Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2020/7: Playing Easy or Playing Hard to Get: When and How to Attract FDI

Thomas A. Gresik (), Dirk Schindler () and Guttorm Schjelderup ()
Additional contact information
Thomas A. Gresik: Dept. of Economics, University of Notre Dame, Postal: 3044 Jenkins Nanovic Halls , University of Notre Dame Notre Dame, IN 46556, France
Dirk Schindler: Erasmus School of Economics, Erasmus University Rotterdam, Postal: Erasmus University Rotterdam , Erasmus School of Economics, Postbus 1738, 3000 DR Rotterdam, The Netherlands
Guttorm Schjelderup: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: We study the link between a country’s institutional quality in tax collection and its optimal corporate tax policies in a model of heterogeneous multinationals that can shift income using both debt and transfer prices. Countries with weak institutional quality can be made worse off adopting policies that attract FDI as the benefits from higher wages and production are more than offset by tax base erosion. Countries with moderate institutional quality can gain from under-utilizing their ability to collect taxes, since the benefit of attracting more FDI outstrips the benefit of increased tax revenue. Countries with very strong institutions benefit from FDI and should utilize their full ability to collect taxes.

Keywords: FDI; thin capitalization rules; transfer pricing; institutional quality

JEL-codes: F23; F68; H26; H32

44 pages, June 30, 2020

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