Equilibrium conditions in corporate tax competition and Foreign Direct Investment flows |
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Authors: | Dimitrios Hristu-Varsakelis Stella Karagianni Anastasios Saraidaris |
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Institution: | 1. Ifo Institute — Leibniz-Institute for Economic Research at the University of Munich, Poschingerstr. 5, D-81679 Munich. Germany;2. University of Erlangen-Nuremberg, Department of Economics, Lange Gasse 20, 90403 Nuremberg, Germany;1. School of Businesrgs, Central South University, Lushan South Road, Yue Lu district, Changsha 410083, Hunan, China;2. School of Management, Hunan University of Technology and Business, Changsha, 410205, Hunan, China |
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Abstract: | We consider a collection of countries which attempt to maximize their corporate tax revenue, the latter being viewed as a function of Foreign Direct Investment (FDI) inflow and the Effective Average Tax Rate (EATR) which each country sets for itself. Under a model that assumes a direct influence of tax differentials on the flow of FDI, each country's decisions are naturally ‘coupled’ to those of others, leading to a non-cooperative game in which countries–players compete for FDI inflows by sequentially altering their tax rates. Their decisions are made via a differential equation-based model used to predict the effect of tax rate changes on a player's share of FDI inflows. Our model, calibrated using empirical data from 12 OECD countries for the period 1982–2005, combines FDI inflow and tax-rate differentials to arrive at a “steady-state” FDI inflow share for each player, given its competitors' corporate tax rates. We explore the game's equilibrium, including the question of whether equilibrium necessarily implies a ‘race to bottom’, with low corporate tax rates for all players. |
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