Articles 5th Lesson

The text highlights three main advantages of using stock variables over flow variables for analyzing FDI: (1) Coherence with the theoretical framework which models decision-making based on capital levels, (2) Stocks are less volatile than flows, making them more reliable in capturing long-term trends, and (3) Stocks are always non-negative, allowing for the use of logarithms and estimations of elasticities.

The text points out that the existing research on FDI has largely ignored the impact of public inputs on FDI. This gap is significant because it implies that the existing literature may be incomplete in understanding the factors influencing FDI, particularly the role of government policy and public infrastructure in attracting investment.

The study by Gabe and Bell (2004) demonstrates the impact of public expenditures and property tax rates on corporate location decisions. Their findings show that increasing education spending by 10% leads to a 6% increase in firms settling in a region. This supports the argument that firms consider the provision of public factors, such as education, when choosing their location, suggesting that public inputs are a significant determinant of FDI.

<p>The text suggests that key factors in choosing a location for FDI include capital levels, stability of investment, public input provision, and tax rates. A favorable investment environment would likely have a stable economy with robust capital levels, a supportive public policy framework that includes investments in education and infrastructure, and a competitive tax regime.</p> Signup and view all the answers

<p>Using logarithms allows researchers to estimate elasticities, which measure the sensitivity of FDI to changes in its determinants. By using logarithms, we can quantify the percentage change in FDI for a given percentage change in a determinant. This provides a more precise and nuanced understanding of the relationship between FDI and its influencing factors compared to simple linear relationships.</p> Signup and view all the answers

<p>Ignoring the impact of public inputs on FDI could lead policymakers to adopt strategies that are ineffective in attracting foreign investment. Policymakers may focus on tax incentives or other factors without fully understanding the role of public infrastructure, education, and other public goods. To address this knowledge gap, policymakers could invest in research to quantify the impact of public inputs on FDI, actively consider the provision of public goods as part of investment attraction strategies, and collaborate with academics and businesses to develop evidence-based policies.</p> Signup and view all the answers

<p>Corporations may be hesitant to invest in countries with low levels of public input provision even with attractive tax incentives for several reasons. Firstly, lack of public input may indicate a weak or unstable economic environment, making it difficult to operate and secure returns on investment. Secondly, inadequate public inputs can increase costs for corporations due to unreliable infrastructure, lower worker productivity, and the need to provide their own services, ultimately reducing the attractiveness of tax incentives.</p> Signup and view all the answers

<p>Public capital</p> Signup and view all the answers

<p>Because they are not expected to have a direct impact on private capital productivity and could even deter foreign direct investors from investing if they anticipate higher tax pressure.</p> Signup and view all the answers

<p>Statutory rates (LSTATUTit) and effective average tax rates (LEATRit), both expressed in logarithms.</p> Signup and view all the answers

<p>Because it takes into account the type of investment, source of financing, inflation rate, interest rate, and pre-tax rate of return on investment.</p> Signup and view all the answers

<p>The thin capitalization strategy, where the way investment is financed could be thought of as endogenous to the tax rate.</p> Signup and view all the answers

<p>Public capital, denoted as LPUBKijt in logarithm for country i, sector j and year t.</p> Signup and view all the answers

<p>To check the robustness of the results, despite the collinearity between this measure of public capital and external distance.</p> Signup and view all the answers

<p>Research has shown that a 1% decline in corporate statutory tax rates leads to a 3-4% increase in inward FDI, based on an analysis of 371-427 recorded semi-elasticities of FDI with respect to corporate tax rates. This suggests a significant and positive relationship between lower corporate tax rates and increased FDI.</p> Signup and view all the answers

<p>The text acknowledges the limited research on public infrastructure's impact on FDI. Studies have utilized indicators like the index of infrastructure quality, composite infrastructure indicators, and electricity production per dollar of GDP. However, a significant challenge in this research area is the difficulty in identifying an appropriate and consistent measure of public infrastructure, which is why the text proposes using the stock of public capital per square kilometer as a proxy for public infrastructure.</p> Signup and view all the answers

<p>Gabe and Bell argue that a strategy combining low taxation with low public good provision is less successful than a strategy that couples high taxation with high public good provision. This aligns with the findings on corporate taxation and FDI, as lower corporate tax rates alone may not be sufficient to attract FDI, particularly if a country has low levels of public infrastructure and other public goods that support investment.</p> Signup and view all the answers

<p>The findings suggest that reducing corporate tax rates can be an effective tool for attracting FDI. However, countries should consider a broader range of factors, including the quality and availability of public infrastructure, the regulatory environment, and the overall macroeconomic stability. A holistic approach that addresses both tax policies and the provision of public goods is likely to be more effective in attracting and sustaining FDI.</p> Signup and view all the answers

<p>The text emphasizes that corporate tax rates are not the only determinant of FDI location. It highlights the importance of public infrastructure, citing studies that show a positive correlation between infrastructure quality and FDI. This suggests that firms consider factors beyond just tax rates when deciding where to invest.</p> Signup and view all the answers

<p>Measuring the impact of public infrastructure on FDI is difficult because there is no single, widely accepted measure of infrastructure quality. Different studies have used various indicators, but these measures can vary in their scope and reliability. The text attempts to address this challenge by proposing the use of the stock of public capital per square kilometer as a proxy for public infrastructure, offering a potentially more standardized and comparable measure.</p> Signup and view all the answers

<p>The research suggests that investing in public infrastructure can be a significant driver of FDI. Countries with strong infrastructure, including transportation, energy, and communication networks, are more attractive to foreign investors. Policymakers can use this information to prioritize investments in infrastructure, particularly in areas that are directly linked to FDI activities. This can help improve their competitiveness and attract more investment.</p> Signup and view all the answers

<p>The data set is well-suited for analyzing FDI because of its large size, covering US FDI in 18 EU members across ten sectors over a decade, and its consistency due to a single reporting country, methodology, and taxation scheme.</p> Signup and view all the answers

<p>Stocks refer to the accumulated value of FDI at a specific point in time, while flows measure the amount of FDI entering or leaving a country during a particular period. Stocks are advantageous because they represent the accumulated investment, providing a more comprehensive picture of FDI's impact on a country's economy.</p> Signup and view all the answers

<p>The &quot;marginal result&quot; refers to the change in FDI as a result of a small change in public input provision. The text states that while the provision of public input is reduced at the margin compared to autarky, it cannot be concluded that the overall amount of public input provided is lower.</p> Signup and view all the answers

<p>Logarithms are used to transform the variables and facilitate a more accurate analysis of the relationship between FDI and its determinants. Logarithms allow for a more precise estimation of elasticities, which quantify the responsiveness of FDI to changes in its determinants, providing a more nuanced understanding of the relationship.</p> Signup and view all the answers

<p>The two measures of corporate tax rates are the statutory corporate tax rate (SCTR) and the effective average tax rate (EATR). The SCTR represents the nominal tax rate specified in the law, while the EATR considers the actual tax burden faced by corporations, accounting for tax deductions and exemptions.</p> Signup and view all the answers

<p>Ignoring the impact of public inputs on FDI can lead to misguided policies and hinder efforts to attract foreign investment. Policies focused solely on tax incentives might not be effective in attracting FDI if public infrastructure and services are inadequate, potentially deterring investors from choosing a particular location.</p> Signup and view all the answers

<p>Despite its weak significance, public capital per capita was used as a measure of public input in a robustness check to examine the consistency of the findings using a different proxy for public input. This approach helps ensure that the results are not overly dependent on the specific measure used and strengthens the validity of the study's findings.</p> Signup and view all the answers

<p>The study found a negative relationship between corporate tax rates and inward FDI, indicating that higher tax rates tend to discourage FDI. The estimated elasticity was -0.25, suggesting that a 1% increase in the effective average tax rate (EATR) leads to a 0.25% decrease in FDI. The study used a range of EATR values from 15% to 35%.</p> Signup and view all the answers

<p>Factors beyond tax rates, such as the quality of public infrastructure, the availability of skilled labor, access to markets, and political stability, also play a significant role in determining FDI location choices. Investors consider a combination of factors to ensure a favorable investment environment.</p> Signup and view all the answers

<p>The plausibility of assuming that voters are doing regression-based evaluations of incumbents in their heads.</p> Signup and view all the answers

<p>The Ricardian view is that tax and debt are equivalent.</p> Signup and view all the answers

<p>It increases the visibility and cost of debt.</p> Signup and view all the answers

<p>Unanticipated own tax increases reduce the odds of reelection, while unanticipated increases in neighbors' taxes increase the probability of reelection.</p> Signup and view all the answers

<p>Unanticipated own tax increases reduce the odds of reelection, while unanticipated increases in neighbors' taxes increase the probability of reelection.</p> Signup and view all the answers

<p>It suggests that tax and debt may not be perfect substitutes in terms of their effect on gubernatorial reelection.</p> Signup and view all the answers

<p>Because tax and debt are substitute ways of financing expenditures, but may not have the same political effects.</p> Signup and view all the answers

<p>The use of total long-term debt, while in reality only certain kinds of debt finance may be politically sensitive.</p> Signup and view all the answers

<p>Because debt is a significant determinant of who is elected, rationalizing effort put into curbing tax increases that are out of line with neighbors.</p> Signup and view all the answers

<p>It provides scope to explore additional implications of yardstick competition for governmental behavior.</p> Signup and view all the answers

<p>Because it is a natural situation in which to study these issues.</p> Signup and view all the answers

<p>It allows for the study of how states compare themselves to their neighbors in terms of debt and taxes.</p> Signup and view all the answers

<p>Because it provides a basis for comparison and can influence policy decisions.</p> Signup and view all the answers

<p>There is no reason to think that taxes and debt would have the same effect on reelection odds.</p> Signup and view all the answers

<p>Because only certain kinds of debt finance may be politically sensitive.</p> Signup and view all the answers

<p>It can inform policy decisions and improve our understanding of the factors that influence reelection odds.</p> Signup and view all the answers

<p>Asymmetric information refers to a situation where one party in a transaction (e.g., the government) has more information than the other party (e.g., citizens) about the underlying circumstances or the need for a tax change. In the context of tax policy, asymmetric information can arise when the government faces shocks, such as a sudden economic downturn or an unexpected surge in healthcare costs, that require rapid adjustments to tax rates. Since citizens may not fully understand the reasons behind these changes, they are more likely to accept them if they perceive them as necessary responses to unforeseen circumstances. This acceptance is facilitated by the fact that the government, as the party with more information, can present these changes as necessary measures to address the unexpected event.</p> Signup and view all the answers

<p>Events like increased Medicaid expenses or infrastructure costs can lead to fiscal crises because they create sudden and often unexpected increases in government spending. When these expenses are not anticipated in the budget, they can lead to a budget deficit or even a crisis, especially if the government's revenue sources are insufficient to cover the increased expenditure. To address these crises, governments can employ various tax policy tools. One common strategy is to increase tax rates, either across the board or on specific goods or services, to generate more revenue. This can help to offset the increased spending and prevent a further decline in the budget balance. Another option is to implement new taxes or fees, targeting specific activities or sectors, to raise additional revenue. The effectiveness of these tax policy measures depends on the severity of the fiscal crisis and the government's willingness to implement potentially unpopular tax increases.</p> Signup and view all the answers

<p>The text suggests that the public's perception of tax changes is not only influenced by the magnitude of the change but also by how it compares to tax changes in neighboring states. This is because taxpayers often consider their tax burden relative to their counterparts in similar regions. If a state raises taxes significantly while neighboring states maintain their rates, it might be perceived as an unfair burden, leading to dissatisfaction and potential political backlash. Conversely, if all neighboring states implement similar tax increases, the change might be perceived as more justifiable and less likely to evoke resistance. This concept highlights the importance of considering the broader fiscal landscape when implementing tax policy changes at the state level. States need to carefully weigh the potential economic and political implications of their tax decisions in relation to the policies of their neighbors.</p> Signup and view all the answers

<p>A new governor's tax program may take more than a year to fully implement for a variety of reasons. These include the need to navigate legislative processes, secure funding, and establish the necessary administrative infrastructure for the new program. Moreover, implementing significant tax changes often involves complex adjustments to existing tax laws and regulations, which can require considerable time and effort. The extended implementation period makes it difficult to accurately measure the immediate impact of tax changes on state finances. Analysis of tax changes must account for the time lag between policy implementation and its full effects on revenue collection and spending patterns. It is essential to consider the cumulative impact of tax changes over time to assess their true budgetary effects.</p> Signup and view all the answers

<p>The cumulative distribution function of the standard normal distribution is a mathematical function that describes the probability of a random variable (in this case, voter preferences) falling below a certain threshold. In the text's context, this function is used to assess the probability of a governor's reelection, which is assumed to be positively correlated with the satisfaction of voters with the governor's fiscal policies, including tax changes. The function effectively captures the distribution of voter preferences, with the area under the curve representing the probability of a governor's reelection. This probability is influenced by factors such as the governor's tax policies, economic performance, and voter perceptions of the governor's overall performance. A higher probability of reelection corresponds to a larger area under the curve, indicating a more favorable distribution of voter preferences toward the governor.</p> Signup and view all the answers

<p>The text suggests that voters have a long-term perspective when evaluating a governor's tax policies. They consider not only the immediate impact of tax changes but also the potential long-term implications for their future tax burdens. This means that a governor who implements a seemingly popular tax cut in the short term might face negative consequences in the future if these cuts lead to unsustainable budget deficits and ultimately require larger tax increases down the road. This concept highlights the importance of fiscal sustainability in gubernatorial decision-making. Governors must carefully weigh the short-term benefits of tax changes against their potential long-term implications for the state's fiscal health. A governor who focuses solely on short-term gains might risk alienating voters in the long run if their actions lead to significant tax increases or other economic problems.</p> Signup and view all the answers

<p>The text suggests that voters may be more accepting of tax increases if they are perceived as necessary responses to unforeseen circumstances, such as economic downturns or unexpected crises. This perception can provide governors with a degree of political cover when implementing unpopular but potentially necessary tax policies. However, it also creates a delicate balance. If governors overuse this approach, voters may become skeptical of their claims of unforeseen circumstances and view tax increases as a convenient way to address budget deficits, even when those deficits are not directly related to unexpected events. This could erode public trust in the government's fiscal management. Therefore, governors must be cautious in using the perception of &quot;appropriate&quot; tax increases in response to unexpected events. They need to maintain transparency, clearly communicate the reasons behind tax changes, and ensure that these policies are genuinely necessary to address unforeseen circumstances. A lack of transparency or a perception of manipulating the system to justify tax increases could ultimately undermine the effectiveness of these policies.</p> Signup and view all the answers

<p>Electoral competition can lead states to reduce tax rate increases to align with neighboring states, thereby avoiding voter backlash.</p> Signup and view all the answers

<p>Yardstick competition signifies that states use their neighbors as benchmarks for tax policies, impacting their tax-setting decisions.</p> Signup and view all the answers

<p>High tax increases can be interpreted as poor performance by officials, motivating citizens to vote them out in subsequent elections.</p> Signup and view all the answers

<p>The ballot box allows voters to express their approval or disapproval of tax policies, pushing officials to adjust tax rates accordingly.</p> Signup and view all the answers

<p>Public input is crucial for attracting foreign investment as it enhances the economic environment beyond mere tax considerations.</p> Signup and view all the answers

<p>Resource flows might mitigate inconsistencies in state tax policies over time, balancing economic interests against political pressures.</p> Signup and view all the answers

<p>Trimming tax rate increases suggests states prioritize maintaining competitiveness and electoral viability over maximizing revenue.</p> Signup and view all the answers

<p>Relatively Leviathan governments are characterized by a higher tax effect of smallness, representing a more aggressive approach to tax competition.</p> Signup and view all the answers

<p>Vertical externalities ensure that equilibrium tax rates never fall below the optimal tax rate, maintaining a baseline for tax competition.</p> Signup and view all the answers

<p>Horizontal externalities can lead to tax competition where lower tax rates in one jurisdiction pressure neighboring states to decrease their rates too.</p> Signup and view all the answers

<p>A positive coefficient indicates that as the size of government increases, the responsiveness of the tax base to changes in tax rates also increases.</p> Signup and view all the answers

<p>Smallness can enhance welfare by allowing for lower equilibrium tax rates, thereby increasing the competitiveness of jurisdictions.</p> Signup and view all the answers

<p>Optimal tax rates serve as a threshold that governs the behavior of jurisdictions in tax competition, ensuring that rates do not fall below this level.</p> Signup and view all the answers

<p>This assumption suggests that voters may hold elected officials accountable for tax policies based on observable outcomes, influencing future tax decisions.</p> Signup and view all the answers

<p>A 'Leviathan' government refers to a government that seeks to maximize its own power and resources, often at the expense of individual liberty and economic efficiency. In the context of the text, the argument for tax competition suggests that allowing jurisdictions to compete for taxpayers through lower taxes can act as a constraint on the growth of Leviathan governments. By forcing governments to compete for revenue, tax competition can prevent them from extracting excessive amounts of resources from their citizens.</p> Signup and view all the answers

<p>Tax-base elasticities measure the responsiveness of a tax base to changes in tax rates. A high tax-base elasticity indicates that a small change in tax rates will lead to a large change in the tax base, either through individuals or businesses moving to lower-tax jurisdictions. This makes tax competition more effective, as even small differences in tax rates can significantly impact the flow of resources. For example, if a state with a high tax-base elasticity lowers its corporate tax rate, it might attract a large influx of businesses from neighboring states with higher rates, leading to a substantial increase in its tax revenue despite the lower rate.</p> Signup and view all the answers

<p>Horizontal externalities in tax competition occur when the tax policies of one jurisdiction affect the welfare of residents in neighboring jurisdictions. For example, if one state reduces its corporate tax rate, it might attract businesses away from neighboring states, potentially harming those states' economies and tax revenues. These externalities can complicate the welfare implications of tax competition, as the benefits to one jurisdiction might come at the expense of others. This creates a trade-off between maximizing welfare for individual jurisdictions and minimizing negative spillover effects on neighboring jurisdictions.</p> Signup and view all the answers

<p>The concept of 'smallness' refers to the relative size of a jurisdiction in relation to its neighbors. In the context of the text, small jurisdictions may benefit more from tax competition than larger ones. This is because smaller jurisdictions have a greater incentive to lower taxes to attract residents and businesses, while larger jurisdictions might have less to gain from such competition. This is because a small jurisdiction's tax base is more vulnerable to being lost to a neighboring jurisdiction with lower taxes. This makes tax competition a more powerful tool for small jurisdictions.</p> Signup and view all the answers

<p>Optimal tax rates are the rates that maximize social welfare by balancing the need for government revenue with the potential distortions and negative consequences of high taxes. Factors influencing optimal tax rates include the elasticity of demand for public goods, the level of income inequality, and the efficiency of government spending. Tax competition can affect optimal tax rates by forcing jurisdictions to lower their rates to remain competitive. This can lead to lower than optimal tax rates, especially for small jurisdictions with highly elastic tax bases. On the other hand, it can also serve as a check on government's ability to extract resources, potentially leading to more efficient government spending and a better allocation of resources overall.</p> Signup and view all the answers

<p>'Second-best' in this context means that tax competition, while not necessarily the ideal solution for maximizing social welfare, can still lead to improvements in welfare given certain constraints. These constraints might include political realities, pre-existing distortions in the economy, or the presence of externalities. For example, if a central government cannot effectively coordinate tax policy across jurisdictions, tax competition can still encourage efficiency and prevent excessive taxation, even if it doesn't reach the theoretical 'first-best' outcome. This emphasizes that in real-world scenarios, policymakers may need to consider practical limitations and accept solutions that are not perfect, but still lead to improvements.</p> Signup and view all the answers

<p>Ignoring the impact of public inputs on FDI can lead to misguided policies, such as focusing solely on tax incentives while neglecting the provision of essential public infrastructure, education, and healthcare. This can undermine efforts to attract FDI, as businesses may choose locations with more comprehensive public support, even if tax rates are higher. To address this knowledge gap, policymakers should invest in research to better understand the relationship between public inputs and FDI, gather data on the specific needs of different sectors, and develop more nuanced strategies that consider both fiscal and non-fiscal factors in attracting foreign investment.</p> Signup and view all the answers

<p>Leviathan Government suggests that governments will maximize their revenue through taxation, often leading to inefficiencies and welfare losses for the citizens.</p> Signup and view all the answers

<p>Tax-base elasticities measure how responsive tax revenues are to changes in tax rates, guiding policymakers in setting optimal rates to maximize revenue without discouraging economic activity.</p> Signup and view all the answers

<p>Horizontal externalities occur when the tax policy of one jurisdiction affects the welfare or tax base of another, complicating efforts to establish fair tax rates.</p> Signup and view all the answers

<p>'Smallness' implies a limited government scope that may lead to lower taxation and increased individual welfare, but it can also limit public goods provision.</p> Signup and view all the answers

<p>Optimal tax rates are influenced by inter-jurisdictional competition, the mobility of the tax base, and the elasticity of demand for public goods.</p> Signup and view all the answers

<p>Externalities can shift the burden of costs and benefits between states, prompting policymakers to consider neighboring jurisdictions' tax policies when setting their own.</p> Signup and view all the answers

<p>Vertical externalities arise when actions at one governmental level impact revenues or expenditures at another level, complicating cohesive tax policy across federal, state, and local levels.</p> Signup and view all the answers

<p>Governments' ability to shift taxes can lead to inefficiencies, as it may incentivize individuals and businesses to relocate to jurisdictions with lower tax burdens, thus affecting overall welfare.</p> Signup and view all the answers

<p>Progressive taxes typically aim for equity by taxing higher incomes at greater rates, which can enhance overall welfare, while regressive taxes may disproportionately burden lower-income groups and reduce welfare.</p> Signup and view all the answers

<p>The Leviathan government model is based on the idea that governments have a tendency to maximize their revenue and power, leading to tax competition among states. This concept is related to the idea that governments may not always act in the best interest of their citizens, but rather prioritize their own interests.</p> Signup and view all the answers

<p>Horizontal externalities arise when states interact with each other, leading to spillover effects that affect welfare. Tax-base elasticities play a crucial role in this context, as they determine how responsive tax bases are to changes in tax policies. Higher tax-base elasticities can lead to greater welfare losses due to horizontal externalities.</p> Signup and view all the answers

<p>Smallness refers to the size of a state in a federal system. Research has shown that smaller states can benefit from lower tax rates, which can lead to higher welfare. This is because smaller states may be more responsive to changes in tax policies, leading to greater tax competition and lower optimal tax rates.</p> Signup and view all the answers

<p>Vertical tax externalities arise when higher-level governments impose taxes on lower-level governments, affecting welfare. The degree of government benevolence, or the willingness of governments to prioritize citizens' welfare, plays a crucial role in determining the impact of vertical tax externalities on welfare.</p> Signup and view all the answers

<p>The deviation of equilibrium state tax rates from their optimum is a key indicator of the presence of tax competition among states. When states engage in welfare-improving tax competition, they adjust their tax rates to attract businesses and investment, leading to higher welfare and lower optimal tax rates.</p> Signup and view all the answers

<p>Idiosyncrasies in revenue structures refer to differences in the way states raise revenue. Smallness can amplify the impact of these idiosyncrasies on welfare, as smaller states may be more vulnerable to changes in revenue structures and more responsive to changes in tax policies.</p> Signup and view all the answers

<p>Smaller states may have lower optimal tax rates due to their greater responsiveness to changes in tax policies and their desire to attract businesses and investment. This is related to the concept of Leviathan government, as smaller states may be more inclined to prioritize citizens' welfare and limit government revenue and power.</p> Signup and view all the answers