Tax Competition, Location, and Horizontal Foreign Direct Investment
CORE Discussion Paper No. 2005/91
35 Pages Posted: 24 Feb 2006
Date Written: December 2005
We develop a model of capital tax competition in which imperfectly competitive firms choose both the number of plants they operate and their location. When compared to models with single-plant firms, the presence of multinationals reverses some standard results. First, instead of being subsidized, capital may actually be taxed in equilibrium, which shows that the presence of taxable 'multinational rents' relaxes tax competition. Second, even when firms are subsidized, their subsidy-inclusive profits may be decreasing in subsidies, due to fiercer price competition by more multinationals. Third, multinationals may give rise to multiple equilibria in the tax game, one of which can be a 'subsidy trap' characterized by many multinationals, high subsidy levels, and low welfare.
Keywords: capital tax competition, international trade, multi-plant location problem, foreign direct investment, imperfect competition
JEL Classification: F12, F23, H27, H73, R12
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