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Optimal capital and labor income taxation in small and developing countries

Besart Avdiu

MPRA Paper from University Library of Munich, Germany

Abstract: This paper argues that smaller and poorer countries have lower optimal tax rates on capital and labor income than their larger and richer counterparts. It further provides an alternative explanation for such empirically observed differences in tax rates. The model focuses on a closed economy, but is extended by introducing mobile capital. The difference in tax rates here is efficient and not due to tax competition. For the result, less than perfect competition is necessary. The intuition is that monopolistic markups distort markets in a similar way as taxes. Hence, optimal tax rates are inversely related to markups and I show theoretically that smaller and poorer countries have larger markups. Therefore, these countries have lower optimal tax rates. Since smaller and poorer countries face larger competition distortions, there is less space for tax distortions. Hence, a smaller tax rate itself is insufficient to conclude a country is engaging in tax competition. Empirical analysis of the banking industry also shows that smaller and poorer countries have larger markups.

Keywords: Optimal Taxation; Monopolistic Competition; Developing Countries; International Fiscal Issues; Tax Competition (search for similar items in EconPapers)
JEL-codes: D43 H21 O23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-pbe and nep-pub
Date: 2018-03-01
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https://mpra.ub.uni-muenchen.de/84884/1/MPRA_paper_84884.pdf original version (application/pdf)
https://mpra.ub.uni-muenchen.de/89266/1/MPRA_paper_89266.pdf revised version (application/pdf)

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