Federal tax autonomy and the limits of cooperation

We consider the hold-up problem between a foreign direct investor and the government(s) in a host country with weak governmental structure and lack of power to commit. Using “Nash threats,” we show that an efficient investment level can be sustained for a sufficiently high discount factor and ask whether a vertically disintegrated government structure makes collusion more or less sustainable. We show that collusion between the government and the investor is easier to sustain if the host country is vertically more integrated, or if the different vertical layers of government can commit to fixed tax-sharing rules.