Competing for a duopoly: international trade and tax competition

Abstract We analyse the tax/subsidy competition between two potential host governments to attract the plants of firms in a duopolistic industry. While competition between identical countries for a monopolist's investment is known to result in subsidy inflation, two firms can be taxed in equilibrium with the host countries appropriating the entire social surplus generated within the industry, despite explicit non‐cooperation between governments. Trade costs mean that the firms prefer dispersed to co‐located production, creating these taxation opportunities for the host countries. We determine the country‐size asymmetry that changes the nature of the equilibrium, inducing concentration of production in the larger country.     

Cross-border acquisitions and taxes: efficiency and tax revenues

Abstract .  We develop a theoretical oligopoly model to study how international differences in profit and capital gains taxes affect foreign acquisitions. Reductions in foreign profit taxes tend to trigger inefficient foreign acquisitions, while reductions in foreign capital gains taxes may trigger efficient foreign acquisitions. Foreign acquisitions can increase domestic tax revenues even when profit taxes are evaded. The reason is that bidding competition between foreign firms ensures that all benefits from the acquisition, including tax advantages, are captured by a domestic seller paying capital gains taxes. Tax code issues, such as the treatment of goodwill, are shown to affect the pattern of foreign acquisitions.     

Does tax competition make mobile firms more footloose?

We examine a two‐period regional model with evolving economic geography, potentially creating incentives for firm relocation between periods. We argue that tax competition makes firms more footloose, but that this increases efficiency relative to the laissez‐faire outcome. We establish that: (i) tax competition leads to efficient investment outcomes and (ii) firm mobility is greater with tax competition than with a laissez‐faire regime. When relocation is costly, there can be too little mobility over time, as firms do not take into account the impact of FDI on social welfare in each country. With lump‐sum taxes or transfers, firms capture these benefits and internalize them, such that tax competition leads to the efficient outcomes. When more time periods are examined, tax competition induces firm relocation sooner than in its absence.     

The impact of corporate and personal income taxes on the location of firms and on employment: some panel evidence for the Swiss cantons

The impact of corporate income taxes on location decisions of firms is widely debated in the tax competition literature. Tax rate differences across jurisdictions may lead to distortions of firms’ investment decisions. Empirical evidence on tax-induced relocation and subsequent economic development in the US and Europe is still inconclusive. Much the same applies to Switzerland. While there is some evidence on personal income tax competition between Swiss cantons, evidence on the impact of intercantonal corporate income tax differences on the location of business within Switzerland is missing. In this paper, we present econometric evidence on the influence of corporate and personal income taxes on the regional distribution of firms in 1981 and 1991 and on cantonal employment using a panel data set of the 26 Swiss cantons from 1985 to 1997. The results show that corporate and personal income taxes deter firms to locate in a canton and subsequently reduce cantonal employment.     

Profit taxation and the mode of foreign market entry

Abstract This paper studies the role of profit taxation for an international firm's decision upon how to penetrate a foreign market – through exports or through foreign direct investment (FDI) and local supply. We show that with harmonized taxes the international firm may choose FDI even though this has welfare costs from a global point of view. With tax competition, the host country can enforce exporting instead of FDI. This leads to a Nash equilibrium associated with higher world welfare than harmonized taxes. Thus, because of the effect on entry mode, tax competition provides heretofore unexplored benefits as compared to tax harmonization.     

Dividend taxes,corporate investment,and ‘Q’

Taxes on corporate distributions have traditionally been regarded as a ‘double tax’ on corporate income. This view implies that while the total effective tax rate on corporate source income affects real economic decisions, the distribution of this tax burden between the shareholders and the corporation is irrelevant. Recent research has suggested an alternative to this traditional view. One explanation of why firms in the United States pay dividends in spite of the heavy tax liabilities associated with this form of distribution is that the stock market capitalizes the tax payments associated with corporate distributions. This capitalization leaves investors indifferent at the margin between a corporation's decision to pay out dividends or to retain earnings. This alternative view holds that while changes in the dividend tax rate will affect shareholder wealth, they will have no impact on corporate investment decisions.This paper develops econometric tests which distinguish between these two views of dividend taxation. By extending Tobin's ‘q’ theory of investment to incorporate taxes at both the corporate and personal levels, the implications of each view for corporate investment decisions can be derived. The competing views may be tested by comparing the performance of investment equations estimated under each theory's predictions. British time series data are particularly appropriate for testing hypotheses about dividend taxes because of the substantial postwar variation in effective tax rates on corporate distributions. The econometric results suggest that dividend taxes have important effects on investment decisions.     

Taxing the Financially Integrated Multinational Firm

This paper develops a theoretical model of corporate taxation in the presence of financially integrated multinational firms. Under the assumption that multinational firms use some measure of internal loans to finance foreign investment, we find that the optimal corporate tax rate is positive from the perspective of a small, open economy. This finding contrasts the standard result that the optimal‐source‐based capital tax is zero. Intuitively, when multinational firms finance investment in one country with loans from affiliates in another country, the burden of the corporate taxes levied in the latter country partly falls on investment and thus workers in the former country. This tax exporting mechanism introduces a scope for corporate taxes, which is not present in standard models of international taxation. Accounting for the internal capital markets of multinational firms thus helps resolve the tension between standard theory predicting zero capital taxes and the casual observation that countries tend to employ corporate taxes at fairly high rates.     

Trade taxes and international investment

Abstract .  This paper demonstrates that international investment disturbs the conventionally understood equivalence between import tariffs and export taxes. Fundamentally, remittances to foreigners introduce an additional pecuniary channel between countries so that two-good Lerner Symmetry generally will not hold. Moreover, because tariffs subsidize investors in the local import competing sector while export taxes can extract rent from foreign investors in the export sector, the pattern of international investment will influence government preferences over trade policy  instruments  as well as levels. Notably, trade tax symmetry is restored by introducing a third policy tool in the form of a direct a tax on international remittances.     

Tax Uniformity: A Commitment Device for Restraining Opportunistic Behavior

We show that uniform and differentiated tax systems diverge in their propensity to generate distortionary opportunistic behavior. First, when firms choose investment before the government can commit to its taxes, the tax scheme creates strategic incentives for firms to distort their investment. Second, a system of differentiated taxes has a greater propensity to foster strategic distortions in investment than a uniform tax regime. While the paper makes these points in a set‐up in which polluting firms face an emission tax and invest in abatement, the main message is shown to hold for a wide class of tax policy games.     

Production and Abatement Distortions under Noisy Green Taxes

A pollution regulator seeking to maximize social surplus can be viewed as facing two efficiency problems. One is that, given abatement technology investment decisions, it should attempt to ensure that firms which should produce do produce and firms which should not produce do not produce. This ex-post efficiency problem is not trivial when there is noise concerning the extent of environmental damage a firm does. We use a Bayesian information framework to show that the regulator may find it efficient to tax a firm that reads as a high (low) damage polluter at less (more) than the damage reading. Unfortunately when an abatement decision has to be made, this ex-post efficient tax system also dampens the incentive to abate. In the absence of wrong-firm concerns, a regulator can solve the abatement problem by an ex ante declaration that taxes will not be adjusted for signal noise. However, the regulator has a commitment problem as such taxes may not be ex-post efficient. The most appropriate policy may involve a combination of instruments.     

Corporate Investment and Tax Disincentive: Evidence from China

This study investigates how taxes influence corporate investment behavior. Based on a census of Chinese industrial enterprises, we utilize a tax-adjusted q model to examine the effects of taxes on corporate investment in fixed assets in China. Results show that the effective tax rate has a relatively small but significantly negative impact on Chinese firms’ investment in fixed assets. We extend the tax-adjusted q model to control for the lagged investment effect and peer effect of investment. Models with these effects do better at explaining the impact of taxes on firms’ investment. The lagged investment models present smaller but significant tax disincentive. Firms compete for investment with other firms both in the same region and in the same industry through peer effect. In addition, the tax disincentive differs among state owned enterprises, private enterprises, and other enterprises in China.     

The importance of government commitment in attracting firms: A dynamic analysis of tax competition in an agglomeration economy

Agglomeration tendencies of industrial firms significantly affect the nature of tax competition. This paper analyzes tax competition between two countries over an infinite time horizon in an economy with trade costs and internationally mobile industrial firms. Most of the previous studies on tax competition in the ‘new economic geography’ framework employ static models. In this study, two governments dynamically compete with each other to attract firms through their choices of taxes and subsidies. It is shown that the commitment of the governments to their policies is crucial in determining the distribution of firms in the long run. Specifically, if governments find each others׳ tax policies credible, then one country will attract all the firms when trade costs are low enough to make agglomeration forces dominant. If policies are not credible, both countries may attract an equal share of firms even when trade costs are low, as the lack of commitment by governments acts as a dispersion force.     

EU regional policy and tax competition

The European Union (EU) provides coordination and financing of trans-European transport infrastructures, i.e. roads and railways, which link the EU member states and reduce the cost of transport and mobility. This raises the question of whether EU involvement in this area is justified by inefficiencies of national infrastructure policies. Moreover, an often expressed concern is that policies enhancing mobility may boost tax competition. We analyze these questions using a model where countries compete for the location of profitable firms. We show that a coordination of investment in transport cost reducing infrastructures within union countries enhances welfare and mitigates tax competition. In contrast, with regard to union-periphery infrastructure, the union has an interest in a coordinated reduction of investment expenditures. Here, the effects on tax competition are ambiguous. Our results provide a rationale for EU-level regional policy that supports the development of intra-union infrastructure.     

Financial structure and the effectiveness of pollution control in an oligopolistic industry

This paper explores the link between pollution taxes and the financial and output decisions of firms in an oligopolistic industry facing demand uncertainty. It is shown that environmental regulations such as pollution taxes may induce firms to alter their financial structure, which in turn influences both output levels and the effectiveness of the tax in controlling pollution emissions. It is demonstrated that there exist circumstances in which highly leveraged firms may respond to pollution taxes by expanding output and emission levels. This possibility arises in a leveraged oligopoly since the tax acts as a credible commitment device which leads to more aggressive competition in output markets.     

The effects of company taxation in EU accession countries on German FDI1

This article investigates how company taxation affects German foreign direct investment (FDI) in European Union (EU) accession countries. In 2004 and 2007, 10 former socialist eastern European countries joined the EU. Although the EU integration is associated with increasingly favourable investment conditions, accession countries also pursue active strategies to attract foreign firms. In particular, taxes on corporate income have been significantly reduced during the last decade. We analyse whether corporate tax policies of eastern European countries affect three aspects of multinational activity: the location decision, the investment decision and the capital structure choice. The results suggest that local taxes are negatively related to both location and investment decisions. The analysis of the capital structure confirms that higher local taxes imply higher debt‐to‐capital ratios.     

DYNAMIC ENVIRONMENTAL TAXES UNDER INTERNATIONAL DUOPOLY

This paper studies a dynamic game of environmental taxes between two countries in the absence of explicit trade policies when both governments and firms act strategically. We demonstrate that the environmental tax in the steady‐state equilibrium in a dynamic environmental tax game is lower than that in a static environmental one. Therefore, the dynamic behaviour of the governments results in an increase in the environmental damage. Further, as a result of international cooperation on environmental taxes between two countries in the beginning of policy competition, there is an increase in the optimal environmental tax. This implies that it is important to set cooperative environmental taxes in the beginning of policy competition because non‐cooperative environmental taxes in the dynamic game result in the race‐to‐the‐bottom, which does not lead to environmental improvement.     

Emission Taxes and Product Differentiation in the Presence of Foreign Firms

Industries characterized by differentiated products are important contributors of greenhouse gases and currently subject to market‐based policies such as emission taxes. In the context of developing countries, fears about foreign investment leaving the country are often used as an argument not to address industry emissions through emission taxes. This paper develops a Cournot model with product differentiation in the presence of abatement efforts where host and foreign firms are subject to an emission tax. The analysis indicates that abatement efforts and differences in pollution intensity coefficients across firms may play a significant role in the characterization of optimal policy. The analysis also suggests that the government may opt to encourage foreign, less pollution‐intensive firms via higher taxation. Additionally, this paper examines how an optimal emission tax may be adjusted as products become more differentiated; industry emissions may fall/rise as a result of more differentiated products. One important contribution of this paper is that it emphasizes the role of abatement efforts, product differentiation, and differences in pollution intensity coefficients across firms in the characterization of the optimal emission tax.     

Jurisdictional Tax Competition and the Division of Nonrenewable Resource Rents

This paper presents a model of nonrenewable resource extraction across multiple jurisdictions which engage in strategic tax competition. The model incorporates rents due to both resource scarcity and capital scarcity as well as intra-region Ricardian rents. Regions set taxes on nonrenewable resource production strategically to balance tax revenues and local benefits from investment conditional on other regions’ tax rates. A representative extraction firm then allocates production capital across regions and time to maximize the present value of profits. Generally, we find that the division of resource rent between firms and regional governments ultimately depends on the relative scarcity of natural and production capital, relative costs across space, and the value regional governments place on economic activity. This theoretical result provides policymakers with information on the determinants of optimal tax rates and motivates future empirical research on the factors influencing the division of resource rent in practice.     

Consumption taxes in monopolistic competition: a comment

We show that an ad valorem tax is better than an equal-revenue unit tax when consumers spend some fixed proportion of income on taxed goods, when firms use constant mark-up pricing, and entry and exit drive per-firm profit to zero. These key assumptions implies that ad valorem taxes are superior in oligopoly as well as monopolistic competition, showing that earlier results on taxes in monopolistic competition (Schröder in J Econ 83(3):281–292, 2004) are not due to the mode of competition, but rather are due to the functional forms used.     

ON THE DETERMINANTS OF LOCAL TAX RATES: NEW EVIDENCE FROM SPAIN

This article examines the determinants of local tax rates. For the two main local taxes in Spain—the property tax and the motor vehicle tax—we test the existence of tax mimicking, yardstick competition, and political trends in a sample of 2,713 municipalities. Using various spatial models, the results support the hypothesis of tax mimicking, with coefficients above 0.40. We also show the relevance of political variables such as the ideology of incumbents and political fragmentation. The fact that incumbents with weaker political support exhibit stronger mimicking behavior is interpreted as evidence in favor of yardstick competition. Finally, we find that incumbents mimic neighboring municipalities ruled by the same political party, confirming the political trends hypothesis. (JEL C31, H71, H77)