The Dilemma of Tax Competition: How (Not) to Attract (Inefficient) Firms?

CentER Discussion Paper Series No. 2004-68

16 Pages Posted: 15 Oct 2004

See all articles by Khaled Diaw

Khaled Diaw

Tilburg University - Center for Economic Research (CentER)

Jérôme Pouyet

Ecole Nationale des Ponts et Chaussées (ENPC) - Centre d'Enseignement et de Recherche en Analyse Socio-Economique (CERAS); National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST); Centre for Economic Policy Research (CEPR)

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

Diaw, Khaled and Pouyet, Jerome, The Dilemma of Tax Competition: How (Not) to Attract (Inefficient) Firms? (July 2004). CentER Discussion Paper Series No. 2004-68, Available at SSRN: https://ssrn.com/abstract=603323 or http://dx.doi.org/10.2139/ssrn.603323

Khaled Diaw (Contact Author)

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 0 13 466 3339 (Phone)
+31 0 13 466 8001 (Fax)

Jerome Pouyet

Ecole Nationale des Ponts et Chaussées (ENPC) - Centre d'Enseignement et de Recherche en Analyse Socio-Economique (CERAS) ( email )

28, rue des Saints-Peres
75007 Paris
France
+33 1 4458 2870 (Phone)
+33 1 4458 2880 (Fax)

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST)

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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