Vying for Foreign Direct Investment: An EU-Type Model of Tax Competition

Assaf Razin and Efraim Sadka

No 5511, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper brings out the special mechanism through which taxes influence bilateral FDI, when investment decisions are two-fold in the presence of fixed setup flows costs. For each pair of source-host countries, there is a set of factors determining whether aggregate FDI flows will occur at all, and a different set of factors determining the volume of FDI flows (provided that they occur). We develop a two-country tax competition model which yield an asymmetric Nash-equilibrium with high corporate tax rate and high level of public good provision in the rich source country for FDI outflows and with low corporate tax rate and low level of public good provision in the poor host country for FDI inflows. This is akin to the asymmetry among the EU 15 and EU 10 in the enlarged European Union, as of 2004. We also demonstrate that the notion that the mere international tax differentials are a key factor behind the direction and magnitude of FDI flows, the traditional race to the bottom argument in tax competition are too simple.

Keywords: Enlarged european union; Source-host country foreign direct investment; Tax competition (search for similar items in EconPapers)
JEL-codes: F15 F2 H3 (search for similar items in EconPapers)
Date: 2006-02
New Economics Papers: this item is included in nep-ifn, nep-int and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Working Paper: Vying for Foreign Direct Investment: A EU-type Model of Tax Competition (2006)
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