The Growth Effects

Recent aggregate tests of the impact of taxes on long-run growth rates in OECD countries remain vulnerable to two criticisms. First, they typically use ‘an aggregate average rate, or constructed marginal rate, that probably does not affect the rate that any particular economic decision maker is facing’ (Myles, 2007, p.89). Second, despite increased testing of corporate tax effects, the models examined are essentially ‘closed economy’ in nature, yet corporate tax effects appear increasingly to operate via international competition for firms, profits and investment. Based on an open economy model, we propose a method for testing how far both domestic corporate tax settings, and those in competitor countries, affect individual countries’ aggregate long-run growth rates. This predicts asymmetric effects between ‘high tax’ and ‘low tax’ competitor countries. We then use annual panel data on statutory tax rates (both personal and corporate), and effective average and marginal corporate tax rates, to test for these tax-growth effects in a sample of OECD countries. We find robust evidence that (i) marginal rates of personal income tax (as measured by the top personal rate); and (ii) both domestic and foreign corporate tax rates (statutory and/or effective), have affected OECD growth rates as predicted by theory. (iii) The predicted asymmetric effects find strong empirical support. Our evidence suggests that ‘bucking the OECD trend’ towards lower corporate tax rates is likely to be growthretarding, but joining it is likely to be growth-neutral. The evidence also suggests that tax effects on growth operate through both factor accumulation and factor productivity. * University of Nottingham, UK; + The Treasury, New Zealand; ** Universidad Rey Juan Carlos, Madrid, Spain.