The Dilemma of Tax Competition: How (Not) to Attract (Inefficient) Firms?
CentER Discussion Paper Series No. 2004-68
16 Pages Posted: 15 Oct 2004
Date Written: July 2004
Abstract
We consider a tax competition game between asymmetrically un-informed governments. Two governments simultaneously propose tax arrangements to attract a multinational firm (MNF) which has an ex-ante preference to operate in both countries, and governments anticipate that once the MNF accepts their other, each host will know the marginal cost of local production, but not the marginal cost in the other country. We show that when the multinational prefers to operate in both countries or not operate at all, then the tax competition game features two equilibria. In one equilibrium, efficient MNFs are attracted in the two countries, while in the other equilibrium, inefficient MNFs are attracted. The equilibrium in which only efficient firms are attracted may occur as the unique outcome if the MNFs can ultimately decide to settle in one country only. Our results suggest that, the existence of (small) countries who are aggressive in attracting MNFs by o ering substantial tax advantages allows competing governments to keep inefficient firms away from their territories.
Keywords: taxation, competition, firms, agencies, multinational companies
JEL Classification: D82, L51, H21
Suggested Citation: Suggested Citation
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