Taxation and Perfect Capital Mobility: the Effect of Competition among Countries to Attract Foreign Direct Investment

The paper studies the equilibrium level of taxation in an AK growth model in the presence of perfect capital mobility. The analysis indicates that, in the absence of an agreement among countries, the desire to attract capital from abroad causes a generalised reduction in taxes with respect to the closed economy equilibrium. In the presence of homogeneity or weak heterogeneity, this reduction is shown to be disadvantageous for all economies while, if heterogeneity is strong, it is damaging for all but one.