It pays to be a tax haven. Ireland has become rich that way. Why do not all countries follow the Irish example, cut their capital taxes and get wealthy? One reason is structural. As the economic standard model of tax competition explains, small countries gain from competitive tax cuts while large countries suffer. Yet not all small (large) countries have low (high) capital taxes. Why? The reason, we argue, is political. While the economic standard model implicitly assumes competing governments to be democratic, more than a third of countries world-wide are non-democratic. We explain theoretically why autocracies are less likely to adjust to competitive constraints and test our argument empirically against data on the corporate tax policy of 99 countries from 1999 to 2011. Our findings shed light on how domestic institutions and global markets interact in economic policy making.
