Corporate Tax Competition and Public Capital Stock

This paper argues that the governmental decisions on corporate tax and public capital stock are not independent. In order to explain this relationship, we have built a general equilibrium model of corporate tax competition where governments supply public capital and compete for corporate profits. When international tax competition drives the statutory tax rate down from 50% to 30%, public capital stock goes down by 10% of GDP. To confirm this relation, we estimate two policy functions for 18 OECD countries. We find that corporate tax rate and public investment are endogenous and that a decline of 20% in the corporate tax rate, driven by competition, reduces public investment by 0.5% to 0.9% of GDP. We also find evidence that there is international competition in both policy tools and that tax competition increases with the degree of openness of the economy.