Page 13 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)

DDTC Working Paper 1416
13

home country. The level of incentive here is solely It appears that in determining which tax regime
determined by how much tax they have to pay if to be used, there is trade-off between maximizing
they are to invest at home country. I divide the level public goods or private goods consumption.
into three categories. First, if they are certainly pay Unsurprisingly, nowadays, countries tend to
lower tax investing at home country, the level of shift to source principle. With this principle, the
incentive is high. Second, if the amount of tax to governments will just whether losing capital
pay at home country can possibly lower, higher, inflow but sustaining tax revenue (when foreign
or equal, then the level of incentive is at moderate countries uses residence principle), or potentially
level. Third, if they are certain that they have to pay gaining capital inflow with increasing tax revenue
higher tax at home country, the level of incentive as well due to the increasing tax base (when foreign
is low. countries uses source principle). On the other side,
if the home country prefer residence principle,
In short, the table above implies that residence capital will possibly attracted to flow inside –
principle has clearly bigger opportunity to attract depends on foreign countries’ tax regime, but the
capital inflow. If, say, the foreign country holds tax revenue will certainly not increase.
source principle, the home country would have
absolute advantage in attracting foreign residents 5. Policy Implication
to move their investment inside, since the foreign
residents will not be obliged to pay any taxes.
The provided results inform us that in deciding
Next, suppose the foreign country holds residence
optimal corporate income tax policy, there are
principle, making the foreign residence compare
two factors that should be of consideration:
the tax rate imposed by both country. In such case,
consumption on private goods and consumption
if t = t* , the expected return of investing such
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capital of home and foreign country will be the on public goods. In maximizing these two, the
government tries to attract capital inflow, which
consideration of the capital owner deciding where
can be perceived as both tax base and job creator.
to put the capital. In this scenario, the incentive
In considering optimal tax policy, the government
is to invest at home country is at moderate level,
tries to seek the best option of corporate income
certainly below the previous scenario.
tax, whether in terms of its rate or its regime, in
Now, suppose the home country holds source which public goods consumption and private
principle, while the foreign country also uses goods consumption could be trade-off. Hence, in
source principle. Similarly, foreign residents will effort to maximize the society’s welfare, several
compare the home country’s tax rate and foreign policy implications can be inferred as follows:
country’s tax rate to make investment decision. It a. Lowering corporate income tax rate?
becomes direct tax rate competition between home
country and foreign country. Again, in this case, the
It clearly appears that capital are attracted
level of incentive is at moderate level. But if the
to move to countries with lower income tax rate,
foreign country implements residence principle,
so that in tax competition, the winner is the one
the foreign residents will have to pay tax two times.
who can manage to apply low corporate income
This certainly discourages capital to flow inside
tax rate. Does it mean, for large developing
the home country, making the incentive to invest
countries, lowering corporate income tax rate
at home country is low. If the home country holds
increases economic welfare? To enlighten the
residence principle, on the contrary, the foreign
answer, the government should consider with
residents will only have to pay t* no matter where broad perspective.
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they decide to put their capital. The incentive to
invest in home country will be still at moderate Recall that through ZMW model equated
level, nevertheless. in (5), country’s welfare is function of
consumption on public and private goods.
These scenarios provide us insightful
Suppose a large developing country lowers
information not only about the relation between tax
its tax rate. The effect to the country’s welfare
regimes and the incentive level to attract capital, but
then can be breakdown as follows. First, remind
also about improving welfare as general. Remind
that public goods consumption is reflected by
that from (5), the welfare is maximized through
tax revenue, which is equal to . By lowering the
private goods and public goods consumption.
corporate income tax rate, it simply means that
By attracting capital inflow through residence
is reduced. The impact to , however, is uncertain.
principle, we should note that while private good
Despite through KK framework lower tax rate
consumption increases, the government revenue is
incentivize capital inflow, such occurring will
reduced, since the foreign residents pay zero tax to
also depend to the tax regime hold by the home
the home country’s government.
country and its competitors.