Capital Mobility, Agglomeration and Corporate Tax Rates: Is the Race to the Bottom for Real?

Based on a data set for 19 OECD countries for the period 1981–2001, we estimate the impact of FDI on corporate tax rates, where changes in FDI are a measure for changes in capital mobility. So far the literature has been concerned with the related but rather different question as to the sensitivity of FDI to tax rates. Our article takes an opposite perspective and asks what the impact of capital mobility is on corporate tax rates. In doing so, we explicitly take the role of agglomeration into account. In theory, core countries can afford a higher tax rate compared to peripheral countries. In our estimation strategy, we instrument capital mobility to deal with reverse causality. The main conclusion is that increased international capital mobility, measured by FDI flows, implies a lower corporate tax rate. But we also find that agglomeration matters: core countries have a higher corporate tax rate than peripheral countries. If there is a race to the bottom, it seems that it is more real for some countries than others. (JEL code: H25)