Federico Revelli University of Torino

1. Tax havens and tax competitionBocconi University, June 18-19 2007Setting the research agenda:What empirical tests would distinguish among theoretical models? Federico Revelli University of Torino

2. From theory to empirics:2 main issues 1) Model specification issue: What are the distinguishing features of alternative tax competition theoretical models? In particular, what is the role of the tax system? 2) Econometric issue: Can common “environmental” shocks be separately identified from substantive patterns of fiscal competition?

3. 1) Model specification issue Most existing empirical tax competition literature: • Tax base determination equation: elasticity of mobile tax bases to (corporate) tax rates: bit = b(it,…,fi, ht) • Tax setting equation: determinants of (corporate) tax rates, with two variants: • implicit test of tax competition: “internal” determinants only it = (xit,…,fi, ht) • explicit test of tax competition: tax reaction function, including the tax rates of “competing” countries on the rhs it = (nt,…,fi, ht) n i

4. Origins of that empirical specifications: Pigou tradition benevolent governments Public Choice tradition Leviathan governments & refinements “constrained” governments Role of the tax system: revenue-raising Unifying approach putting the 2 views in one framework: “policy-makers are neither wholly benevolent nor wholly self-serving” Edwards and Keen (1996) Still, the role of the tax system: revenue-raising

5. Tax competition in an incomplete information setting Model with mobile resources and incomplete information (policy-makers’ quality, competence, honesty unknown)  political process: selection and discipline (Besley and Smart, 2007) Role of the tax system: 1) revenue-raising tax competition (location) 2) signaling yardstick competition (reputation) • key issue in empirical tax competition research: modeling and identifying the two roles of the tax system

6. Empirical implications: • “world of multiple taxes” (Desai, Foley and Hines, 2004) and multiple signals (e.g., direct & indirect taxes in tax base equation) • “optimal tax mix” (on mobile and immobile factors) (Haufler, Klemm and Schjelderup, 2006) (e.g., testing the backstop hypothesis in tax setting equation) • “political environment” (e.g., institutions, constraints, incentives: Janeba and Schjelderup, 2006; Bordignon, Cerniglia and Revelli, 2003)

7. 2) Econometric issueit = (nt,…,fi, ht) n i • “international reflection” problem: reaction to a common changing environment versus interaction due to competition (Devereux, Lockwood and Redoano, 2004); • some assumptions need to be imposed either on the pattern of interactionor on the pattern of environmental shocks; • scepticism about the “reduced-form” tax reaction function approach; • need an empirical representation “in structural form” (Ghinamo, Panteghini and Revelli, 2007), modelling tax setting along with the behavioural responses to taxation.

8. Ghinamo, Panteghini and Revelli (2007) • Related literature: empirical tests of tax competition at international level (Devereux, Lockwood, Redoano, 2002; Slemrod, 2004; Winner, 2005; …) • Aim is to add to that literature in 2 ways: 1) impact of “volatility” on corporate tax setting policy; 2) move towards a more “structural” approach • Theoretical framework (Panteghini and Schjelderup, ITPF, 2006): option pricing model where increased volatility lowers equilibrium tax rates • Volatility variables: real interest rate, exchange rate, GDP, plus “political uncertainty” • Sample of 51 countries for about 20 years (1983-2003)

9. Reduced form model: (1) τit = ρτit-1 + xit′β + vit′φ + fi + ht + εit where: τit = top statutory corporate income tax rate xit = determinants of corporate tax setting policy (including a measure of “openness”) vit′ = various measures of economic and political volatility

11. Structural form model: (1) τit = ρτit-1 + αbit + xit′β + fi + ht + εit (2) bit = vit′φ + zit′ + κτit-1 + gi + mt + ηit where: τit = top statutory corporate income tax rate bit = flow of FDI to country i in tear t vit′ = various measures of economic and political volatility

13. Main findings • economic volatility (interest rate and exchange rate, but not GDP) discourages FDI inflow and exerts a negative effect on corporate tax rates; • political volatility has little effect; • “openness” has a positive effect on the inflow of FDI and a negative effect on tax rates: taken together (in a reduced form) these effects tend to cancel each other out.