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Competition in Taxes and Performance Requirements for Foreign Direct Investment

  • Ronald B. Davies

    ()

    (University of Oregon Economics Department)

  • Christopher J. Ellis

    ()

    (University of Oregon Economics Department)

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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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2001-4.

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Length: 19
Date of creation: 01 Jun 2001
Date of revision: 01 Jun 2001
Handle: RePEc:ore:uoecwp:2001-4
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