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Competition for foreign capital: Endogenous objective, public investment and tax

  • Rupayan Pal

    ()

    (Indira Gandhi Institute of Development Research)

  • Ajay Sharma

    ()

    (Indira Gandhi Institute of Development Research)

In this paper we endogenize the objective functions of the regions as well as their decision to provide public investment in a model of competition for foreign owned mobile capital. We demonstrate that the competing regions can `restrict race-to-the-bottom' in tax rates by deviating away from social welfare to net tax revenue. It is optimal for a region to be fully revenue oriented even if that region's ultimate goal is to maximize social welfare, irrespective of whether the rival region is concerned about social welfare or net tax revenue. Moreover, we demonstrate that the regions have unilateral incentive to spend on public investment, except in case of perfect spillover. In equilibrium, both the regions spend on public investment and end up with Pareto inferior outcomes.

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Paper provided by Indira Gandhi Institute of Development Research, Mumbai, India in its series Indira Gandhi Institute of Development Research, Mumbai Working Papers with number 2011-021.

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Length: 29 pages
Date of creation: Sep 2011
Date of revision:
Handle: RePEc:ind:igiwpp:2011-021
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  1. Ihori, Toshihiro & Yang, C.C., 2009. "Interregional tax competition and intraregional political competition: The optimal provision of public goods under representative democracy," Journal of Urban Economics, Elsevier, vol. 66(3), pages 210-217, November.
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  3. Wilson, John Douglas, 2005. "Welfare-improving competition for mobile capital," Journal of Urban Economics, Elsevier, vol. 57(1), pages 1-18, January.
  4. Hindriks, Jean & Peralta, Susana & Weber, Shlomo, 2008. "Competing in taxes and investment under fiscal equalization," Journal of Public Economics, Elsevier, vol. 92(12), pages 2392-2402, December.
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  17. Eckhard Janeba, 2000. "Tax Competition When Governments Lack Commitment: Excess Capacity as a Countervailing Threat," American Economic Review, American Economic Association, vol. 90(5), pages 1508-1519, December.
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