Capital Intensity and Corporate Tax Burden: Understanding the Non-Linear Dynamics

This paper investigates non-linear relationship between capital per worker and the effective corporate tax rate within a structural framework grounded in sectoral capital allocation. We develop a two-sector model that allows for heterogeneity in the capital–labour ratio and endogenous effective tax rates, and we examine how high capital-labour ratio regimes are lead to lower corporate tax liabilities, thus declining corporate tax revenues. Empirically, we employ a Logistic Smooth Transition Regression (LSTR) on firm-level panel data from six European countries addressing the potential endogeneity bias in the threshold variable (capital-labour) without relying on external instruments. The results reveal strong regime-dependent effects: while a linear specification suggests a uniformly positive association between the capital–labour ratio and tax liabilities, the threshold model identifies a reversal of this relationship in high-capital regimes. Our findings highlight the growing issue of uneven fiscal contributions and the policy challenge of mitigating fiscal asymmetries. Overall, the analysis emphasizes the need to incorporate sectoral capital dynamics and capital productivity into the design of corporate tax systems—particularly in the context of technological divergence and intensifying international tax competition.