Tax competition, tax policy, and innovation

Abstract

My research concerns how governments make economic decisions and interact with other governments, to increase social welfare; in particular, my focus lies in the area of taxation and technological innovation. In a globalized economy with mobile capital, increasing interest has been paid to capital tax policy. My research is among the first to examine empirically and explain theoretically the tax competition among states in the U.S. Moreover, I also study how state governments set their tax rates using historical data and explain why the pattern observed is different from the zero-tax theory. Due to the absence of state-level average capital tax rate data, I first construct a panel dataset of average capital income tax rates at the state level for the period 1958-2007 for the capital taxation studies. In Chapter 1, I analyze the tax policy of each individual state government. Empirical evidence implies that tax rates are history-dependent. I provide an alternative explanation for nonzero capital tax rate, reexamining Ramsey's (1927) rule. With a lack of commitment power from government, households form adaptive expectations on capital tax rates. The equilibrium capital tax rate is thus history-dependent with a balanced-budget requirement on state governments. The investment decision combines income and substitution effects, and the U.S. states differ on investment sensitivity to capital tax rates. I provide empirical findings on investment sensitivity for each state, and then a structural model is applied to replicate the empirical. In Chapter 2, I analyze the pattern of strategic interaction on capital tax rates among states in the U.S. This paper is the first to apply MLE estimation of the SAR panel data model with fixed-effects to study tax competition behavior. Through a joint investigation into both tax competition behavior and capital allocation decision, I demonstrate the existence of capital tax competition among states in the South and West, but competition is less significant in the Midwest and Northeast. I then apply a high-order SAR panel data estimation with fixed-effects to study the impact of population growth on tax competition, and results suggest that faster population growth significantly relates to stronger reaction to changes in neighbors' tax policy. I also apply two weighting schemes of neighbors to validate the findings. A two-period structural model with a saving decision is developed to explain this result. The model features a capital dilution effect which is also tested empirically. In Chapter 3, a quality ladder model is developed in which the technology gap between the North and the South is endogenously determined. A stronger intellectual property rights (IPR) in the South discourages imitation and reduces the FDI cycle length. The optimal IPR strength balances two effects, long-run and short-run effects, and it is non-monotonic in the market size and increasing in the number of imitating firms. The social welfare of the South is decreasing in the FDI cycle length, but is decreasing in IPR strength given cycle length.