Economic Integration, Tax Erosion, and Decentralisation: An Empirical Analysis

Francesca Gastaldi,Paolo Liberati,Antonio Scialà

doi:10.2139/ssrn.1754430

Abstract

This paper addresses the issues of whether and how the degree of economic integration may affect central government tax revenues and the intensity of decentralisation. To this purpose, we empirically test the direct impact of economic integration on central tax revenues using the concept of implicit tax rates (ITRs) updated to take into account mobile and immobile capital taxation. On this basis we derive a country-specific measure of tax erosion that is used as a determinant of the decentralisation of the public sector in an Arellano-Bond environment. We find that: i) an increase of economic integration generates a downward pressure on ITRs on mobile capital, and growing at increasing rates as far as economic integration increases; ii) the process of tax erosion gives rise to a corresponding process of increasing public sector decentralisation.

Highlights

A large number of contributions that address the impact of international tax competition on public finance variables reveal that economic integration may introduce significant constraints on national public policies
The coefficients of OPEN and OPEN2 are both negative, signalling that an increase of economic integration may generate a downward pressure on implicit tax rates on mobile capital, and that this pressure may grow at increasing rates as far as economic integration increases
Suggests that if economic integration leads to a reduction of the tax burden on mobile tax bases, part of the compensating effect is likely to fall on labour, rather than on other tax bases

Summary

Introduction

A large number of contributions that address the impact of international tax competition on public finance variables reveal that economic integration may introduce significant constraints on national public policies. In these cases, the public sector is usually considered as a monolithic entity and the impact of economic integration analysed ‘as if’ states were unitary. Those studies that investigate the link between decentralisation and government size disregard the possibility that the vertical structure of the public sector may be affected by economic integration, analysing the issue ‘as if’ states were closed.. The main justification lies on the possibility that following increasing tensions on the use of central tax bases and on the levels of central public spending caused by wider economic integration, the central government might find convenient to decentralise both tax and spending powers as a way to spread responsibilities among government levels

Methods

Results

Conclusion