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Incentives to tax foreign investors

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  • Rishi R. Sharma

    (Colgate University)

Abstract

This paper shows that a small country can have an incentive to tax inbound FDI even in a setting with perfect competition and free entry that is compatible with the Diamond–Mirrlees (Am Econ Rev 61(1):8–27, 1971) framework. While firms make no aggregate profits worldwide due to free entry in this setting, they make taxable profits in foreign production locations because their costs are partly incurred in their home countries. These profits are not perfectly mobile because firm productivity varies across locations. Consequently, the host country does not bear the entire burden of a tax on foreign firms, giving rise to an incentive to tax foreign investors. The standard zero optimal tax result can be recovered in this model under an apportionment system that ensures zero economic profits in each location.

Suggested Citation

  • Rishi R. Sharma, 2019. "Incentives to tax foreign investors," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 26(2), pages 257-281, April.
  • Handle: RePEc:kap:itaxpf:v:26:y:2019:i:2:d:10.1007_s10797-018-9506-3
    DOI: 10.1007/s10797-018-9506-3
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    More about this item

    Keywords

    International taxation; Foreign direct investment; Firm heterogeneity; Rents; Diamond–Mirrlees; Production efficiency;
    All these keywords.

    JEL classification:

    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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