Page 7 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)

DDTC Working Paper 1416
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Considering in case all countries raise their tax tax. But, later in this section, by the work done
21
rates some common and small amount dt = dt, then by Keen and Konrad (2014) , we can see that
i
it holds that from equation (1), this simply reduces the generated result can also logically apply for
the common net return ρ by the same amount and profit shifting interpretation. Assume there are
leaves the allocation of capital unchanged, so that two countries (i = 1,2), where the population is
the welfare of country i is dWi = –k dt + G 'k dt ; uniformly distributed in each, but population
i
i
i
Evaluating this from Nash equilibrium, ’s first- sizes h differs in a way that h > h . In each
2
i
1
order condition (7) then implies country, there is only one unit of some good.
Suppose that t > t , then the consumers in
1
2
country 2 find it worth to purchase abroad in
country 1 if t + �s < t , or
2
1
By assuming all countries are identical (k = k ),
i
i
then
In consequence, revenues of the two
countries are:
Given the positive sign, it shows that the Nash
equilibrium is Pareto inefficient: all countries would
benefit from a small, uniform increase in all tax
rates. This does not hold if the tax-rate increasing It appears that because of the movement,
actions are not followed by the related countries. an amount of move from country 2
If there are only one or few countries take such to buy the good in country 1. In effect, the tax base
actions, capital will simply move away from the of country 2 is only as many as .
countries and enter the other countries who do not Accordingly, assuming that each government
increase the tax rate. This then becomes the central wants to maximize its tax revenue, taking as
argument against unconstrained international tax given the tax set of the other, then maximizing
competition. the r heavily depends on its relative size. After
mathematical routine done by Kanbur and Keen
3. Moving toward More Realistic (1991), the best response of each t ( t ) and t (
2
2
1
Assumption t ) are
1
3.1. Incorporating Profit-Shifting Practices
Despite the insightful information that
ZMW model can give, its assumption is too And, for t
2
simplistic and general. It is thus inherently
limited to comprehend the complex practices
of international tax competition. For instance,
moving capital does not necessarily mean a
multinational move its subsidiary from one
to another country, but it can just move away
its earning through profit shifting practices – The described responses revealed in (14)
mostly by transfer price and thin capitalization and (15) shows that there are mismatched
instruments. UNCTAD has recently estimated responses between country 1 and country 2.
that, every 10% increase of investment from This is visually depicted in Figure 2.
certain countries will impact to the reduce
As depicted in the illustration, when the
of the rate of return of the related companies
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2
in developing countries by 1%. Thus, it is large country set low t , it is optimal for the
small country to set t above t . Some citizen
necessary to make more realistic assumption 1 2
of the small country are moving to the large
underlying the model.
country, but the tax rate in the large country
How does profit-shifting activities affect the is so low that this condition will not hold long
way in which strategic aspects of international for them. But, as the large country increases its
competition works? To get the answer, we can tax rate beyond , it becomes gainful for the
start with Kanbur and Keen (1993) model. This small country to set a lower tax (discontinued
model is actually constructed for commodity from the path of � + t /2. As the tax rate of large
1
20. UNCTAD, “FDI, Tax, and Development: The Fiscal Role of 21. Michael Keen and Kai A. Konrad, “The Theory of International Tax
Multinational Enterprise towards Guidelines for Coherent International Competition and Coordination,” Max Planck Institute for Tax Law and Public
Tax and Investment Policies”, UNCTAD Working Paper, (2015). Finance Working Paper, No. 06 (2014).