Incentives to tax foreign investors

Rishi Sharma

International Tax and Public Finance, 2019, vol. 26, issue 2, No 2, 257-281

Abstract: Abstract This paper shows that a small country can have an incentive to tax inbound FDI even in a setting with perfect competition and free entry that is compatible with the Diamond–Mirrlees (Am Econ Rev 61(1):8–27, 1971) framework. While firms make no aggregate profits worldwide due to free entry in this setting, they make taxable profits in foreign production locations because their costs are partly incurred in their home countries. These profits are not perfectly mobile because firm productivity varies across locations. Consequently, the host country does not bear the entire burden of a tax on foreign firms, giving rise to an incentive to tax foreign investors. The standard zero optimal tax result can be recovered in this model under an apportionment system that ensures zero economic profits in each location.

Keywords: International taxation; Foreign direct investment; Firm heterogeneity; Rents; Diamond–Mirrlees; Production efficiency (search for similar items in EconPapers)
JEL-codes: F23 H25 H87 (search for similar items in EconPapers)
Date: 2019
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Working Paper: Incentives to Tax Foreign Investors (2016)
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DOI: 10.1007/s10797-018-9506-3

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