Competition in Taxes and Performance Requirements for Foreign Direct Investment
University of Oregon, Economics Working Paper No. 2001-4
19 Pages Posted: 1 Oct 2003
Date Written: January 2002
Tax incentives offered to attract firms engaged in foreign direct investment are often tied to performance requirements such as domestic content restrictions. The tax competition literature has repeatedly shown that competition between municipalities for mobile firms tends to drive taxes to low levels. One would expect a comparable result for burdensome performance requirements. Despite this, the evidence suggests that while taxes have indeed been driven down, performance requirements are as popular as ever. We explain this seeming conundrum by showing that in the presence of spillovers, binding performance requirements can act as a coordination device for firms. In equilibrium, municipalities choose performance requirements which maximize joint surplus from investment. Competition between municipalities then transfers this surplus to firms via tax subsidies.
Keywords: Foreign direct investment, tax competition, domestic content requirements
JEL Classification: F21, F23, H25
Suggested Citation: Suggested Citation