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Testing the tax competition theory: How elastic are national tax bases in Western Europe?

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Author Info
Aleksandra Riedl () (Institute for Economic Geography and GIScience, Vienna University of Economics and Business Administration,)
Silvia Rocha-Akis () (Department of Economics, Vienna University of Economics and Business Administration,)

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Abstract

In this paper, we test one of the fundamental assumptions in the tax competition literature, namely, that a country's taxable income depends on the tax policies pursued in the domestic and in neighbouring countries. Based on a panel of annual data of 14 Western European countries spanning the period 1982 to 2004, we show that the common trend in falling corporate income tax (CIT) rates can in part be explained by the existence of fiscal externalities in the form of international resource flows. Our results confirm the presumption put forward in recent empirical tax reaction function studies, that interdependent tax setting behaviour is evidence of tax competition. However, taxable corporate income is shown to react inelastically to domestic and to foreign tax rates. Thus, the observed rise in CIT revenues in Europe between 1982 and 2004 cannot be explained by the trend in falling CIT rates. Moreover, we find that large countries' tax bases are more responsive to neighbouring countries' tax policies, which is in contrast to the classic asymmetric tax competition literature.

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Paper provided by Oesterreichische Nationalbank (Austrian Central Bank) in its series Working Papers with number 142.

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Length: 36 pages
Date of creation: 28 Apr 2008
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Handle: RePEc:onb:oenbwp:142

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Keywords: tax competition corporate income tax base elasticity asymmetric countries instrumental variables spatial econometrics.

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Find related papers by JEL classification:
H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
H72 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Budget and Expenditures
H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data

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  1. Nadja Dwenger & Viktor Steiner, 2008. "Effective Profit Taxation and the Elasticity of the Corporate Income Tax Base : Evidence from German Corporate Tax Return Data," Discussion Papers of DIW Berlin 829, DIW Berlin, German Institute for Economic Research. [Downloadable!]
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