The growth effects of corporate and personal tax rates in the OECD

Recent aggregate tests of the impact of taxes on long-run growth rates in the OECD countries remain vulnerable to two important criticisms. First, they typically use 'an aggregate average rate, or constructed marginal rate, that probably does not affect the rate that any particular economic decision maker is facing' (Myles, 2007, p.89). Second, despite increased testing of corporate tax effects, the models examined are essentially 'closed economy' in nature, yet corporate tax effects appear increasingly to operate via international competition for firms, profits and investment. This paper confronts both these criticisms with new data and new methods. Based on an open economy model, we propose a method for testing how far both domestic corporate tax settings, and those in competitor countries, affect individual countries' aggregate long-run growth rates. This predicts asymmetric effects between 'high tax' and 'low tax' competitor countries. We then use annual panel data on statutory tax rates (both personal and corporate), and effective average and marginal corporate tax rates, to test for these tax-growth effects in a small sample of similar OECD countries. Unlike most previous studies, these are not constructed from data on tax revenues. We find evidence that: (i) using the best available exogenous tax rates, there is evidence of statistically robust, but economically small, GDP growth effects from changes in marginal rates of both personal and corporate income tax;(ii) domestic and foreign corporate tax rates (statutory and/or effective) have affected OECD growth rates in the asymmetric manner predicted by theory;(iii) 'bucking the OECD trend' towards lower corporate tax rates is likely to be growth-retarding, but joining it is likely to be approximately growth-neutral.(iv) tax effects on growth appear to operate largely via impacts on factor productivity rather than factor accumulation.