Spillovers and international competition for investments

Abstract

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 gain from governmental tax coordination. 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. Equilibrium outcomes in the taxation game depend on the firm’s ownership structure, and the firm as well as the governments may wish to influence this structure to affect the equilibrium.