Abstract
We study the effect of corporate taxation on unemployment utilizing a dynamic panel covering 41 countries over 11 years. The purpose of this article is to investigate how changes in the corporate income tax affect unemployment. We employ system general method of moments (GMM) due to peculiarities of the data set and the endogeneity issues present in the research problem. We find that a rise in the effective average corporate tax rate significantly increases unemployment levels, which directly contradicts past findings of some seminal authors. In addition, the present research supports findings of past studies on capital tax elasticity that obtained similar insights using differing methodologies. This research lays the groundwork for future studies, which may take the same methodology and apply it to even larger international panels. This research implies that international tax competition is affecting unemployment, presumably through its effects on international capital investment. These results provide support for policy makers who may be wary of raising corporate tax rates in countries where capital is especially mobile because of the negative effects which may accumulate to the voting public in the form of unemployment.
Highlights
The effect of corporate taxation on unemployment is much speculated but scarcely studied
The main variable of interest, effective average tax rates (EATR) is highly significant and implies that for a 1% raise in the tax rate, unemployment is expected to rise by 0.4%, which is a large effect not fully captured by the fixed effects or the OLS model
The main novel result of this research is that a rise in the expected average corporate tax rate is associated with increases in the unemployment rate
Summary
The effect of corporate taxation on unemployment is much speculated but scarcely studied. The purpose of this article is to investigate how changes in the corporate income tax affect unemployment. We begin with a thorough literature review, starting with works which indirectly look at the problem at hand by investigating how corporate tax changes impact investment. These works infer that changes in investment have an effect on unemployment. We review the much smaller body of literature on studies which directly test the relationship between corporate or capital tax rates and unemployment. We present the results of our regressions along with analysis. In the conclusions section we present some limitations along with possible implications for policy makers
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