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Tax competition in the eurozone: Capital mobility, agglomeration, and the small country disadvantage

  • Rademacher, Inga
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    The increasing economic integration among OECD countries since the late 1970s has attracted much attention in tax policy research. Although several studies have tested whether capital mobility induces a race to the bottom in capital taxation, the two approaches - competition and compensation theory - provide diametrically opposed answers to this question. One theory predicts a reduction in taxation, the other a stagnation or increase in taxation. This paper examines the question once again. However, instead of aggregating all OECD countries into one sample, it compares EMU countries - with nearly perfect capital mobility - to non-EMU countries in a difference-in- differences regression. Controlling for market size, I found that the EMU led to a divergence in taxation for small and large countries. Although the reduction in small countries could be explained by competition theory, the increase in large countries is not in line with the conventional theories. I argue that agglomeration forces give large countries an advantage in terms of attracting foreign direct investment (FDI) because of beneficial supply and demand chains. Small countries are disadvantaged in terms of capital attraction, which they counter by reducing capital taxation.

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    File URL: http://econstor.eu/bitstream/10419/82644/1/768188121.pdf
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    Paper provided by Max Planck Institute for the Study of Societies in its series MPIfG Discussion Paper with number 13/13.

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    Date of creation: 2013
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    Handle: RePEc:zbw:mpifgd:1313
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    1. Pavlos Petroulas, 2006. "The Effect of the Euro on Foreign Direct Investment," Working Papers 48, Bank of Greece.
    2. Brülhart, Marius & Jametti, Mario & Schmidheiny, Kurt, 2007. "Do Agglomeration Economies Reduce the Sensitivity of Firm Location to Tax Differentials?," CEPR Discussion Papers 6606, C.E.P.R. Discussion Papers.
    3. Bucovetsky, S., 1991. "Asymmetric tax competition," Journal of Urban Economics, Elsevier, vol. 30(2), pages 167-181, September.
    4. Marianne Bertrand & Esther Duflo & Sendhil Mullainathan, 2004. "How Much Should We Trust Differences-in-Differences Estimates?," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 249-275, February.
    5. Dani Rodrik, 1997. "Trade, Social Insurance, and the Limits to Globalization," NBER Working Papers 5905, National Bureau of Economic Research, Inc.
    6. Barro, Robert J., 1990. "Government Spending in a Simple Model of Endogeneous Growth," Scholarly Articles 3451296, Harvard University Department of Economics.
    7. Forslid, Rikard & Andersson, Fredrik, 1999. "Tax Competition and Economic Geography," Research Papers in Economics 2000:5, Stockholm University, Department of Economics.
    8. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
    9. Garrett, Geoffrey, 1995. "Capital mobility, trade, and the domestic politics of economic policy," International Organization, Cambridge University Press, vol. 49(04), pages 657-687, September.
    10. Hannes Winner, 2005. "Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data," International Tax and Public Finance, Springer, vol. 12(5), pages 667-687, September.
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