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Economic integration and the optimal corporate tax structure with heterogeneous firms

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  • Christian Bauer

    ()
    (University of Munich)

  • Ronald B. Davies

    ()
    (University College Dublin; Institute for International Integration Studies, Trinity College Dublin)

  • Andreas Haufler

    (University of Munich)

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 IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp373.

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Length: 37 pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:iis:dispap:iiisdp373

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

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Cited by:
  1. Peter Egger & Horst Raff, 2011. "Tax Rate and Tax Base Competition for Foreign Direct Investment," Kiel Working Papers 1734, Kiel Institute for the World Economy.
  2. Dominika Langenmayr & Andreas Hau fler & Christian J. Bauer, 2013. "Should tax policy favour high or low productivity firms?," Working Papers 1308, Oxford University Centre for Business Taxation.

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