Optimal Tax Policy when Firms are Internationally Mobile

government. The government now maximizes the welfare function:

dB

with π and v* defined as in (14) and (15), subject to

F(K,A^l) (1 - и) - (1 - au) K = О

F(K,A^ft) (1 - и) - (1 - au) K = F (K*,A^ft) (1 - t) - (1 - βt) K* - C(24)

The optimality condition with respect to и is:

∂W                  ['^b+ A^h                     ['^b+ A"

-— = Q = Ud' - U')J   J   [(F - aK)] dAdB + H'J   J  [u (F_κ - a) K_u] dAdB

The optimality condition with respect to a is:

Zb⁺ A^h              B+⁺ A^h

I [uK] dAdB + H'     I [u (F_κ - a) K_a] dAdB

⁺( ^h' ^{ι (F}‘^{- aK}' > ■)^{dB -} £ ^h' (^{u fl - aKl)}    ) ^b'

First, it follows from equation (25) that u > О, a = 1, H' = U' cannot be an

optimum, because

^dw =£ ^h' (^u (^f (AK'■) - ^k^) ^d-A) ^dB = ⁰        (²7)

Second, u has to be greater than zero to satisfy Д^" = 0. This can be explained
as follows: The first term on the RHS of equation (25) is strictly positive, the
three other terms are strictly negative. Therefore, u = 0 and u < 0 are no possible
solutions.

Can u > 0, a = 1, H' > U' be an optimum?

12

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