Optimal Tax Policy when Firms are Internationally Mobile

∂W
ди

∂W
да

bB⁺ ∕∙Aⁱ

О = (H' - U') / I [(F - К)] dAdB
Bb- Ja¹

⁺^h ' Г (^u⁽^f^h-^κ^h⁾ )^dB

b+⁺ aA¹

О = - (H' - U') / / [иК] dAdB

Bb- Aa¹

⁺^h ' B- (^u⁽^F^h^-^κ^h⁾ )^dB

(28)

(29)

As demonstrated in the appendix, given Д^ = О, it follows that

∂W = _ωда

r^h

COV

⁽ F'h _- κhɔ rfA^h F^h-K^h

(F^h - κ^h) ^Ah

(30)

where r = ^fk^k is the average return per capital unit of all firms operating

domestically and r^h

_ F F^h~K^h∖
∖ K ^hJ

is the average return per capital unit of the firms

who are just indifferent between staying and leaving.

Ω = (H' - U')

jBAtFlAAll^-κi)¾FB-
∫b^b+ (u (^p^h - κ ^h) - ■■^dB

bb+ A^h

Bb- Aa¹

uκdAdB > О

(31)

is some scale factor.

How can (30) be interpreted? First, if the covariance term is equal to zero,
(30) does not differ qualitatively from the result in the simple two firm economy.
Define the marginal group of firms as those firms which are just indifferent between
staying and leaving the country. If the average marginal firm is more profitable
than the average non-marginal firm in the economy, the optimal tax policy is to
set а < 1 (tax rate cut cum base broadening). If the two groups do not differ in
average profitability, the tax system should not distort investment (α = 1). If the
average marginal firm is less profitable, the tax system should subsidize investment
(α > 1).

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