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Tax Holidays in a Business Climate

Listed author(s):
  • Jean-Francois Wen

This paper provides a new explanation for "tax holidays," as well as their subsequent removal in a tax reform stage. In a two-period model, I assume that perfectly competitive foreign investors are uncertain about the host country government's propensity for public spending, and that infinitely divisible capital is subject to strictly convex adjustment costs. The host country government's current period tradeoff between public spending and the associated deadweight loss from distortionary taxation may signal the host's type and spare the investors from an unanticipated future tax hike. A separating equilibrium requires a deep tax concession early on, which corresponds to a tax holiday. When there are overlapping generations of foreign investors the tax profile flattens out over time as the information from tax holidays is exhausted; this is the tax reform phase.

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File Function: First version 1992
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 864.

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Length: 49 pages
Date of creation: Nov 1992
Handle: RePEc:qed:wpaper:864
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