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Economic integration and the optimal corporate tax structure with heterogeneous firms

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

We study the optimal combination of corporate tax rate and tax base in a model of a small open economy with heterogeneous firms. We show that it is optimal for the small country's government to e®ectively 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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File URL: http://epub.ub.uni-muenchen.de/12310/1/Bauer_Davies_Haufler_2011_mimeo_Economic_integration_and_the_optimal_corporate_tax_structure_with_heterogeneous_firms.pdf
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Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 12310.

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Date of creation: Aug 2011
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Handle: RePEc:lmu:muenec:12310
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