Abstract
Preferential Trade Agreements (PTAs) affect both the pattern of trade and the location choices of Foreign Direct Investment (FDI). Thus, the formation of a PTA may have adverse effects on the excluded countries and result in inter-regional tax competition. Nonetheless, this connection has not so far been fully analysed in the literature. This thesis is an attempt to fill in this gap in the theoretical literature by examining the effects of the formation of a PTA on the location of industry and welfare of the countries involved, as well as investigating the impact of subsequent policy responses that may arise as a result of the adverse effects of the formation of a PTA.We motivate our theoretical analysis we first conduct a preliminary empirical study to investigate whether a recent decline in the statutory rates of corporation income tax (CIT) is caused by tax policy interactions among countries. To do so, we use data for 21 EU countries from 2000 to 2009 to carry out an econometric analysis of tax policy interactions among EU countries. Our results support the hypothesis that some European countries’ governments used statutory CIT rates to compete against other countries. We also find that, at the individual country level, the high personal income tax rate countries use the effective marginal tax rate while the lower personal income tax rate countries use the CIT rate to compete over attracting investment.
We then construct a three-country general equilibrium model based on the New Economic Geography approach to analyse the possible effects of the formation of a PTA as well as the effects of the subsequent policy responses. We consider the situation in which two of the countries form a PTA and the third country acts as the ‘rest of the world’. The simulation results suggest that:
- An eradication of intra-tariff between PTAs member countries always attracts investments from the excluded country.
- A rise in the external tariff rate - by the excluded country – is not an effective policy to retain investments, where firms already agglomerate in PTA area.
- The excluded country’s government has no incentive to reduce its CIT rate if the external tariffs are sufficiently high.
Our theoretical setup also enables us to show that PTA member countries may respond to the reduction of the excluded country’s CIT rates. Specifically, the scenario in which only one of the member countries engages in tax competition with the excluded country, while another member keeps imposing its status quo CIT rate, the most innovative part of our contribution, can be used to explain the difference in CIT rates observed within the EU in which, in the presence of virtually free intra-EU trade, some members impose very low CIT rates and are able to attract a large portion of investments whilst other EU countries choose to maintain higher CIT rates.
| Date of Award | 2013 |
|---|---|
| Original language | English |
| Supervisor | Catia Montagna (Supervisor) & Hassan Molana (Supervisor) |