Tax Competition, Policy Competition and the Strategic Use of Policy Restrictions on Foreign Direct Investments

Kaushal Kishore

No 201684, Working Papers from University of Pretoria, Department of Economics

Abstract: In a dynamic two-period model of tax competition where competing countries strategically choose foreign investment restrictions which increases sunk cost of investments, we show that choosing a higher level of restriction is beneficial for the competing countries. A higher level of restriction reduces competition and increases tax revenue in the later period, which allows the government to offer large tax holidays during the initial period of investment. The result is counter-intuitive as it is widely believed that sunk cost reduces foreign direct investments. Moreover, even though competing countries are ex-ante symmetric, equilibrium choice of the level of restrictions may not be equal. The result provides sunk cost as another rationale for tax holidays in the presence of competition.

Keywords: Dynamic Tax Competition; Non-preferential regime; Ownership restrictions; Foreign Direct Investment (search for similar items in EconPapers)
JEL-codes: F21 H21 H25 H87 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2016-11
New Economics Papers: this item is included in nep-pub
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Persistent link: https://EconPapers.repec.org/RePEc:pre:wpaper:201684

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