The Impact of Trade Integration and Agglomeration Economies on Tax Interactions : Evidence from OECD Countries

Abstract

In average, statutory tax rates in OECD countries fell over 34,84% between 1982 and 2005. While the seminal papers on tax competition explain this fall in corporate tax rates by greater capital mobility, we build on the New Economic Geography literature to investigate empirically the impact of trade integration on tax competition. We use the disaggregated Trade and Production Database of the CEPII to build an index of trade phi-ness following the method of Head and Mayer (2004a). Firstly, we show that trade integration matters for the tax policy through two channels: (i) on the one hand trade integration reinforces tax interactions and accelerates the race to the bottom in corporate taxe rates, but (ii) on the other hand trade integration makes it possible for countries to set higher corporate tax rates as it improves their market access. We show that the second e¤ect becomes insigni...cant when we control for the ...rst one. This indicates that the overall impact of trade integration on corporate tax rates is negative and could explain the negative relationship between trade integration and corporate tax rates that we observed in OECD countries between 1983 and 1999. Secondly, we show that countries do not have the same ability to limit their dependence on other countries'...scal policy. More precisely, the ability of a country to set a high corporate tax rate increases with its market size and its market access, but decreases with the degree of its government involvement in the wage-setting.