Globalization and taxation: Theory and evidence

Abstract

We construct a theoretical model to capture the compensation and efficiency effects of globalization in a set up where the redistributive tax rate is chosen by the median voter. The model predicts that the two alternative modes of globalization-trade liberalization and financial openness could potentially have different effects on taxation. We then provide some empirical evidence on the relationship between taxation and the alternative modes of globalization using a large cross-country panel data set. On average, globalization is associated with lower taxation but there is some evidence that in countries with high capital-labor ratio, globalization is associated with increased taxation. We make a distinction between de fore and de facto measures of globalization and find a strong negative relationship between taxation and de jure measures of globalization. The results for de facto measures of globalization are mixed.