Program > Papers by author > Avdiu Besart

Monday 12
B4 - Fiscal Policies and Behavior of Economic Agents I
Chair: Besart Avdiu
› 14:55 - 15:20 (25min)
› Room 005 - E. Jaques-Dalcroze
Capital and Labor Income Taxation in Small and Developing Countries
Besart Avdiu  1@  
1 : Goethe-University Frankfurt

This paper argues that smaller and poorer countries have lower optimal tax rates on labor and capital income than their larger and richer counterparts. The paper provides a new explanation for the empirically observed lower capital and labor tax rates in developing and lower capital tax rates in small countries. I argue that it may be optimal to have these tax differences, even in the absence of tax competition or informal sectors, which are current prominent explanations.

For the result, less than perfect competition is necessary. I draw on the dynamic capital taxation literature, which argues that optimal tax rates depend negatively on monopolistic markups. The intuition is that monopolistic markups distort markets in a similar way as taxes. Hence, optimal tax rates are inversely related to markups. By extending such models, I show theoretically that smaller and poorer countries have larger markups. Therefore, these countries have lower optimal tax rates. Hence, a low tax rate itself is insufficient to conclude a country in engaging in tax competition. These optimal tax rates, however, increase in response to a market expansion that lowers markups. Hence, a tax decrease in response to a market expansion or integration would imply deliberate tax competition in this model.

The model focuses on a closed economy, but is extended by introducing mobile capital. The paper relies on markups for intermediate goods. Hence, I examine data for the banking industry, as their services are often intermediate inputs. I find empirical support for the theoretically predicted markup differences.



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