DP25 Taxation of Foreign Multinationals: A Sequential Bargaining Approach to Tax Holidays

Author(s): Christopher Doyle, Sweder van Wijnbergen
Publication Date: August 1984
Keyword(s): Sequential Bargaining, Tax Holiday, Taxation of Multinationals
JEL(s): 323, 442
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=25

In this paper we view the tax schedule applied to the profits of a Multinational Enterprise (MNE) as the outcome of a sequential bargaining process and show, using modern game theory developments (the "perfect equilibrium" solution concept) that tax holidays will emerge from such a process if a MNE incurs fixed costs upon entry. At the core of our results is the recognition that the existence of sunk costs creates an ex post (entry) bilateral monopoly situation. We show that the tax rate emerging from this form of bargaining has a dynamic structure. We obtain results on the length and discounted value of the tax holiday, its precise form and the way all this responds to changes in fixed costs.