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Incentives to Tax Foreign Investors

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Abstract

This paper shows that a small country can have incentives to tax inbound FDI even in a setting with perfect competition and free entry. While firms make no aggregate profits worldwide due to free entry, 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 impose taxes. The standard zero optimal tax result can be recovered in this model under an apportionment system that ensures zero economic profits in each location.

Suggested Citation

  • Sharma, Rishi, 2016. "Incentives to Tax Foreign Investors," Working Papers 2016-02, Department of Economics, Colgate University, revised 13 Sep 2016.
  • Handle: RePEc:cgt:wpaper:02
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    More about this item

    Keywords

    international taxation; foreign direct investment; firm heterogeneity; tax competition;
    All these keywords.

    JEL classification:

    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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