CORPORATE-INCOME TAX COMPETITION, DOUBLE TAXATION TREATIES, AND FOREIGN DIRECT-INVESTMENT

In the presence of international capital mobility, foreign direct investment is influenced by corporate income tax rates and the rules of how taxes paid in the host country are treated at home. In this paper the exemption, credit and deduction methods are considered as tax rules. Tax competition is modeled as a non-cooperative game with respect to both corporate tax rates and the form of double taxation relief. The subgame perfect equilibrium is shown to be independent of the tax rules. Since capital is inefficiently allocated, the feasibility and the content of a cooperative contract between governments are analyzed. It is argued that only the credit method requires neither compensatory payments nor fully harmonized tax rates. This is consistent with the observation that tax credits are very often adopted in double taxation treaties.