Are Consumers Paying the Bill? How International Tax Competition Affects Consumption Taxation

This paper empirically investigates whether governments are substituting from corporate to consumption taxation due to tax competition using a novel self-collected data set of corporate and consumption tax regime information. I estimate the slope of the tax policy reaction function between corporate and consumption tax rates exploiting the cross-sectional interdependence of corporate tax rates for an instrumental variable approach. Additionally, I analyze the rate-revenue relationship of both tax instruments to evaluate the overall revenue implications of corporate tax competition. I find that, on average, a one percentage point decrease in the corporate tax rate leads to a 0.35 percentage point increase in the consumption tax rate. The rate-revenue relationship of both corporate and consumption tax rates follows an inverted U-shape. Furthermore, governments can fully compensate for revenue losses from tax competition by substituting to consumption taxation. These results indicate that the debate on corporate tax competition may overstate efficiency considerations and underestimate equity concerns.