Dynamic Inconsistency, Falling Cost of Capital Relocation and Preferential Taxation of Foreign Capital

Kaushal Kishore

No 201633, Working Papers from University of Pretoria, Department of Economics

Abstract: When capital is sunk after it is invested, a host government facing heterogeneous foreign investors who differ in their cost of capital relocation (which falls over time) has a strong incentive to wait in order to gain from relatively lower cost of capital relocation and offer preferential taxes over time in order to attract less eager investors. We ?nd that, if the government can commit to future tax rates, the tax revenue increases as the cost of relocation decreases. Moreover, under preferential taxation scheme the equilibrium tax revenue of the government is equal to what it can earn under full commitment. The tax revenue under non-preferential taxation scheme is lower compare to full commitment outcome when cost of capital relocation falls considerably over time but remains strictly positive. Under every taxation schemes considered in this paper, the equilibrium tax rate falls over time if cost of capital relocation falls considerably which offers another explanation for- ``why the tax rate falls over time in tax treaties?"

Keywords: Dynamic inconsistency; Foreign direct investment; Falling cost of capital relocation; Non-preferential taxation (search for similar items in EconPapers)
JEL-codes: F21 H21 H25 H87 (search for similar items in EconPapers)
Pages: 16 pages
Date: 2016-04
New Economics Papers: this item is included in nep-acc and nep-pbe
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