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A tale of two taxes: State-dependency of tax policy

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  • K. Peren Arin
  • Emin Gahramanov
  • Tolga Omay
  • Mehmet A. Ulubasoglu

Abstract

Previous literature provided mixed evidence regarding the effects of two major tax instruments, namely, labor income taxes and corporate taxes on economic growth. We hypothesize that the mixed evidence may be due to state-dependency of labor taxes. While corporate taxes retard economic growth by discouraging entrepreneurship in a linear fashion, the negative effect of labor taxes on growth may depend on the state of the economy, and may, thus, be non-linear. We provide a simple theoretical model which supports the latter hypothesis, and empirically test our predictions by using both statutory and average tax rates for a sample of 19 OECD countries over the 1981–2005 period. We also contribute to the literature by employing a newly developed Panel Smooth Transition (PSTR) model that controls for non-linearities in the tax structure-economic growth relationship. Our empirical findings suggest that while taxes on corporate income are distortionary for growth in both high- and low-growth regimes, taxes on labor income are harmful only during the high-growth regime.

Suggested Citation

  • K. Peren Arin & Emin Gahramanov & Tolga Omay & Mehmet A. Ulubasoglu, 2019. "A tale of two taxes: State-dependency of tax policy," CAMA Working Papers 2019-68, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:een:camaaa:2019-68
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    Cited by:

    1. Dennis Bonam & Paul Konietschke, 2020. "Tax multipliers across the business cycle," Working Papers 699, DNB.

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    More about this item

    Keywords

    Panel Smooth Transition; Fiscal Policy; Tax Policy; Growth;
    All these keywords.

    JEL classification:

    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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