Page 16 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)

DDTC Working Paper 1416
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policy solely in the competition, the government far outweighed by the capital inflow. Meanwhile, for
should also attract investment by monetary bigger-populated countries, it becomes more difficult
policy, which influence the rate of return of since losing more tax revenue could be very harmful
capital. for the welfare of the countries. It thus making them
weaker in the ‘race-to-the-bottom’ competition. This
5. Conclusion explains why small countries are the ones who are
reluctant to take united action in tax matters. 43
The diverse national tax system in the world The generated idea from such work not only open
economy can influence the way capital flow across larger ground for further research on taxation, but also
country border. Free movements of capital have enlighten us to several relevant policy implications:
important consequence for corporate tax policy, first, considering the magnitude of impact from
which relates to how the government formulate the tax lowering tax rate in affecting country’s welfare
system. Countries cannot decide tax policies without with broad perspective; second, implementing tax
taking into account other countries’ tax system. incentive wisely so that harmful tax competition can
Hence, what is at stake for countries now is whether be prevented; third, creating onshore financial center
to keep the delusional tax sovereignty by moving with with lower tax rate in order to attract capital inflow
uncoordinated acts with other countries, or, to admit without harming the country’s tax revenue; fourth,
that the sovereignty is distorted by globalized economy, for a longer-run purpose, initiating tax coordination
thus recognizing that the best way to deal with recent with other countries; fifth, linking tax policies with
economic situation is by taking coordinated actions. monetary policies as a complement to each other in
We show that from rational decision making order to attract capital inflow and minimizing capital
process, tax system is tailored in a way to maximize outflow.
a country’s welfare through private goods and public The theoretical framework developed in this paper
goods consumption. Without any tax coordination, gives us rational relevant choices in the perspective
Nash equilibrium is not at the pareto maximum state. of large developing countries. Thus, the generated
By increasing tax rate together, every country can gain idea can also be applied to Indonesia, as one of large
better off condition since capital owner is still in the developing country. The policy recommendations
same preference as before. This action is impossible suggested in this paper can thus be very helpful for
to be taken without agreement between countries. If the government to deal with the integrated economy
such move is only taken by few countries, any other in maximizing the national welfare.
countries can take advantage by keeping their tax rate
in order to attract the capital flow into their countries.
This enforces the perspective that tax coordination is a
better way in dealing with globalized economy.
Accordingly, in maximizing society’s welfare
without tax coordination, a country tries to tailor its
tax system to attract capital inflow. The function of
capital under the framework is to enlarge tax bases and
increase job creation, so that both public goods and
private goods consumption can then be maximized.
We show with Kanbur and Keen (1992) that different
tax rate attracts multinational firms to shift their profit,
causing the country with higher tax rate losing its tax
base. They also show that large country is less able
to deal with tax competition, since small country
can lower its tax rate without losing much welfare.
Then, through framework model constructed by
Frenkel (1992), we show that the tax regime used by
associated countries affects the amount of tax the firms
pay, which affects the decision of capital owners in
deciding where to put their capital.

Countries with low size of population is better
equipped for tax competition. It is mainly because such
tax-revenue loss caused by lowering tax rate can be
43. Michael Keen and Kai A. Konrad, “The Theory of International Tax
Competition and Coordination,” Max Planck Institute for Tax Law and Public
Finance Working Paper, No. 06 (2012). I partially follow the sequential
Paper, No. 13 (2013). step of the modelling in this paper.