Page 14 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)

DDTC Working Paper 1416
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If the tax regime hold by the home country can be useful for the country. Remind that
is source principle, it means that the foreign from Table 1 that there are various scenarios
residents only has moderate level, means consisting of combination of tax principles
that it is not certain whether will increase or that can incentivize capital to be invested
not. However, if the regime used is residence in the home countries. One can try, for
principle, it certainly means that the home example, implementing residence principle
country will lose the tax base, since the foreign just for certain type of investment that are
capital cannot be taxed. Since the impact to as actively competed by other countries to pull
tax base is uncertain, the tax revenue of the the investment from the home country. For
home country will be more likely reduced. How other type of investments that are included
about the impact to private goods consumption? as comparative advantage, the country can
It is uncertain, since it also depends on the tax maximize the revenue with implementing
regime, as previously explained. source principle.

The reason of lowering tax rate, however, This way, attracting capital inflow can
might be justified if we look at broader be done efficiently. Since the decision of tax
perspective. Using KK model’s perspective, regime for certain type of investments can be
lower tax rate does not only attract capital taken separately from tax regime for other
inflow from foreign residence, but also prevent type of investment, bigger capital inflow and
capital outflow from home residents, especially government revenue can be achieved. This
in terms of profit shifting. That being said, is because certain type of investment can be
lower tax rate can help to combat profit shifting associated with different country counterparts,
practices and thus increase tax compliance who possibly use different tax regime. If the
of the country. Nevertheless, in pursuing tax regimes are decided according to other
tax compliance, anti-avoidance rule must associated countries’ tax regime, the country’s
be enforced, accompanied with effective tax welfare can then be maximized.
33
administration.
c. Implementing tax incentives
Hence, as a whole, for large developing
country it is more likely that the welfare is From the theoretical framework provided,
reduced. It is because public goods consumption, it is assumed that the type of investment is
which is highly valued for the country, is very unitary, meaning that there is only one type of
likely reduced. Meanwhile, for the same case in good, except in section 3.2. Competing the tax
the perspective of small country, the outcome system directly other countries’ tax system can
can be different. That is why for large developing be not only difficult, but also costly and thus
country, lowering corporate income tax rate in redundant in sacrificing the whole system just
order to compete with small countries is not to win a certain type of investment. Therefore,
recommended. using tax incentive is certainly a better option.
b. Differentiating the tax regime as well in order to As there are tendencies from developed
attract capital inflow economies to shift their tax regime into source
principle34, developing countries should be
Remind again the impact of choosing tax alert in utilizing the opportunities that will
regime using Frenkel’s framework (1992) arise. When the large economies are shifting
associated with ZMW model (1992), using to source base principle, then the firms are
residence principle might give bigger incentive set to look to those countries to move their
for capital inflow. But it certainly means that tax capital. This simply means that in this context,
revenue is reduced. Conversely, using source developing countries are competitor to each
principle will lower other countries’ capital other as they posit themselves as capital-
to flow inside, but tax revenue will be still importing countries.
maintained. As capital importing country, large
developing country has dilemma in deciding On the effort to boost investment inflow
which tax regime in welfare-maximizing. through optimal corporate tax policy, developing
countries can utilize other instruments such as
However, having more than one tax regime tax incentives. It would be useful if every type
of the associated investment is linked with a
33. Kristiaji (2015) found that anti-avoidance rule can effectively specific tax policy, which are tailored in such a
reduce profit shifting practices up to 72%, if supported by effective tax
administration system. The magnitude is only 35%, however, if it is not
accompanied with effective tax administration system. See B. Bawono 34. Thornton Matheson, Victoria Perry, and Chandara Veung, “Territorial
Kristiaji, “Incentives and Disincentives of Profit Shifting in Developing vs. Worldwide Corporate Taxation: Implications for Developing Countries”,
Countries,” MSc Thesis., Tilburg University, 2015. IMF Working Paper, No. 13/205 (2013): 3-18.