Tax competition describes a situation where the fiscal activities in one jurisdiction induce fiscal externalities in other jurisdictions. The theory of international tax competition suggests that this competition leads to a tendency to abandon capital taxes. Since most governments are interested in maintaining the level of public expenditure, they will raise taxes on immobile factors, in particular labor. Because a small country faces a higher elasticity of capital supply, the capital tax rate in a small country should be lower than the capital tax rate in a large country.*

In Has Tax Competition Emerged in OECD countries? Evidence from Panel Data Hannes Winner assessed these hypotheses by estimating the impact of two important components of tax competition, capital mobility and country size, on the taxation of factor incomes. Empirically, he (i) utilized a data set of 23 OECD countries between 1965 and 2000, (ii) calculates average effective tax burdens on capital and labor (actual revenue of taxes on factor income related to the relevant tax base), (iii) adopts a measure of capital mobility based on saving-investment correlations**, and (iv) estimates a static (HAC and outlier corrected) and a dynamic panel data model (GMM, see Arellano and Bond 1991) to capture the short- and long run effects of tax competition.


Some sign and asterisk econometrics: Tax competition in terms of capital mobility has a significant negative (short and long run) impact on capital tax burden, and significantly positive effect on labor tax burden in the static model. Further, a positive (short and long run) relationship between country size (population relative to US population) and tax burdens on factor incomes exists. My only concerns: First, I'd like to take a closer look at the capital mobility series. Otherwise not much can be said about the economic significance of the coefficients. Second, most of the increase of the average effective tax rate on labor is due to increases in social security contributions. This makes the interpretation harder. Third, GDP in levels was included as a control variable. This doesn't make too much sense to me.

Hannes Winner also investigates whether tax competition has intensified over time. For this purpose, he estimates the static model using interaction effects between capital mobility and the fixed time effects (typo in paper?):

The results are as follows (A negative (positive) entry indicates a negative (positive) effect of capital mobility on factor income taxes in the corresponding year (the dotted points denote significance at least at the 10% level): θ_t:

He finds that the negative impact of capital mobility on capital tax burden has increased markedly in recent years. Up to the mid 1980’s there are no significant effects of capital mobility on capital tax burden. Since then one can observe negative coefficients throughout, which confirms the widely held belief that tax competition has intensified in recent years. With respect to labor taxation, however, no such clear picture can be identified.

*An intuitive explanation, put forth by Kanbur and Keen (1993) for commodity taxation, is that by lowering its tax rate the small country attracts more capital in per capita terms, which in turn improves the welfare position of its residents by a larger extent than for residents of large countries.

** "With perfect world capital mobility there should be no relation between domestic saving and domestic investment: Saving in each country responds to the worldwide opportunities for investment while investment in that country is financed by the worldwide pool of capital“ (Feldstein & Horioka (1980), p. 317). Winner's measure for capital mobility is the Euclidean distance between the domestic savings ratio and the domestic investment ratio.