Welfare, taxes and foreign investment

R&D-based growth models imply a positive growth effect of foreign investment through the introduction of new technologies. However, it has been shown that in an economy without taxes, national welfare may decrease due to the transfer of profits to foreigners. This paper investigates whether the introduction of a tax on profits warrants a positive welfare effect of foreign investment. It is shown that the welfare effect of foreign investment may be negative due to the existence of transfers of profits to foreigners even when the domestic economy is following the optimal tax policy. (c) 2005 Elsevier B.V. All rights reserved.