Regional Tax Coordination and Foreign Direct Investment

This paper analyses the effects of a regionally coordinated
corporate income tax in a model with three active countries, one of
which is not part of the union, and a globally mobile firm. We show
that regional tax coordination can lead to two types of welfare
gain. First, for investments that would take place in the union in
the absence of coordination, a coordinated tax increase can
transfer location rents from the firm to the union. Second, by
internalising all of the union’s benefits from foreign direct
investment, a coordinated tax reduction can attract more
welfare-enhancing investment than when member states act in
isolation. Depending on which motive dominates, tax levels may thus
rise or fall under regional coordination.