Sergi, Bruno S. (2006) Central and Peripheral Regions in Europe: Can Tax Competition Attract Foreign Direct Investment Forever? ACES Cases No. 2006.3. UNSPECIFIED.
Abstract
This paper studies the linkage between tax competition and foreign investment in Europe. Although the majority of economists consider a link between these two phenomena to be unambiguous, the literature ignores its long-term implications. To gauge the economic rationale of this issue, the paper considers experience in western and eastern Europe, which are understood as "central" versus "peripheral" regions, respectively, and distinguishes between short- and longterm perspectives. In this paper, it is argued that policymakers, who want to attract foreign investment but have incomplete information over optimal taxation policy, may be inspired to initiate cuts in tax rates. Because other countries may be tempted to respond similarly, a dynamic tax- policy response would cause methodical tax rivalry among peripheral regions, as well as between peripheral and central regions. The current reality in Europe shows that tax competition benefits peripheral regions in the short-term but that a continuing tax competition would make short-term tax advantages to peripheral regions either disappear or exert negligible weight on international investment decisions over the long-term.
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