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01 Oct 2005

Tax Competition and Public Input

Agnès Bénassy-Quéré / Nicolas Gobalraja / Alain Trannoy

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European Network of Economic Policy Research Institutes (ENEPRI) Working Paper No. 40, 24 pages

This paper assesses the extent and policy implications of simultaneous competition among countries on both corporate tax rates and the provision of public goods used by firms as production factors (‘public factors’). First, we derive the relevant theoretical results in a unified framework where a corporate tax is used to finance a public good that raises both household utility and firm productivity. Then, the relevance of such simultaneous competition is tested using data on foreign direct investment from the US to EU member states.
Both the theoretical analysis and the empirical results presented in this paper suggest that focusing on the tax side of the competition for the location of multinationals is misleading. It shows that there are grounds for the coexistence of high tax/spending countries and low tax/spending ones. Furthermore, provided multinationals are heterogeneous concerning their use of public factors, the competition for attracting them could take the form of a vertical or horizontal specialisation, whereby each government would seek to attract a certain type of activity through the adequate provision of certain public factors. In this framework, international competition could act as a vector for raising public-sector efficiency rather than as a standardisation factor.