nr 113 - Capital Mobility, Agglomeration and Corporate Tax Rates: Is the Race to the Bottom for Real?

DNB Working Papers
Date 14 September 2006

Based on a data set for 19 OECD countries for the period 1981-2001, we estimate the impact of capital mobility (FDI) on corporate tax rates. So far the literature has been concerned with the related but rather different question as to the sensitivity of FDI to tax rates. Our paper takes an opposite perspective and asks what the impact of capital mobility is on corporate tax rates. In doing so, we explicitly take the role of agglomeration into account. In theory, core countries can afford a higher tax rate compared to peripheral countries. In our estimation strategy, we instrument capital mobility to deal with reverse causality. The main conclusion is that increased international capital mobility implies a lower corporate tax rate. But we also find that agglomeration matters: core countries have a higher corporate tax rate. If there is a race to the bottom, it seems that it is more real for some countries than others. Key words: new economic geography, corporate income taxation, capital mobility JEL Codes: F12, F20, H32