Corporate Tax Competition and the Decline of Public Investment

52 Pages Posted: 21 Aug 2008

See all articles by Pedro Gomes

Pedro Gomes

University of London - Economics, Mathematics and Statistics; Charles III University of Madrid

Francois Pouget

Université Paris IX Dauphine - EURIsCO

Multiple version iconThere are 2 versions of this paper

Date Written: August 21, 2008

Abstract

The government's choices of the corporate tax rate and public investment are interdependent. In particular, they both respond positively to the other. Therefore, international tax competition not only drives corporate tax rates to lower levels but might also affect negatively the stock of public capital. We build a general equilibrium model that illustrates the relation between the two variables. We then add an element of international tax competition. Our simulations show that when international tax competition drives the statutory tax rate down from 45% to 30%, public investment is reduced by 0.4% of output at the steady state. The short run effect is three times higher. The second part of our study displays an empirical analysis that corroborates the main outcome of the model. We estimate two policy functions for 21 OECD countries and find that corporate tax rate and public investment are endogenous. More precisely, a decline of 15% in the corporate tax rate reduces public investment by 0.6% to 1.1% of GDP. We also find evidence that international competition operates on both policy tools.

Keywords: Tax competition, Corporate tax, Public investment, Public capital

JEL Classification: H0, H26, H54

Suggested Citation

Gomes, Pedro M. and Gomes, Pedro M. and Pouget, Francois, Corporate Tax Competition and the Decline of Public Investment (August 21, 2008). ECB Working Paper No. 928, Available at SSRN: https://ssrn.com/abstract=1212130 or http://dx.doi.org/10.2139/ssrn.1212130

Pedro M. Gomes (Contact Author)

University of London - Economics, Mathematics and Statistics ( email )

United States

HOME PAGE: http://www.eco.uc3m.es/~pgomes/

Charles III University of Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

Francois Pouget

Université Paris IX Dauphine - EURIsCO ( email )

Place de Lattre de Tassigny
Paris, 75016
France

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