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Abstract

Tax incentives offered to attract firms engaged in foreign direct investment are often tied to performance requirements such as domestic content restrictions. The tax competition literature has repeatedly shown that competition between municipalities for mobile firms tends to drive taxes to low levels. One would expect a comparable result for burdensome performance requirements. Despite this, the evidence suggests that while taxes have indeed been driven down, performance requirements are as popular as ever. We explain this seeming conundrum by showing that in the presence of spillovers, binding performance requirements can act as a coordination device for firms. In equilibrium, municipalities choose performance requirements which maximize joint surplus from investment. Competition between municipalities then transfers this surplus to firms via tax subsidies.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 51 (2007)
Issue (Month): 6 (August)
Pages: 1423-1442

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Handle: RePEc:eee:eecrev:v:51:y:2007:i:6:p:1423-1442

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Find related papers by JEL classification:

• F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
• F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
• H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

References

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Cited by:

1. Ronald B. Davies, 2009. "The Silver Lining of Red Tape," The Institute for International Integration Studies Discussion Paper Series iiisdp328, IIIS.
   
   • Ronald B Davies, 2010. "The Silver Lining of Red Tape," Working Papers 201018, School Of Economics, University College Dublin.
2. Ronald B. Davies & Carsten Eckel, 2007. "Tax Competition for Heterogeneous Firms with Endogenous Entry:The Case of Heterogeneous Fixed Costs," The Institute for International Integration Studies Discussion Paper Series iiisdp213, IIIS.
   
   • Ronald B. Davies & Carsten Eckel, 2007. "Tax Competition for Heterogeneous Firms with Endogenous Entry: The Case of Heterogeneous Fixed Costs," University of Oregon Economics Department Working Papers 2007-7, University of Oregon Economics Department.
3. Ronald B. Davies & Carsten Eckel, 2010. "Tax Competition for Heterogeneous Firms with Endogenous Entry," American Economic Journal: Economic Policy, American Economic Association, vol. 2(1), pages 77-102, February.
   
   • Ronald B. Davies & Carsten Eckel, 2007. "Tax Competition for Heterogeneous Firms with Endogenous Entry," University of Oregon Economics Department Working Papers 2007-6, University of Oregon Economics Department.
   • Ronald B. Davies & Carsten Eckel, 2007. "Tax Competition for Heterogeneous Firms with Endogenous Entry," The Institute for International Integration Studies Discussion Paper Series iiisdp214, IIIS.

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