It is in their profit-maximising nature that firms seek out low-tax locations, but this natural urge is not equally strong for all firms. According to research by Professors Marius Brülhart, Mario Jametti and Kurt Schmidheiny, firms in industries where everyone benefits from geographical clustering are prepared to accept higher tax burdens if in return they can locate closer to the industry cluster.
The study, which is published in the September 2012 issue of the Economic Journal, finds that the size of the effect is not trivial. For example, firms in a relatively clustered industry, such as watch making, are less than half as sensitive to corporate tax differentials as firms in a relatively dispersed industry, such as software engineering.
These findings imply that there is less danger of a global ''race-to-the-bottom'' in corporate taxes than there would be in the absence of forces that promote clustering. At the European level, this could mean that the capacity to raise taxes in economically central locations – such as Germany, France and the UK – may not be fundamentally threatened by low corporate taxes in Europe''s periphery in the south and east.
The authors analyse data for Switzerland, estimating how strongly start-up firms seek to locate in low-tax locations and how this tendency varies with the clustering intensity of the industry to which the firms belong.
Swiss cantons and municipalities are almost entirely free to set their individual corporate tax rates, which leads to large variations in regional tax burdens. For example, the highest-tax canton applies a corporate tax rate more than three times higher than that of the lowest-tax canton.
But apart from its exceptional internal variation in tax burdens, Switzerland covers a relatively small, institutionally homogeneous and economically highly integrated territory. This makes it a useful setting for testing the effects of regional differences in taxation.
The key challenge for the research design is that firms can participate in local politics and thereby influence tax rates. Hence, local taxes can be both a cause and consequence of firms'' location choices.
The researchers take a number of analytical precautions to ascertain that what they measure is indeed the causal effect running from taxes to location choices and not the other direction. One such precaution is their focus on start-up firms only, since newly established firms are much less likely than incumbent firms to affect pre-existing generally applicable local tax rates.
''Do Agglomeration Economies Reduce the Sensitivity of Firm Location to Tax Differentials?'' by Marius Brülhart, Mario Jametti and Kurt Schmidheiny is published in the September 2012 issue of the Economic Journal.
