Part 1 - AL-Tax

International Taxation Handbookand refer them to our Monte Carlo experiments to decide for themselves which orwhich combination of estimates they prefer, as none statistically dominates.3.5 Spatial-lag empirical models of capital-taxcompetitionAlthough all theoretical models of and arguments regarding tax competitionclearly, indeed inherently, imply the spatial interdependence of capital taxes,few scholars have empirically modeled such interdependence directly. Two recentexceptions (Hays, 2003; Basinger and Hallerberg, 2004), however, do estimatespatial-lag models of international capital-tax competition, using S-OLS. In thenext section, we discuss the empirical work in these two papers and then conducta reanalysis of the regression models in Hays (2003). Our empirical resultssupport the conclusion of strong international interdependence in capital-taxpolicy.Hays (2003) argued that the effect of globalization – specifically, increasedinternational capital mobility – on a country’s capital tax rate depends on its capitalendowment and political institutions. Thus, his theoretical argument is of theOE-CPE variety. An exogenous increase in international capital mobility affectsthe capital tax rate in two ways. First, it shifts the revenue-maximizing tax ratedownward. Second, by making the supply of capital more elastic, it increases themarginal gain from increasing (decreasing) the capital tax rate when it is below(above) the revenue-maximizing level. How much globalization reduces therevenue-maximizing tax rate depends on a country’s capital endowment: The dropis large for capital-rich countries and relatively small for capital-poor ones. Theimpact of increasing the elasticity of the supply of capital on tax rates, conversely,is a function of a country’s political institutions. In brief, the capitalsupplyelasticity determines the marginal revenue gain from changing tax rateswhile political institutions determine the marginal cost of changing tax rates.Hays’s theoretical argument explains why increased international capital mobilitywill have the greatest negative impact on capital-tax rates in relatively closedand capital-rich countries with majoritarian political institutions (e.g. the UK).To test this hypothesis, Hays estimated a spatial-lag model with a temporal lagand country-fixed effects. The Mendoza et al. (1997) capital-tax rates are thedependent variable; The key independent variables are the degree of capitalmobility – measured by Quinn’s (1997) indices of capital and financial openness –and capital mobility interacted with a measure of each country’s capital endowment60