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We examine a two-period regional model with evolving economic geography, potentially creating incentives for firm relocation between periods. We argue that tax competition makes firms more footloose, but that this increases efficiency relative to the laissez-faire outcome. We establish that: (i) tax competition leads to efficient investment outcomes and (ii) firm mobility is greater with tax competition than with a laissez-faire regime. When relocation is costly, there can be too little mobility over time, as firms do not take into account the impact of FDI on social welfare in each country. With lump-sum taxes or transfers, firms capture these benefits and internalize them, such that tax competition leads to the efficient outcomes. When more time periods are examined, tax competition induces firm relocation sooner than in its absence. |
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