Competition for FDI and Profit Shifting: On the Effects of Subsidies and Tax Breaks

Abstract

We investigate competition for FDI within a region when a foreign multinational firm can profitably exploit differences in statutory corporate tax rates by shifting taxable profits to lower-tax jurisdictions. In such a framework we show that targeted tax competition may lead to higher welfare for the region as a whole than lump-sum subsidies when the difference in statutory corporate tax rates and/or their average is high enough. Tax competition can also increase overall surplus by changing the firm’s investment decision when profit-shifting motivations induce the firm to locate in the (beforetax) least profitable country.