Follow you, follow me: public investment under tax competition

The mobility of capital and the presence of multinational firms able to shift profits to tax havens limit the ability of governments to tax capital income and domestic profit. Profit shifting leads to an estimated revenue loss for developing countries that is roughly three times greater than the amount they receive each year in foreign aid (DEVE 2014). In this policy brief, we report recent theoretical research on the interaction between the taxation of multinational corporations and public investment. In our setting, public investment increases the productivity of capital that in turn induces a comparative advantage in the tax-competition. We show that it is preferable for countries to commit first on public investment and then to set taxes.