Tax and Public Input Competition

45 Pages Posted: 26 Mar 2007

See all articles by Agnès Bénassy-Quéré

Agnès Bénassy-Quéré

Paris School of Economics (University Paris 1)

Nicolas Gobalraja

Université Paris X

Alain Trannoy

National Center for Scientific Research (CNRS) - Ecole des Hautes Etudes en Sciences Sociales (EHESS)

Abstract

The debate on tax competition lacks due attention when it comes to the provision of public goods used by firms in their production process. Indeed, firms may accept higher corporate taxation provided they enjoy good infrastructure and public services. We quantify such trade-off, i.e. the extent to which a 'high tax, high public goods' strategy is attractive to capital as compared to a 'low tax, low public goods' combination. We revisit and develop the popular model of tax competition introduced by Zodrow and Mieszkowski (1986) in a way that allows for the testing of its main prediction. The under-provision of public inputs can be tested econometrically by estimating and comparing two simple elasticities: capital with respect to the tax rate, and capital with respect to public inputs. We regress US foreign direct investment in 18 EU countries over 1994-2003 on several variables, including the corporate tax rate and the stock of public capital, used as a proxy for public input. Based on these estimations (-1.1 for the tax elasticity and +0.2 for the public input elasticity), we conclude that raising public input through an increase in the corporate tax rate reduces inward FDI, and that tax competition may indeed lead to an under-provision of public inputs. Furthermore, a 'high' equilibrium (high taxation and high level of public input) is not attainable for a country starting from a 'low' equilibrium unless households have a strong preference for public inputs. On the whole, the impact of tax competition may be more diverse than a mere 'race to the bottom'.

Suggested Citation

Benassy-Quere, Agnes and Gobalraja, Nicolas and Trannoy, Alain, Tax and Public Input Competition. Economic Policy, Vol. 22, No. 50, pp. 385-430, April 2007. Available at SSRN: https://ssrn.com/abstract=976083 or http://dx.doi.org/10.1111/j.1468-0327.2007.00179.x

Agnes Benassy-Quere (Contact Author)

Paris School of Economics (University Paris 1) ( email )

106-112 boulevard de l'Hopital
Paris, F-75013
France
+33 1 44 07 82 19 (Phone)

HOME PAGE: http://www.parisschoolofeconomics.com/benassy-quere-agnes/agnesb.html

Nicolas Gobalraja

Université Paris X

Room G301, Building G
92001 Nanterre Cedex, 92001
France

Alain Trannoy

National Center for Scientific Research (CNRS) - Ecole des Hautes Etudes en Sciences Sociales (EHESS) ( email )

54, boulevard Raspail
Paris, 75006
France

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