Tax Competition and Employment

Abstract

We examine how exposure to international tax competition affects domestic firms’ employment. Consistent with prior work, we find evidence that reductions in foreign tax rates affect the domestic competitive environment via increases in import competition and investment in foreign-owned subsidiaries. We posit that these changes in the domestic competitive environment can cause managers to reduce their firms’ employment levels. Consistent with our expectation, we find that relative decreases in foreign tax rates negatively affect total labor compensation at domestic firms ex ante exposed to import competition and competition from foreign-owned peers. The effect of exposure to tax competition is greater for firms more exposed to product-market competition and those that are less able to expand investment without also increasing employment levels. Taken together, our results suggest that foreign tax rate changes can affect managers’ domestic employment decisions by changing the domestic competitive environment. JEL Classifications: E24; F14; F16; H23; H35.