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

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  • Rademacher, Inga

Abstract

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.

Suggested Citation

  • Rademacher, Inga, 2013. "Tax competition in the eurozone: Capital mobility, agglomeration, and the small country disadvantage," MPIfG Discussion Paper 13/13, Max Planck Institute for the Study of Societies.
  • Handle: RePEc:zbw:mpifgd:1313
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    References listed on IDEAS

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    1. Fredrik Andersson & Rikard Forslid, 2003. "Tax Competition and Economic Geography," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 279-303, April.
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    3. Hannes Winner, 2005. "Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 12(5), pages 667-687, September.
    4. 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.
    5. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 103-126, October.
    6. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    7. Petroulas, Pavlos, 2007. "The effect of the euro on foreign direct investment," European Economic Review, Elsevier, vol. 51(6), pages 1468-1491, August.
    8. Marius Brülhart & Mario Jametti & Kurt Schmidheiny, 2012. "Do agglomeration economies reduce the sensitivity of firm location to tax differentials?," Economic Journal, Royal Economic Society, vol. 122(563), pages 1069-1093, September.
    9. Bretschger, Lucas & Hettich, Frank, 2002. "Globalisation, capital mobility and tax competition: theory and evidence for OECD countries," European Journal of Political Economy, Elsevier, vol. 18(4), pages 695-716, November.
    10. Dani Rodrik, 1997. "Trade, Social Insurance, and the Limits to Globalization," NBER Working Papers 5905, National Bureau of Economic Research, Inc.
    11. Marianne Bertrand & Esther Duflo & Sendhil Mullainathan, 2004. "How Much Should We Trust Differences-In-Differences Estimates?," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 249-275.
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    Cited by:

    1. Lukas Hakelberg, 2014. "The Power Politics of International Tax Cooperation. Why Luxembourg and Austria accepted automatic exchange of information on foreign account holders’ interest income," EUI-RSCAS Working Papers p0375, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).

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