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Equilibrium conditions in corporate tax competition and Foreign Direct Investment flows

  • Hristu-Varsakelis, Dimitrios
  • Karagianni, Stella
  • Saraidaris, Anastasios
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    We consider a collection of countries which attempt to maximize their corporate tax revenue, the latter being viewed as a function of Foreign Direct Investment (FDI) inflow and the Effective Average Tax Rate (EATR) which each country sets for itself. Under a model that assumes a direct influence of tax differentials on the flow of FDI, each country's decisions are naturally ‘coupled’ to those of others, leading to a non-cooperative game in which countries–players compete for FDI inflows by sequentially altering their tax rates. Their decisions are made via a differential equation-based model used to predict the effect of tax rate changes on a player's share of FDI inflows. Our model, calibrated using empirical data from 12 OECD countries for the period 1982–2005, combines FDI inflow and tax-rate differentials to arrive at a “steady-state” FDI inflow share for each player, given its competitors' corporate tax rates. We explore the game's equilibrium, including the question of whether equilibrium necessarily implies a ‘race to bottom’, with low corporate tax rates for all players.

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    Article provided by Elsevier in its journal Economic Modelling.

    Volume (Year): 28 (2011)
    Issue (Month): 1 ()
    Pages: 13-21

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    Handle: RePEc:eee:ecmode:v:28:y:2011:i:1:p:13-21
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