Learning and International Policy Diffusion – The Case of Corporate Tax Policy ∗

A recent empirical literature has arisen documenting the response of one nation’s policy choices, including tax, environmental, and labour policies, to those of others. This has been largely interpreted as evidence of competition, be it for mobile resources (like FDI, taxable book income, etc.) or yardstick. We present a third explanation based on learning. When countries’ tax choices reflect private information about unobserved conditions, this encourages nations to update their policies not in order to retain investment or manipulate trade flows, but because the new information conveyed by overseas tax rates allows them to fine-tune their own policies. With this “social learning”, countries converge on their optimal policies faster than in isolation. Furthermore, this convergence implies a pattern of policy convergence often attributed to competition for mobile resources. The benefits of social learning are smaller in the presence of policy adjustment costs although welfare remains higher than learning in isolation. In addition, adjustment costs result in inefficient policy adjustment because countries do not internalize the benefits conveyed by their own adjustments to other nations. We further show that these baseline results are robust to alternative network architectures, the choice of which can be used to replicate stylized facts found in the empirical tax competition literature. Finally, we discuss additional applications of social learning with adjustment costs well beyond the international tax debate. JEL classification: H25, H32, H87