The Unemployment Puzzle of Corporate Taxation

Abstract

Using annual data on nineteen industrial countries for the period 1979–2005 and a large number of controls, this article is the first to empirically study the impact of corporate taxes on the unemployment rate. In contrast to previous empirical research on the labor demand, investment and growth effects of corporate taxation, which consistently finds adverse effects, the regression results suggest that higher corporate taxes may have a favorable impact, lowering the unemployment rate. The magnitude of the estimated effect is substantial. The results of this study are robust to both endogeneity and numerous variations in specification.

Impact of Corporate Taxation on Unemployment

“…The main variable of interest, EATR is highly significant and implies that for a 1% raise in the tax rate, unemployment is expected to rise by 0.4%, which is a large effect not fully captured by the fixed effects or the OLS model. This result directly contradicts the results of the other main study using a Feldmann (2011). Looking at the tests provided, the only problematic result is the Sargan test, but, as mentioned earlier, this test is unreliable under the conditions of heteroscedasticity that is expected to be severe due to structural governmental differences between countries.…”

“…This dummy should account for the theoretically dampening effect of free labour movement on unemployment rates. While there are a host of other control variables mentioned in the literature that could have also been included, which are used by Feldmann (2011), the use of system GMM imposes restrictions on the number of variables which may be included in the regression. The inclusion of each new variable requires that lags of the variable also be included into the instrument set.…”

“…To the best of the authors' knowledge, there have only been several empirical studies (Fuest et al 2015;Siegloch 2014;Feldmann 2011) whose main aim is to test for the relationship between corporate taxation and unemployment. The majority of other studies on the topic only indirectly study the effect on unemployment (or wages) as a byproduct of foreign direct investment (FDI) changes, or capital tax elasticity.…”

Unemployment, tax competition, and tax transfer policy

“…This belief is only valid in the model if . However, empirical evidence on the relation of employment to the corporate tax rate is controversial: Feld and Kirchgassner (2002), Bettendorf et al (2009), and Zirgulis and Sarapovas (2017) found that a rise in the corporate tax rate significantly increased unemployment levels while Feldmann (2011) showed that higher corporate taxes may lower the unemployment rate. Hence, we need to consider both possibilities in the analysis below.…”

“…The motivation for the tax reforms in OECD countries was the promotion of investment and employment via reductions in the corporate income tax rate, and many of the countries that lowered the tax rate did so via a series of cuts over several years (OECD, 2017). The reforms are supported by empirical evidence which shows that the corporate income tax rate affects the employment rate (e.g., Feld & Kirchgassner, 2002; Feldmann, 2011).…”