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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. Kempf, H. & Rota Graziosi, G., 2010. "Endogenizing leadership in tax competition: a timing game perspective," Working papers 299, Banque de France.
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  14. HINDRIKS, Jean & PERALTA, Susana & WEBER, Shlomo, 2006. "Competing in taxes and investment under fiscal equalization," CORE Discussion Papers 2006109, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  17. Carlo Perroni & Kimberley A. Scharf, . "Tiebout with Politics: Capital Tax Competition and Constitutional Choices," EPRU Working Paper Series 97-05, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  18. Dembour, Carole & Wauthy, Xavier, 2009. "Investment in public infrastructure with spillovers and tax competition between contiguous regions," Regional Science and Urban Economics, Elsevier, vol. 39(6), pages 679-687, November.
  19. Laussel, Didier & Le Breton, Michel, 1998. "Existence of Nash equilibria in fiscal competition models," Regional Science and Urban Economics, Elsevier, vol. 28(3), pages 283-296, May.
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