An Auction Theoretical Approach to Fiscal Wars

Abstract

I examine a situation where a firm has to choose to locate a new factory in one of several jurisdictions. The value of the factory may differ among jurisdictions and it depends on the private information held by each jurisdiction. Jurisdictions compete for the location of the new factory. This competition may take the form of expenditures already incurred on infrastructure, commitments to spend on infrastructure, tax incentives or even cash payments. The model combines two elements that are usually considered separately; competition is desirable because we want the factory to be located in the jurisdiction that values it the most, but competition in itself is wasteful. I show that the expected total amount paid to the firm under a large family of arrangements. Moreover, I show that the ex-ante optimal mechanism – that is, the mechanism that guarantees that the firm chooses the jurisdiction with the highest value for the factory, minimizes the total expected payment to the firm, and balances the budget in an ex-ante sense – can be implemented by running a standard auction and subsidizing participation.