A Tale of Two Taxes: State-Dependency of Tax Policy

22 Pages Posted: 6 Sep 2019

See all articles by K. Peren Arin

K. Peren Arin

Zayed University

Emin Gahramanov

American University of Sharjah - Department of Economics

Tolga Omay

Atilim University, Department of Economics, Ankara, Turkey

Mehmet Ali Ulubasoglu

Deakin University - School of Accounting, Economics and Finance

Date Written: August 21, 2019

Abstract

Previous literature provided mixed evidence regarding the effects of two major tax instruments, namely, labor income taxes and corporate taxes on economic growth. We hypothesize that the mixed evidence may be due to state-dependency of labor taxes. While corporate taxes retard economic growth by discouraging entrepreneurship in a linear fashion, the negative effect of labor taxes on growth may depend on the state of the economy, and may, thus, be non-linear. We provide a simple theoretical model which supports the latter hypothesis, and empirically test our predictions by using both statutory and average tax rates for a sample of 19 OECD countries over the 1981–2005 period. We also contribute to the literature by employing a newly developed Panel Smooth Transition (PSTR) model that controls for non-linearities in the tax structure-economic growth relationship. Our empirical findings suggest that while taxes on corporate income are distortionary for growth in both high- and low-growth regimes, taxes on labor income are harmful only during the high-growth regime.

Keywords: Panel Smooth Transition, Fiscal Policy, Tax Policy, Growth

JEL Classification: O23, H30

Suggested Citation

Arin, Kerim Peren and Gahramanov, Emin and Omay, Tolga and Ulubasoglu, Mehmet Ali, A Tale of Two Taxes: State-Dependency of Tax Policy (August 21, 2019). CAMA Working Paper No. 68/2019, Available at SSRN: https://ssrn.com/abstract=3448862 or http://dx.doi.org/10.2139/ssrn.3448862

Kerim Peren Arin (Contact Author)

Zayed University ( email )

P.O. Box 4783
Abu Dhabi
United Arab Emirates

Emin Gahramanov

American University of Sharjah - Department of Economics ( email )

PO Box 26666
Sharjah
United Arab Emirates

Tolga Omay

Atilim University, Department of Economics, Ankara, Turkey ( email )

Kýzýlcaþar Köyü - Ýncek - Gölbaþý
Ankara, 06836
Turkey

Mehmet Ali Ulubasoglu

Deakin University - School of Accounting, Economics and Finance ( email )

Burwood, Victoria 3215
Australia
+61 3 9244 6592 (Phone)

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