ABSTRACT We investigate tax competition between two asymmetric countries bidding for an MNE subsidiary. Departing from standard zero‐sum models of profit reallocation between hosts, we introduce an “inward shifting” mechanism where profits flow from a high‐tax headquarters country to the host. This expands the host's tax base, strategically incentivizing the small country to adopt lax transfer pricing regulations. In equilibrium, the small country leverages this regulatory leniency to overcome its market‐size disadvantage, attracting the MNE and raising tax revenue. Furthermore, this outcome is reinforced as trade costs decline and economic integration advances.
Ma et al. (Fri,) studied this question.