Profit Taxation, Monopolistic Competition and International Relocation of Firms

This paper presents a two-country monopolistic competition trade model to analyze how the profit taxation determines the location of firms and national welfare. Profit tax cuts may increase or decrease the number of firms in a country, depending on the elasticities of substitution between domestic and foreign goods and between goods produced in the same country. Accordingly, profit tax cuts may increase or decrease domestic consumption and welfare, depending on these elasticities. The paper provides parameter conditions under which a decrease in the domestic profit tax attracts foreign firms and increases domestic welfare.