Coordination of tax policies toward inward foreign direct investment

• Author: Amy Jocelyn Glass,Kamal Saggi
• Date: 01 March 2014
• DOI: http://doi.org/10.1111/ijet.12029
• Published date: 01 March 2014

doi: 10.1111/ijet.12029

Coordination of tax policies toward inward foreign

direct investment

Amy Jocelyn Glass∗and Kamal Saggi†

Westudy competition for foreign direct investment (FDI) between host countries and the impli-

cations of tax policy coordinationbetween them. By reducing its tax on multinational production,

a host country can attract additional FDI, some of which is diverted from other host countries.

The shift in FDI causes host wages to rise while wages elsewhere fall. The host country with the

lower natural attractiveness for FDI (absent intervention) adopts a smaller tax on multinational

production. Coordination between hosts eliminates the FDI diversion effect and leads them to

impose a harmonized FDI tax that is larger than their non-cooperative tax levels.

Key wor ds foreign direct investment, subsidies, taxes, oligopoly,multinational firms

JEL classification F1, F2, L1

Accepted 22 October 2013

1 Introduction

The rise in the importance of multinational firms in world production and the changes in the global

policy environment have heightened interest in the impact of foreign directinvestment (FDI) on the

host and source countries involved. During the period 1990–2012, the global stock of inward FDI

increased from roughly $US2 trillion to over $US20 trillion (United National Conference on Trade

and Development 2013). At the same time, policies toward FDI became relativelymore liberal across

the world. Many countries—not only developing countries but also developed ones—go further

than mere liberalization of their policies and offer tax holidays and other tax concessions to entice

multinational firms to establish or expand local production facilities.

The rapidly increasing global stock of FDI raises the question whether countries need to coor-

dinate their policy decisions with respect to FDI. While member countries of the Organisation for

Economic Co-operation and Development (OECD) were unable to reach a multilateral agreement

on investment during the 1990s, their failed attempt did raise the issue of whether the agenda of the

World Trade Organization (WTO) ought to be expanded to allow for negotiations of international

investment policies. A potential concern for some countries is whether such international negoti-

ations will result in limits on their ability to attract FDI. Our goal in this paper is to examine the

interaction between the FDI policies of rival host countries in order to evaluate the potential rationale

for policy coordination.

We begin with the premise that countries that host FDI face limited supplies of skilled labor

(or other factors) required for production by multinational firms. While FDI into such countries

∗Department of Economics MS 4228, TexasA&M University, College Station, USA. Email: aglass@tamu.edu

†Department of Economics, VanderbiltUniversity, Nashville, USA.

International Journal of Economic Theory 10 (2014) 91–105 © IAET 91

International Journal of Economic Theory