Optimal Tax Policy when Firms are Internationally Mobile



Let A1 denote the vector of firm specific profitabilities for which π',B) =0,
for a given
B. In addition, firms can decide to change the production location and
go abroad. In this case, firms have to bear the migration cost
C which is equal
across firms. Without loss of generality, we normalize location-specific profitability
abroad to zero. Suppose that the foreign government sets its tax rate to
t and the
rate of depreciation allowances to
β. The firm stays in the home country if

π («, a) π* (t, β) C                           (12)

where the asterisk denotes the foreign country and. Ah denotes the vector of
firm specific profitabilities which satisfy
π = π* C.

3.2 Households

Domestic households own all firms in the economy. Profits are their only source
of income. Household consumption is therefore:

ZB+ ∕∙Ah               ∕∙B+ pA+

j   [π] dAdB + J   J

[π* C] dAdB


(13)


with

π = F (K,A,B)(1 — u) (1 au) K               (14)

π* = F (K *,A,B )(1 t) — (1 βt) K *              (15)

3.3 Government

The government uses profit tax revenue to finance the public good g. The budget
constraint of the government is given by

bB+ rAh

Bb- Aa1


u (F (K, A, B)


aK) dAdB


(16)


The government is supposed to maximize the social welfare function W :

W = U (c) + H (g)

(17)




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