Strategic Production Subsidy/Tax under Mutual Endogenous Entry of Foreign Firms

Considering a subsidy/tax on domestic production, this study examines the tax competition between two symmetric countries in the presence of the mutual endogenous entry of foreign ï¬ rms into each country’s market through exports and foreign direct investment (FDI). In the absence of FDI, we ï¬ nd that whether the equilibrium tax rate is positive or negative is determined by the export intensity of domestic ï¬ rms and thus the tax rate is always negative (i.e., a subsidy) in the symmetric interior case. However, in the presence of FDI, the necessary and sufficient condition for the sign of the equilibrium tax rate is weighted toward FDI (but still characterized by an observable indicator); hence, the tax rate can plausibly be positive (i.e., a tax). We also show that from the perspective of global welfare, the equilibrium tax rate is excessively low (high) if and only if it is a subsidy (tax).