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Economic integration and the optimal corporate tax structure with heterogeneous firms

  • Bauer, Christian J.
  • Davies, Ronald B.
  • Haufler, Andreas

This paper links recent tax-rate-cut-cum-base-broadening reforms of corporate taxation to the closer integration of international trade. We study the corporate tax structure in a small open economy with heterogeneous firms, in a setting where it is optimal to 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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Paper provided by University of Munich, Department of Economics in its series Munich Reprints in Economics with number 20123.

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Date of creation: 2014
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Publication status: Published in Journal of Public Economics 110(2014): pp. 42-56
Handle: RePEc:lmu:muenar:20123
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