Dynamic Effects of Corporate Taxation in Open Economy

We exploit the downward and common trend of profits' taxation across OECD countries rooted into tax competition to identify exogenous shocks to corporate taxation. By adopting an internal instrument SVAR strategy, our evidence reveals that a permanent decline in profits' taxation leads to significant technology improvements concentrated in traded industries and generates an expansionary effect on hours concentrated in the non-traded sector. While technology dramatically improves in English-speaking and Scandinavian countries, hours significantly and persistently increase in continental Europe. A two-sector open economy model with endogenous technology decisions can rationalize the evidence conditional on a set of elements related to preferences and technology. To account for large technology improvements in former countries, traded industries must be highly intensive in R&D, exposed to foreign technology and display low technology utilization adjustment costs while habit persistence in consumption along with wage stickiness shape the expansionary effect on nontradable hours in continental Europe.