Dynamic Effects of Corporate Taxation in Open Economy

By exploiting the downward trend of profits' taxation observed in OECD countries which is rooted into international competition to attract capital, we identify exogenous variations in the corporate income tax rate. Estimating a SVAR model with long-run restrictions for a panel of eleven OECD countries over 1973-2017, we find that a permanent decline in profits' taxation leads to significant technology improvements which are concentrated in traded industries. The corporate tax cut has also an expansionary effect on hours concentrated in non-traded industries. The country-split shows that technology significantly improves in English-speaking and Scandinavian countries only while hours persistently increase only in continental European countries. To account for the dynamic effects of a corporate tax cut, we consider a two-sector open economy model with tradables and non-tradables and endogenous technology decisions where both capital and technology can be used more intensively. The model can account for the magnitude of technology improvements we estimate empirically as long as the traded sector is intensive in R&D, experiences low costs in the use of the stock of knowledge and also highly benefits from international R&D spillover. While large elasticities of utilization-adjusted-TFP w.r.t. the domestic and international stock of knowledge must be assumed in English-speaking and Scandinavian countries, in accordance with our estimates, we have to allow for sticky wages in continental European countries to account for our evidence.