Research seminar: Openness and the Optimal Taxation of Foreign Know-How
Speaker: Prof. Alexander Monge-Naranjo, PhD (Federal Reserve Bank of St. Louis)
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Many developing countries o¤er tax incentives and even subsidize the entry and operation of foreign fi rms. I examine the optimality of such policies. Openness allows foreign ideas to disseminate inside a country and can foster the countrys domestic accumulation of know-how. However, laissez-faire openness is suboptimal and can be growth- and even welfare-reducing when externalities are present in the diffusion of ideas. I examine the optimal taxation program the self-funding taxes on domestic and foreign fi rms that maximize the welfare of the recipient country, subject to the equilibrium behavior of national and foreign firms. Under optimal taxation, openness is always welfare enhancing and leads lagging countries to catch up with the world frontier. Yet, a country may want to subsidize the entry of foreign firms only if it can also subsidize the domestic accumulation of know-how. I also consider the optimal tax program under a number of restrictions that developing countries typically face. For instance, a country must not subsidize entry of foreign fi rms if doing so requires taxing the concurrent cohort of domestic fi rms. Similarly, an international agreement that requires equal taxation of domestic and foreign fi rms can be welfare reducing for a country close to the knowledge frontier.
Registration for this event is not required!