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Title:Do Countries Compensate Firms for International Wage Differentials? PDF Logo
Authors:Mittermaier, Ferdinand
Rincke, Johannes
Issue Date:2010
Series/Report no.:CESifo working paper: Public Finance 3197
Abstract:We address the role of labor cost differentials for national tax policies. Using a simple theoretical framework with two countries competing for a mobile firm, we show that in a bidding race for FDI, it is optimal for governments to compensate firms for international labor cost differentials. Using panel data for western Europe, we then put the model prediction to an empirical test. Exploiting exogenous variation in labor cost differentials induced by the breakdown of communism in eastern Europe, we find strong support for the model prediction that countries with relatively high labor costs tend to set lower tax rates in order to attract mobile capital. Our key result is that an increase in the unit labor cost differential by one standard deviation decreases the statutory tax rate by 7.3 to 7.5 percentage points.
Subjects:foreign direct investment
corporate taxation
labor costs
JEL:H25
H73
F23
Document Type:Working Paper
Appears in Collections:CESifo Working Papers, CESifo Group Munich

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