Document Type

Working Paper

Publication Date

2016

JEL Codes

H87, H25, F23

Working Paper Number

2016-03

Abstract

Many countries impose taxes on foreign investors while also having in place targeted subsidies and tax incentives that are designed to attract them. This paper shows that such a policy can be optimal from the standpoint of a host country. The government has an incentive to tax inframarginal firms because they are relatively immobile. It also has an incentive to subsidize marginal firms because the economic activity generated by such a subsidy can increase domestic wages in excess of the fiscal cost of the subsidy. These tax and subsidy policies improve host country welfare at the expense of foreigners. This analysis is thus able to provide an explanation for why tax coordination efforts can simultaneously entail reduced taxes and subsidies on foreign firms.

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