Optimal Tax Policy when Firms are Internationally Mobile

в+ а⁺

U ɔ /   /

в-   A¹

ZB⁺ A⁺                 B⁺ A⁺

J   [иК] dAdB + H'J J   [и (F_κ - а) K_a] dAdB

The solution is the well-known result, that investment should not be distorted:
а = 1, knowing that in this case it is F_κ — а = 0 and F^l — аК^l = 0. The
government sets the tax rate so that the marginal utility of the public good equals
the marginal utility of private consumption: H' = U' (Samuelson condition).

3.5 Optimal tax policy with mobile firms

Now assume that A¹ < A^h < A⁺, i.e. there are some firms which will produce
abroad. In this case, the equilibrium can be illustrated as in figure 2:

Figure 2: Mobile firms.

In addition to the firms which are not profitable enough to produce at all
(bottom left), there are now firms which prefer producing abroad (top left). Only
firms in the non-shaded area produce domestically an can be taxed by the domestic

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