Taxing and Subsidizing Foreign Investors

Many countries impose taxes on foreign investors while also having in place targeted subsidies that are designed to attract them. This paper shows that such a policy can be optimal for a host country. The government has an incentive to tax inframarginal firms because they are relatively immobile and an incentive to subsidize marginal firms because the economic activity generated by such a subsidy can increase domestic wages in excess of the fiscal cost. These policies improve domestic welfare at the expense of foreigners. Hence, this analysis can explain why tax coordination efforts can simultaneously entail reduced taxes and subsidies.