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Competition in taxes and performance requirements for foreign direct investment

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  • Davies, Ronald B.
  • Ellis, Christopher J.

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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References

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Citations

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Cited by:
  1. Valeska Groenert & Benjamin Zissimos, 2011. "Developing Country Second-Mover Advantage in Competition over Environmental Standards and Taxes," CESifo Working Paper Series 3686, CESifo Group Munich.
  2. Davies, Ronald B., 2013. "The silver lining of red tape," Journal of Public Economics, Elsevier, vol. 101(C), pages 68-76.
  3. Davies, Ronald B. & Eckel, Carsten, 2010. "Tax Competition for Heterogeneous Firms with Endogenous Entry," Munich Reprints in Economics 20021, University of Munich, Department of Economics.
  4. Valesca Groenert & Myrna Wooders & Ben Zissimos, 2008. "Competition over Standards and Taxes," Vanderbilt University Department of Economics Working Papers 0820, Vanderbilt University Department of Economics.
  5. 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.
  6. Peter Egger & Horst Raff, 2011. "Tax Rate and Tax Base Competition for Foreign Direct Investment," Kiel Working Papers 1734, Kiel Institute for the World Economy.

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