A spatial model of corporate tax incidence

Abstract

Using a unique, self-compiled data-set on international tax rates, we explore the link between taxes and manufacturing wages for a panel of 66 countries over 25 years. We find, controlling for other macroeconomic variables, that wages are significantly responsive to corporate taxation. Higher corporate tax rates depress wages. Using spatial modelling techniques, we also find that tax characteristics of neighbouring countries, whether geographic or economic, have a significant effect on domestic wages. We test for, and reject, spatial autocorrelation in our model using a modification of the Moran-I test statistic that accounts for country-specific fixed effects in a panel data setting. Our article fits in with the new economic geography literature as well as the urban economics literature which attempt to explain the spatial distribution of wages.

Keywords:

• corporate tax
• incidence
• spatial model
• wages

JEL Classification:

• F21
• H2
• J3
• C3

Notes

¹ See Auerbach (2005) for a more recent analysis of who bears the burden of the corporate tax.

² AEI International Tax Database.

³ Other recent papers model how countries can choose to set tax rates to attract foreign firms in such a way that they either compensate for high labour costs as measured by higher wages or rigid labour markets, as measured by a higher degree of unionization. These are Haufler and Mittermaier (2011) and Mittermaier and Rincke (2012), respectively.

⁴ This is not a balanced panel, since data on taxes are missing for several countries, both OECD and non-OECD. The list of countries includes Australia, Austria, Azerbaijan, Belgium, Bulgaria, Bolivia, Brazil, Botswana, Canada, Switzerland, Chile, China, Croatia, Colombia, Costa Rica, Cyprus, Czech Republic, Denmark, Dominican Republic, Ecuador, Spain, Estonia, Finland, France, Great Britain, Germany, Ghana, Guatemala, Hungary, Iceland, Israel, Italy, Jamaica, Japan, Kazakhstan, Kenya, Kyrgyzstan, South Korea, Lithuania, Latvia, Mexico, Mauritius, Malaysia, Nicaragua, Netherlands, Norway, New Zealand, Pakistan, Panama, Philippines, Poland, Portugal, Paraguay, Romania, Russia, Singapore, Slovakia, Slovenia, Thailand, Trinidad and Tobago, Turkey, Ukraine, United States, South Africa, Zambia, Zimbabwe.

⁵ Access to the AEI International Tax Database can be provided by writing to the authors.

⁶ We use 5-year averages in order to study changes over long periods. In addition, it allows us to deal with cyclicality and measurement errors in the wage data.

⁷ To calculate EATR and EMTR, we assume an economic depreciation rate of 12.25%, a real annual discount rate of 10% and an expected annual inflation rate of 3.5% for all countries and all years. These are the assumptions made by Devereux et al. (2002). Author calculations are available upon request.

⁸ http://homepage.newschool.edu/~foleyd/epwt/. The data have been compiled by Adalmir Marquetti from the Penn World Table and other sources.

⁹ This is not ideal since manufacturing is more capital intensive than other sectors, and therefore may be more responsive to capital costs than other sectors. However, we are unaware of a cross-country data source for manufacturing capital-labour ratios.

¹⁰ These results are not presented, but are available upon request.

¹¹ Note that a regression of the contemporaneous corporate tax variable on lagged values of corporate tax rates yields a significant coefficient only on the 1-year lag. Hence we use that as an instrument rather than longer lags of the corporate tax variable.

¹² Results available upon writing to the authors.

¹³ See Bloningen et al. (2005) and Franzese and Hays (2005) for an application of different spatial weighting matrices.

¹⁴ Immigration and trade flow linkages are likely to be better captured by using within region income weights rather than across regions, since geographic distance increases the costs of labour mobility and transportation of goods.

¹⁵ Distances are calculated as the physical distance between two capital cities.

¹⁶ Lee and Gordon (2005) estimate the impact of corporate taxes on economic growth. They use neighbour tax rates as instruments for the domestic tax rate. We believe this is incorrect since both variables may have independent effects on growth and wages, and both therefore need to be included in the regression.

¹⁷ Measured by the number of ILO conventions ratified by the country or the per cent of workers covered by collective bargaining agreements.

¹⁸ Measured by enrolment at different levels of schooling, such as primary, secondary and tertiary (ILO).

¹⁹ Measured as the estimated number of personal computers in use as a fraction of the population, available from ILO.

²⁰ In addition, we tested our model using different specifications to see if the results were robust. For example, we tested to see if our results were significantly different for small economies as opposed to large economies. The intuition for this is that relatively small economies are much more likely to experience a sudden spurt in productivity and wages as a result of increased capital investment as compared to the richer economies that have capital stocks relative to the world supply of investment. Hence we should expect to see a larger impact of corporate taxes on wages in these small economies, in terms of a larger size estimate of the coefficient on tax rates. Therefore we ran a regression with the highest income economies excluded from the sample. As we expected, the coefficient on the corporate tax rate increased to −0.965 from its value of −0.781 in Column (1) of Table 2. These results suggest that at least in the medium to short run (in the 5-year period used in the sample), smaller economies are significantly more likely to respond to corporate tax rates and see visible changes in productivity and wage rates. In other specifications, we added in a measure of average personal taxes in the regression.

²¹ We would like to thank Harry Kelejian for his help in developing this statistic for panel data models with fixed effects. Additional details can be provided upon writing to the authors.

²² It is also interesting that when we include capital-labour ratios in the wage equation, the effect of neighbour country and own tax rates becomes insignificant. This suggests that tax rates are important to the extent that they influence capital formation and affect worker productivity, and thereby affect wages. However, the fact that controlling for K/L makes the coefficients insignificant implies that they are unlikely to have other direct impacts on wages.