Spillovers and international competition for investments

Two jurisdictions compete to attract shares of the investment budget of a large multinational enterprise, whose investments confer positive spillovers on national firms. The firm has private information about its efficiency and about spillovers. It is shown that the firm may be harmed by tax competition. Relative to a cooperative tax agreement, tax competition may induce excessive investments in the country where the positive spillover effects are lowest. Also, with sufficiently asymmetric spillovers, investments under competition will be excessively spread out, not properly concentrated to the country where spillovers would be largest.