Document Type

Working Paper

Publication Date

2016

JEL Codes

H87; H25; F23

Working Paper Number

2016-02

Abstract

This paper shows that a small country can have incentives to tax inbound FDI even in a setting with perfect competition and free entry. While firms make no aggregate profits worldwide due to free entry, they make taxable profits in foreign production locations because their costs are partly incurred in their home countries. These profits are not perfectly mobile because firm productivity varies across locations. Consequently, the host country does not bear the entire burden of a tax on foreign firms, giving rise to an incentive to impose taxes. The standard zero optimal tax result can be recovered in this model under an apportionment system that ensures zero economic profits in each location.

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