The Political Economy of Capital Taxation: How Constraining Are Interest Rates?

Abstract

Previous empirical studies have shown that left-wing governments are commonly expected to be associated with lower interest rates and higher tax rates on capital than their rightist counterparts. The importance of interest rates in shaping the variation in tax policies of OECD countries, where they have been dominated by leftist governments, offers an interesting topic for research. Using data for up to 20 OECD countries in the period of 1966-2000, this paper tries to investigate a hypothesis that challenges the partisan theories of economic growth. We argue that the strategic nature of tax competition is not the sole factor in determining a country’s choice of taxation policy, and that other factors, notably interest rates, play an important role as well. We find that left-wing governments tend to lower capital taxes as a consequence of increased interest rates, which is consistent with the predictions of international tax competition theories, but in contrast to the partisan theories of economic growth presented in this paper.

Keywords

• tax competition
• capital taxation
• government partisanship
• interest rates
• spatial models