What Drives Corporate Tax Rates Down? A Reassessment of Globalization, Tax Competition, and Dynamic Adjustment to Shocks

We reassess the driving forces behind the recent decline of corporate tax rates in Europe. Using data for up to 32 countries from 1983 to 2006, we analyze the roles of economic and financial openness as well as tax competition, while allowing for dynamic adjustment to shocks and period-specific and country-specific effects. While there is no evidence that countries that have become more open have reduced their tax rates more, our findings suggest that countries strongly compete over statutory tax rates. A simulation of tax rates in a scenario with no cross-sectional dependence in tax setting suggests that, in the absence of tax competition, the mean statutory tax rate of Western European countries in 2006 would have been about 12.5 percentage points above its actual level. We conclude that the recent downward trend in corporate taxes is mainly a result of tax competition.