Optimal Country's Policy Towards Multinationals When Local Regions Can Choose between Firm-Specific and Non-Firm-Specific Policies

Abstract

This paper looks at a county’s central government optimal policy in a setting where its two identical local regions compete for the attraction of footloose multinationals to their sites, and where the considered multinationals strictly prefer this country to the rest of the world. For the sake of reality the model allows the local regions to choose between the implementation of firm-specific and non-firm-specific policies. We find that, even though the two local regions are identical, some degree of regional tax competition is good for country’s welfare. Moreover, we show that the implementation of the regional firmspecific policies weakly welfare dominates the implementation of the regional non-firmspecific ones. Hence the not infrequent calls for the central government to ban the former type of policies go against the advice of this paper.