Tax Burden and the Allocation of Investment in International Framework with Monopolistic Firms

The closely interconnected economies of the European Union and associated countries have to be responsive to changes in each other’s tax policy. A mathematical model based on Haufler & Wooton (1999) assumes a monopolistic firm that considers a fixed capital investment in one of two asymmetric countries as regards size, labor costs and corporate tax rate. We assume that the trade between the two countries involves some transaction costs. The model calculates a sustainable corporate tax rate, and it also shows that the smaller country is able to attract the firm’s investment at the expense of its own tax revenues. We have ranked Central European countries based on the results of the model. The model contributes to the discussion of the theory of tax competition, since it shows the importance of non-tax factors for international competitiveness of a country.