International competition for R&D investments

Abstract

Two jurisdictions compete to attract shares of the R&D investment budget of a large multinational enterprise, whose investments potentially confer positive spillovers on national firms. The firm contributes to local welfare by these spillovers (should they materialize), by tax payments and by dividends paid to local investors. The firm has private information both about its efficiency and about spillovers, and in particular whether the latter do exist or not. It is shown that strategic tax competition may lead to over-investments relative to the first-best allocation, that the excessive investments occur in the country where the positive spillover effects are lowest, and that they are most severe for the least efficient firms.