Dynamic Tax Competition, Home Bias and the gain from Non-preferential Taxation Regimes: A case for unilateral commitment

Abstract

In a dynamic two-period model of tax competition between two symmetric countries, where an investor has home bias for the country where he/she invests in the initial period, we show that a country has an incentive to unilaterally commit to a non-preferential taxation regime even when the competitor follows a preferential taxation strategy. When one country commits to a non-preferential taxation regime and the other adopts a preferential taxation strategy, the tax revenue of the country which commits to a non-preferential taxation is higher than what it can obtain when both countries jointly adopt non-preferential taxation regimes. The tax revenue of the country which adopts a preferential taxation strategy is equal to what it obtains when both countries jointly adopt non-preferential taxation regimes.