13. Hagen, K.P. & Osmundsen, P. & Schjelderup, G., 1995. "Internationally Mobile Firms and Tax Policy," Papers 8/95, Norwegian School of Economics and Business Administration-.
  14. John C. Driscoll & Aart C. Kraay, 1998. "Consistent Covariance Matrix Estimation With Spatially Dependent Panel Data," The Review of Economics and Statistics, MIT Press, vol. 80(4), pages 549-560, November.
  15. Clemens Fuest & Thomas Hemmelgarn, 2003. "Corporate Tax Policy, Foreign Firm Ownership and Thin Capitalization," CESifo Working Paper Series 1096, CESifo Group Munich.
  16. Haufler, Andreas & Wooton, Ian, 1997. "Tax Competition for Foreign Direct Investment," CEPR Discussion Papers 1583, C.E.P.R. Discussion Papers.
  17. Wilson, John Douglas & Wildasin, David E., 2004. "Capital tax competition: bane or boon," Journal of Public Economics, Elsevier, vol. 88(6), pages 1065-1091, June.
  18. Doyle, Christopher & van Wijnbergen, Sweder, 1984. "Taxation of Foreign Multinationals: A Sequential Bargaining Approach to Tax Holidays," CEPR Discussion Papers 25, C.E.P.R. Discussion Papers.
  19. Peter Egger & Simon Loretz & Michael Pfaffermayr & Hannes Winner, 2009. "Corporate Taxation and Multinational Activity," Working Papers 0904, Oxford University Centre for Business Taxation.
  20. Barros, Pedro P & Cabral, Luis, 2000. "Competing for Foreign Direct Investment," Review of International Economics, Wiley Blackwell, vol. 8(2), pages 360-71, May.
  21. Fuest, Clemens, 2005. "Economic integration and tax policy with endogenous foreign firm ownership," Journal of Public Economics, Elsevier, vol. 89(9-10), pages 1823-1840, September.
  22. Michael P. Devereux & Rachel Griffith & Alexander Klemm, 2002. "Corporate income tax reforms and international tax competition," Economic Policy, CEPR & CES & MSH, vol. 17(35), pages 449-495, October.
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Cited by:
  1. Christian Bauer & Ronald B. Davies & Andreas Haufler, 2011. "Economic integration and the optimal corporate tax structure with heterogeneous firms," Working Papers 1114, Oxford University Centre for Business Taxation.
  2. Harald Badinger & Peter Egger, 2008. "GM Estimation of Higher-Order Spatial Autoregressive Processes in Cross-Section Models with Heteroskedastic Disturbances," CESifo Working Paper Series 2356, CESifo Group Munich.

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