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Corporate tax competition and the decline of public investment

  • Gomes, Pedro
  • Pouget, Francois

The government’s choices of the corporate tax rate and public investment are interdependent. In particular, they both respond positively to the other. Therefore, international tax competition not only drives corporate tax rates to lower levels but might also affect negatively the stock of public capital. We build a general equilibrium model that illustrates the relation between the two variables. We then add an element of international tax competition. Our simulations show that when international tax competition drives the statutory tax rate down from 45% to 30%, public investment is reduced by 0.4% of output at the steady state. The short run effect is three times higher. The second part of our study displays an empirical analysis that corroborates the main outcome of the model. We estimate two policy functions for 21 OECD countries and find that corporate tax rate and public investment are endogenous. More precisely, a decline of 15% in the corporate tax rate reduces public investment by 0.6% to 1.1% of GDP. We also find evidence that international competition operates on both policy tools. JEL Classification: H0, H26, H54

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Paper provided by European Central Bank in its series Working Paper Series with number 0928.

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Date of creation: Aug 2008
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Handle: RePEc:ecb:ecbwps:20080928
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  1. 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.
  2. Keen, Michael & Marchand, Maurice, 1997. "Fiscal competition and the pattern of public spending," Journal of Public Economics, Elsevier, vol. 66(1), pages 33-53, October.
  3. Hans Jarle Kind & Helene Midelfart & Guttorm Schjelderup, 2004. "Corporate Tax Systems, Multinational Enterprises, and Economic Integration," CESifo Working Paper Series 1241, CESifo Group Munich.
  4. Randolph, Susan & Bogetic, Zeljko & Hefley, Dennis, 1996. "Determinants of public expenditure on infrastructure : transportation and communication," Policy Research Working Paper Series 1661, The World Bank.
  5. Christophe Kamps, 2005. "New Estimates of Government Net Capital Stocks for 22 OECD Countries 1960-2001," Public Economics 0506015, EconWPA.
  6. Aaron Mehrotra & Timo Välilä, 2006. "Public Investment in Europe: Evolution and Determinants in perspective," Fiscal Studies, Institute for Fiscal Studies, vol. 27(4), pages 443-471, December.
  7. Duarte Bom, P.R. & Ligthart, J.E., 2008. "How Productive is Public Capital? A Meta-Analysis," Discussion Paper 2008-10, Tilburg University, Center for Economic Research.
  8. Huizinga, Harry & Laeven, Luc, 2007. "International Profit Shifting within European Multinationals," CEPR Discussion Papers 6048, C.E.P.R. Discussion Papers.
  9. Fabrizio Balassone & Daniele Franco, 2000. "Public investment, the Stability Pact and the ‘golden rule’," Fiscal Studies, Institute for Fiscal Studies, vol. 21(2), pages 207-229, June.
  10. Elitzur, Ramy & Mintz, Jack, 1996. "Transfer pricing rules and corporate tax competition," Journal of Public Economics, Elsevier, vol. 60(3), pages 401-422, June.
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