Common and Private Values of the Firm in Tax Competition

We develop a simple model of interregional tax competition to explore how the balance between common and region‐specific aspects of a project's value affects the magnitudes of tax breaks offered by governments, when the firm possesses private information on the region‐specific values. We examine cases in which the tax applies to both the common and private values and to each component separately. The model predicts that when the common and observable part of the value of a project increases relative to the variance of the region‐specific private values, the stringency of competition reduces the equilibrium tax rate. Conversely, if the competing regions are sufficiently different, bidding is less aggressive. One interpretation of the results is that firms that are observed to be large get better tax breaks. The intuition is closely related to the Bertrand model of differentiated product market competition.