Hippolyte d’Albis* and Agnès Bénassy-Quéré*

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In high-income countries, corporate tax rates have been substantially reduced since the 1990s. One common explanation for this is the tax competition that states engage in order to attract foreign investment. Financial globalisation leads governments to lower the tax load on capital and to shift the burden of public expenditure onto to other factors of production, in particular labour. Yet, the empirical literature struggles to prove a link between globalisation and the corporate income tax once the other factors that can affect capital taxation are accounted for, e.g. the ageing electorate. On the theoretical level, arguments pit a supposedly perfectly mobile capital against a supposedly perfectly immobile labour. However, capital is not perfectly mobile, while labour is more and more mobile: between 1997 and 2014, labour mobility among OECD countries increased by more than 40% and by even more if we count only the most highly qualified employees, or only movement within the EU. Greater labour mobility means a greater downward pressure on labour taxation. If workers leave taking part of their savings with them, the incentive to cut taxes on labour is even greater: in order to attract capital, workers must be attracted too. Analysis of the effect of globalisation on corporate taxation is therefore especially complicated.

In this article, d’Albis and Bénassy-Quéré revisit the theory of tax competition using a model of capital and labour taxation in which the two factors are likely to cross borders. They show that greater capital mobility reduces corporate taxation (with the tax burden moved on to labour) only in countries that are net exporters of capital, that is, those in which total overseas investments made by residents are greater than the total investments made within the country by non-residents. For these countries, greater capital mobility eliminates the taxation space they had enjoyed previously thanks to the abundance of domestic capital not invested in their economies. Empirical analysis of 29 OECD countries confirms the theoretical conclusion. The US and the UK currently envisage increasing their corporate tax rates and this new trend can be linked to the recent change in their net positions in terms of foreign direct investment: the two countries became net importers of capital in 2016 and 2017, respectively. According to the results reported in this article, they would thus have less incentive to cut corporate tax rates and instead let other incentives take over when deciding on their tax policies.



Original title of the article: Taxing capital and labor when both factors are imperfectly mobile internationally

Published in: International Tax and Public Finance (2021) – forthcoming

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Credits (picture): Brian A Jackson – Shutterstock

* PSE Member