Pillar Two and Tax Competition: Implications for Investment Policy, Incentives, and FDI Dynamics

Abstract

This study examines how the OECD/G20 Pillar Two global minimum tax is reconfiguring international tax competition, the design of investment incentives, and foreign direct investment (FDI) dynamics. The core policy challenge is that jurisdictions that historically relied on low effective tax rates (ETRs), preferential regimes, and profit-based incentives may experience diminished competitiveness once top-up taxes apply where jurisdictional ETRs fall below the 15% minimum. Methodologically, the paper combines doctrinal and policy analysis of the Global Anti-Base Erosion (GloBE) architecture—focusing on jurisdictional ETR computation, the mechanics of top-up taxation, and the operation of transitional and permanent safe harbours—with an empirical illustration based on a structured time series (2020–2025). The dataset includes an ETR proxy, an investment-incentives intensity index, and FDI inflows measured as a share of GDP. The results show a clear movement toward minimum-tax alignment alongside a measurable reduction in the intensity of incentives, while FDI remains broadly stable in aggregate but displays sensitivity to the retrenchment of incentives. Forward-looking scenario projections for 2026–2030 indicate that jurisdictions can mitigate adverse investment effects by shifting from rate-reducing incentives toward Pillar Two–compatible instruments, notably qualified refundable tax credits, and by strengthening non-tax determinants of location attractiveness such as regulatory predictability, infrastructure quality, and human capital. The findings support a policy agenda centered on transparent, rules-based incentive frameworks, enhanced certainty mechanisms, and systematic monitoring of competitive shifts from tax-rate competition to broader investment-climate fundamentals.