Testing the Tax Competition Theory: How Elastic are National Tax Bases in Western Europe?

SFB International Tax Coordination Discussion Paper No. 29

31 Pages Posted: 18 May 2008

See all articles by Aleksandra Riedl

Aleksandra Riedl

Vienna University of Economics and BA - Institute for Economic Geography and GIScience

Silvia Rocha-Akis

Vienna University of Economics and Business - Department of Economics

Date Written: November 6, 2007

Abstract

In this paper, we test one of the fundamental assumptions in the tax competition literature, namely, that a country's taxable income depends on the tax policies pursued in the domestic and in neighbouring countries. Based on a panel of annual data of 14 western European countries spanning the period 1982 to 2004, we show that the common trend in falling corporate income tax (CIT) rates can in part be explained by the existence of fiscal externalities in the form of international resource flows. Our results confirm the presumption put forward in recent empirical tax reaction function studies, that interdependent tax setting behaviour is evidence of tax competition. However, taxable corporate income is shown to react inelastically to domestic and to foreign tax rates. Thus, the observed rise in CIT revenues in Europe between 1982 and 2004 cannot be explained by the trend in falling CIT rates. Moreover, we find that large countries' tax bases are more responsive to neighbouring countries' tax policies, which is in contrast to the classic asymmetric tax competition literature.

Keywords: tax competition, corporate income tax base elasticity, asymmetric countries, instrumental variables, spatial econometrics

JEL Classification: H71, H72, H77, H87, C21, C23

Suggested Citation

Riedl, Aleksandra and Rocha-Akis, Silvia, Testing the Tax Competition Theory: How Elastic are National Tax Bases in Western Europe? (November 6, 2007). SFB International Tax Coordination Discussion Paper No. 29. Available at SSRN: https://ssrn.com/abstract=1133088 or http://dx.doi.org/10.2139/ssrn.1133088

Aleksandra Riedl (Contact Author)

Vienna University of Economics and BA - Institute for Economic Geography and GIScience ( email )

Nordbergstra├če 15
A-1090 Wien
Austria

Silvia Rocha-Akis

Vienna University of Economics and Business - Department of Economics ( email )

Augasse 2-6
A-1090 Wien
Austria

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