Part 1 - AL-Tax

International Taxation Handbookconfer comparative advantages in differing productive activities, which, as Mosherand Franzese (2002) elaborated, implies that, if international tax competitionremains sufficiently muted, capital mobility and trade integration would spurinstitutional and policy specialization, which, in this context, means crossnationalwelfare/tax-state variation rather than convergence or global retrenchment.Swank (2002) argued that the institutional structure of the polity and of thewelfare/tax system itself shape domestic policy responses to capital (and trade)integration. We review such arguments and offer a preliminary evaluation, specifyingempirical models that, unlike these and other previous efforts, embody thespatial relationships central to such diffusion processes.Two recent studies (Hays, 2003; Basinger and Hallerberg, 2004), however, dorecognize the strategic interdependence implicit in tax-competition arguments andincorporate the implied spatial interdependence into their empirical analyses. 1As we show elsewhere (Franzese and Hays, 2004, 2006) and will summarize later,though, least-squares estimation of such spatial empirical models (S-OLS) suffersimportant statistical flaws that, in particular, jeopardize any conclusions drawnfrom hypothesis tests related to the crucial parameter, the coefficient on the ‘spatiallag’, which gauges the strength of interdependence. We reanalyze Hays’s (2003)model by an alternative estimation strategy, spatial two-stage-least-squaresinstrumental variables (S-2SLS-IV) that, in our previous Monte Carlo experiments,produced unbiased hypothesis tests.3.2 Globalization, tax competition, and convergenceIn theory, strong inter-jurisdictional competition undermines the tax-policyautonomy of individual tax authorities, inducing tax rates to converge, especiallythose levied upon more mobile assets. Such inter-jurisdiction competition intensifiesas capital becomes more liquid and more mobile across borders. Indeed,many scholars of domestic and international fiscal competition (e.g. Zodrow andMieszkowski, 1986; Wilson, 1986, 1999; Wildasin, 1989; Oates, 2001) expectsuch intense inter-jurisdiction competition to engender a virtually unmitigatedrace to some (ill-defined: see below) bottom. As a central exemplar, most scholarlyand casual observers see the striking post-1970s rise in international capitalmobility and steady postwar increase in trade integration as forcing welfare- andtax-state retrenchment and a shift in tax-burden incidence from relatively mobile(e.g. capital, especially financial capital) toward more immobile (e.g. labor, especiallyless-flexibly-specialized types). 2 Growing capital-market integration and46