Contribution

The purpose of all research is scientific progress. My dissertation builds on valuable insight of the literature on taxation and tax competition, but transcends existing approaches in several aspects in order to provide a more comprehensive explanation of how governments decide upon domestic taxation and why they implement distinct tax systems. Though I do not claim that all my arguments and assumptions are entirely new, I am not aware of another model which combines and augments different lines of reasoning into an equally comprehensive model of taxation, which is able to explain the variation in tax systems across OECD countries and at the very same time provides a convincing answer to the important question why capital taxes persist.

It is not novel to the discussion of the effects of tax competition that domestic constraints prevent governments from setting very low tax rates on mobile factors. Especially researchers in political science and political economy hold domestic institutional settings responsible for limiting policy makers in their ability to implement the welfare maximizing capital tax rate of zero (Hays 2003, Hallerberg and Basinger 1998, 1999, Basinger and

Hallerberg 2004, Genschel 2002). Some scholars have also argued that budgetary pressures and the necessity of gathering revenue in order to provide public goods exert a significant impact on domestic tax policy making (Swank and Steinmo 2002, Genschel 2002, Swank 1998, 2002, 2004). Particularly, budgetary needs provide an incentive to shift tax burdens from mobile to immobile factors. Yet, this shift is counterbalanced because higher labour taxes tend to boost inequality (Steinmo 1993, 1994), discourage employment and growth (Bird, Perry and Wilson 1991), and governments in an internationalized environment are forced to use tax policy to compensate workers for the market induces fall in gross wages (Rodrik 1997, 1998, Hicks and Swank 1992, Quinn 1997). Based on these observations, corporate taxation remains politically popular leading to a tax symmetry trade-off which causes cuts in corporate tax rates to spill over into personal income taxation (Ganghof 2000b, 2004, Genschel 2002).

The argument of political popularity is implicitly based on the assumption of at least partially opportunistic governments.¹ In several studies on taxation, the notion of governments' need to take voter preferences into account seems to be present (Ganghof 2004, Genschel 2002, Hallerberg and Basinger 1998, 1999, Basinger and Hallerberg 2004), though not explicitly incorporated into theoretical models. The formulated arguments mostly point to the increased international competitiveness. Opportunistic governments not only have to respond to the demands and politically-expressed wishes of the electorate but to the pressure of international market

1 In the economic literature Persson and Tabellini (1994) and Haufler (2001) point to differences in the relative strength of interest groups which can result in different optimal tax mixes of wage and capital taxation when two competing governments maximize the political support from workers and capitalists.

forces (Krugman 1994). Thus, even though politicians behave opportunistically, they are forced by globalization to redesign their tax systems largely irrespective of the preferences or desires of the majority of citizens (Steinmo 1994, p.10). An apparent flaw of this literature consists in the over-emphasis of the international dimension and the under-estimation of how strongly policy makers feel limited by the voter-will.

The question of incomplete capital mobility is not entirely new either. Yet, a number of empirical studies only found inconclusive evidence for the influence of taxation on firm decisions (Mosley 2000, Devereux and Griffith 1998, Hall and Sockice 2001). Proposed explanations for this observation mainly oscillate around the argument that investments come only in lumpy increments (Black and Hoyt 1989). Since the key actors are large firms, they do not react very elastically to changes in tax burdens abroad (Ganghof 1999, Swank 1998, 2002) and have a home bias (Haupt and Peters 2005).

On the other hand large multinational corporations profit from differences in national tax systems by engaging in multiple tax avoidance strategies such as transfer pricing, reallocating profits and debts, and thin capitalization (Zodrow 2006, Stöwhase 2005). This observation indicates a higher de facto mobility of large firms. In addition, the level of regulation (e.g. taxation) might not be the only factor for a firm's decision of location, other variables such as infrastructure exert an important influence as well (Aschauer 1989, 1993).

Even though parts of my argument have been already discussed in the extant literature on taxation, my line of argumentation creates several innovations for the theoretical explanation of domestic tax policy outcomes.

Incorporating the de facto ability of capital to move through jurisdictions

into the theoretical explanation and empirical investigation of domestic tax policy outcomes provides a novel answer to the puzzle of non-zero capital taxation. Analyzing the impact of de facto capital mobility in addition to legal restriction to capital transactions permits to more accurately model the incentives for governments to engage in international tax competition. To put it more directly: since governments need to achieve policy goals such as public good provision and income redistribution in order to stay in office, the main constraint they face in reaching these aims is the actual ability and willingness of capital to leave the domestic economy.

Unlike most economic accounts of tax competition I assume governments to be opportunistic and solely interested in maximizing political support.

Treating policy makers as vote maximizers allows directly incorporating domestic constraints into the political process. Voters' demands for public good provision and tax symmetry directly influence the ability of policy makers to adapt domestic tax policy to international competitive pressures.

Different domestic constraints and settings simultaneously influence the ability of policy makers to play the tax competition game. Yet, opportunistic governments might not only be incapable to implement very low tax rates on mobile capital and shift the tax burden towards the immobile factor labour, they might be unwilling to do so since this strategy does not allow maximizing political support. Hence, even though domestic institutional constraints might limit governments' sheer ability to implement efficient tax rates, the real question is whether government want to do so if this jeopardizes their chances of staying in office.

Since voters directly react to tax asymmetry and the redistributive consequences of taxation, the sketched argument also implies that we have

to analyse taxes on immobile and mobile factors simultaneously. The majority of the electorate punishes a large tax gap and forces policy makers to maintain tax symmetry. Yet, governments can substitute income from one tax base by revenue from another tax source and vice versa. Most of the recent research on tax competition is dedicated to explain non-zero capital tax rates. This limited focus on capital taxation necessarily leaves out an important aspect of domestic tax policy making and provides only partial explanations which might lead to wrong predictions. The simultaneous analysis of capital and labour taxation prevents isolated theoretical accounts of specific aspects of domestic tax policy making leading to incomplete results.

The domestic and international trade-offs governments face are country specific. Policy makers less concerned with budget rigidities and tax equality considerations in economies dominated by highly mobile capital are more likely to engage in tax competition than governments who face greater constraints and a more favourable ownership structure of domestic capital. The proposed theoretical account of domestic taxation allows not only explaining persistently high capital tax rates but also the large variation in domestic tax systems.