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Ec426 Lecture 9 International Issues in Taxation 1 © Jonathan Leape, 2011

Ec426 Public Economics

Lecture 9: International Issues in Taxation

1 Introduction

2 Empirical evidence on incentive effects

3 Globalisation and tax policy

4 Alternative systems for taxing cross-border investment

5 Economic efficiency

6 Non-cooperative tax policy interaction (tax competition)

7 Cooperative tax policy interaction (tax coordination and

tax harmonisation)

8 Implications for tax policy

1 Introduction

investment and transactions have

grown exponentially since 1990

Tax policy can have a decisive influence on the level and pattern of

foreign investment

Tax policy towards investment can be a critical determinant of

economic growth

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2 Empirical evidence on incentive effects

Tax effects on FDI: Summary

– Time series evidence

– _ evidence

Data

– Aggregate data on FDI

– US Bureau of Economic Analysis

US multinational foreign affiliates by country – Consolidated financial accounts

Compustat – Unconsolidated accounting data with ownership

Raw BEA data, Bundesbank, Amadeus (EU)

Wheeler and Mody (92) Hines (96)

Grubert & Mutti (91) Hines and Rice (94) Swenson (94)

Devereux and Lockwood(06)

Cross-section

allocation of

MNE capital by

Altshuler et al (01) Grubert and Mutti (00)

Buettner and Ruf (06)

Cummins and Hubbard (95)

Cross-section

allocation of

MNE capital by

affiliate

Kemsley (98) Devereux and

Griffith (98)

Location choices of

multinationals

Billington (99) Pain & Young(96)

Devereux and Freeman (95)

Panel FDI

Hartman (84) Boskin and Gale (87) Newlon (87) Young (88) Murthy (89)

Slemrod (90)

Time series FDI

Other Average Tax Rate

EATR EMTR

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Summary of evidence on location choice versus level of investment:

(Devereux, 2006)

Discrete location choices depend significantly on measures of

tax rates

Conditional on location, investment choices not significantly

influenced by tax

Allocation of multinationals’ capital across countries dominated

by _

2 Empirical evidence, continued

Tax avoidance: Evidence of tax effects (Desai & Hines, 2003)

– Aggregate evidence by country

– Firm-level (micro) evidence

Tax avoidance: _

– Subsidiary in high tax country reduces taxable profits by overpaying

parent for imports and undercharging for exports

– Evidence:

Higher local tax rates associated with higher

with parent companies

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Tax avoidance: _

Bartelsman & Beetsma (JPubE, 2003)

16 OECD countries, 1980s & 1990s Examined value-added and wage bill

Findings:

Tax rises lead to decreases in _ but not,

to the same extent, in wage bill For one percentage point rise in corporate tax rate, 70% of

possible revenues lost through _.

Tax avoidance:

– Subsidiary in high tax country reduces taxable profits by

increasing leverage (debt)

– Evidence: higher local tax rates associated with higher

ratios

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Corporate tax burdens – rates and compliance costs

Source: The Economist, 18 th November 2006

Ec426 Lecture 9 International Issues in Taxation 10

3 Globalisation and tax policy

Globalisation, and the geographical separation of owners

and investment projects, raises important issues:

– Where is profit generated?

– What is the appropriate link between corporate and personal

taxes? End of _?

– How do taxes affect discrete investment location choices?

– Tax

See Auerbach, Devereux and Simpson (2010) “Taxing corporate income”, Mirrlees, ch.9

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3 Globalisation and tax policy

Increased tax competition as the tax base becomes more

geographically _ and hence more

sensitive to tax differentials

– Tax competition for _

– Tax competition for financial and commercial activities

– Tax competition for skilled labour

See Owens (1993) “Globalisation: The Implications for Tax Policies”, Fiscal Studies,

14:3, 21-44

3 Globalisation and tax policy, continued

Increased difficulty in taxing activities outside a country’s

jurisdiction – because of the increased _

of such transactions and of their changing nature.

– Tax competition and interest-bearing assets

– Globalisation and the division of the tax base of multi-national

enterprises

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principle: Capital income is taxed only in the country

in which it is produced (foreign source income is tax-exempt) Tax on

capital income is independent of the residence (nationality) of the

investor

_ principle: Capital income is taxed in the country of

residence of the investor (firm? shareholder?), double taxation is

avoided by granting credits against any foreign taxes paid Tax on

capital income is independent of where the investment is located

International experience:

– In theory, almost all EU countries apply the residence principle.

– In practice, most systems are hybrids of source and residence

– Shift towards source principle?

4 Alternative systems for taxing cross-border investment

5 Economic efficiency:

International production efficiency result

Model: Fisher two-period model of savings and investment small open

economy (Sinn, 1987, Slemrod, 1988, Giovannini, 1989)

taxation

1 Production is distorted, since investors allocate capital at home only

up to the point where marginal return on domestic investment net of

taxes equals world interest rate.

2 Savings is _, since intertemporal terms

of trade faced by savers equal world interest rate

w

r MRT w

r f

f

L K w

L

K L

K,   (1)  , 

w C

C

r U

U MRS





 1 1 2

1 , 2

1

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_ taxation

1 Production decisions are undistorted by tax

2 Savings is _, since intertemporal terms of

trade faced by savers equals world interest rate after tax

w

r f

f

L

K L

) 1 ( 1

1

2

1 , 2

1C    w  

C

r U

U MRS

5 Economic efficiency:

International production efficiency result

5 Economic efficiency

International production efficiency result :

If there are no constraints on the menu of taxes available to

government, the optimal set of taxes is one that does not distort

production decisions: an optimal tax structure maximises output,

which is then divided between consumption and government

spending

version of the production

efficiency theorem of Diamond-Mirrlees, 1971

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BUT, firms and investment locations are _

We need to define:

Criteria for economic efficiency

1) Capital export neutrality (CEN):

Requires that a company's decision about _ to

invest is not distorted by tax.

_-specific economic rents

Residence-based taxation achieves CEN without international

coordination

required for source taxation to achieve CEN

2) Capital import neutrality (CIN):

Requires that companies investing or selling in the same

market should face the .

_-specific economic rents

Source-based taxation achieves CIN without international

coordination

Residence taxation with foreign tax credits or exemption of

foreign-source income can achieve CIN with _.

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Requires that tax systems do not distort the pattern of

ownership of capital assets (Desai and Hines, 2003a,b)

Evidence on FDI and acquisitions

-specific economic rents

CON holds iff CIN holds

CON and CIN are achieved if foreign income is exempt or if it is

taxed (possibly at different rates) but with

Production by an inefficient company

Production by the least-cost company (CIN holds) Company

Efficient location of investment (CEN holds)

Inefficient location of investment

Location of production

Tax system based on

Residence

Tax system based on

Source

Economic rents arising

from:

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6 Non-cooperative tax policy interaction (“tax competition”)

Tax competition and _

Zodrow and Mieszkowski, 1986 (see Wilson and Wildasin, 2004)

– A world with a fixed number of identical countries

– CRS technology using an immobile factor (labour) and a mobile

factor (capital) which has a fixed world supply

– Consumers use income from K,L to purchase consumer good, c

– Governments use a (source-based) tax on K to produce public

good, g

– Governments set g and tax t to max residents’ u(c,g) subject to

budget constraint, g=tK(r + t), where r is after-tax return on K

and K(r + t) is demand for K as function of before-tax return

Tax competition and undertaxation

Zodrow and Mieszkowski (1986), continued:

– Countries play a Nash game in tax rates and the critical

condition for optimal public good supply is:

where K is elasticity of demand for K, =t/(r+t) is the ad

valorum tax rate and dr/dt ≤ 0 is effect on r of unit tax rate.

– MC of public good exceeds unity because increase in t causes a

(costly) capital outflow (an inflow for other countries)

– ‘fiscal externality’ leads to underprovision of g: _

– Lowering taxes is a “beggar-your-neighbour” policy

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An empirical diversion

Tax competition – competition for what?

For corporations?

– Competitive pressure on effective _ tax rates

to influence discrete location choices

For capital investment?

– Competitive pressure on effective _ tax rates

to influence size of investment, since corporations raise

finance locally and internationally

For corporate profits?

– Competitive pressure on _ rates to

influence allocation of profit (see previous discussion of

transfer pricing)

Direct investment flows depend on different decisions

– Discrete choice of where to locate

depends on effective tax rate

– How much to invest (conditional on discrete choice)

depends on effective _ tax rate

Multinational companies may use transfer pricing and thin

capitalisation to shift profits between countries

depends on _ corporate tax rate

Tax competition – effects on company decisions?

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Significant reductions in statutory corporate tax rates

Smaller decreases in _ tax rates

– due to offsetting broadening of tax bases

Stability in corporate tax _

– due to base broadening and strong profits

OECD and EU initiatives on “harmful” tax competition

Tax competition – evidence?

OECD Average Statutory Corporation Tax Rates

20%

25%

30%

35%

40%

45%

50%

55%

median unweighted mean GDP weighted mean

Source: Auerbach, Devereux and Simpson (2010)

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Source: Devereux and Sorenson, 2005

Tax neutrality in domestic investment (Lecture 8)

– focuses on effective _ tax rates

Tax neutrality in international investment – CIN, CEN, CON:

– focuses primarily on effective tax rates,

which determine location decisions, but also on

Tax competition – Implications for tax design

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Tax competition and country size

(Haufler and Wooton, 1999)

Previous findings indicated that small countries “win” the tax

competition for mobile capital as a result of their more

tax base (Bucovetsky, 1991, and Wilson, 1991)

– Small countries may tax only labour (since capital is, for them, in

infinitely elastic supply whereas labour supply elasticity is finite

Haufler and Wooton show that the existence of trade costs

(following new trade theory, e.g., Krugman, 1980) creates

location-specific rents (from _ avoided)

associated with location in the large market.

– In the presence of trade costs, increasing population size has two

effects:

to increase the profit-tax rate in the large country (as in Wilson

& Bucovetsky), provided trade costs are endogenous, and

to increase the rents of locating in

the large market

– The second effect dominates the first With trade costs, both tax

(on capital) and tariff (including consumption tax) competition

work in favour of large countries

Tax competition and country size (Haufler and Wooton, 1999)

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– Two countries: B with population 1 and A with population n > 1

– Two goods: Z, the numeraire good produced by competitive firms

and X produced by a foreign investor.

– Preferences are identical in the two countries

Model A Tax competition with trade costs

Using quadratic utility,

Haufler and Wooton derive the following expressions for the market

demand curves in the large country (A) and small country (B):

B A i for z

x x

2





x X q

n nx

; ) (

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If firm cannot price discriminate between the two markets and faces

trade costs Aand B, consumer prices in the two countries will be:

Assume (i) a symmetric _ cost, F, is sufficiently large to

ensure that the firm will not choose to produce in both countries and

(ii) that countries can impose lump-sum (profits) taxes on the firm

– Differentiating the profit functions associated with production in each

country, we solve for the optimal prices:

B country in

FDI for p

q p

q

A country in

FDI for p

q p q

B B B A B B

A

B A A B A A

A











;



B country in

FDI for n

n w p

A country in

FDI for n

w p

A B

A









































) 1 ( 2

1 ˆ

) 1 ( 2

1 ˆ







 “Home market bias”:

 Prices depend on _ (but not on lump-sum taxes)

 If trade costs are the same, firm will charge a producer price

if it establishes production in small country B

 Firm will prefer large country A because, in so doing, it avoids the

majority of trade costs.

 Tax premium: Firm willing to pay profits (lump-sum) tax premium

(lower subsidy) – where premium increases with trade costs – to

locate in large market (to avoid trade costs for more customers)

Tiêu đề	International Issues in Taxation
Tác giả	Jonathan Leape
Trường học	University of Economics
Chuyên ngành	Public Economics
Thể loại	bài giảng
Năm xuất bản	2011
Thành phố	Hanoi

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