Taxation of Multinational Firms Summary W1-3

Taxation of Multinational Firms

Lecture I: Introduction

Introduction to Taxation

Why Tax in General?
 There are three main reasons for taxation:
1. Provision of public goods.
2. (Re)distribution of resources.
3. Economic stabilization.

Elements of Tax:
 Taxation comprises several elements:
o Taxable income serves as the base.
o Tax rates can be progressive or flat.
o Taxpayers include individuals and firms.

Main Goals in Tax System Design:
 Equity: Ensuring fairness and justice in tax distribution.
 Efficiency: Designing a system that minimizes economic distortions and maximizes
economic growth.

Multinational Firms

 Definition: A multinational corporation (MNE) is an international corporation that
conducts business activities across at least two countries.
 Classification Criteria:
o If a foreign company holds at least 10% of the stock of a subsidiary, it is
classified as a multinational corporation.

Reasons for Taxing Firms

1. Benefit Principle:
o Similar to individuals, companies benefit from public goods provided by the
state, such as infrastructure, education systems, and judicial systems.
2. Avoiding Erosion of Personal Income Tax:
o Taxation of firms helps prevent individuals from exploiting loopholes by
incorporating themselves to avoid personal income taxes.
3. Political Pressure:
o Large firms, especially, may face scrutiny and negative public perception.
Taxation of firms is seen as fair and necessary to address societal concerns
about equity and fairness in the tax system.

Evolution of Corporate Tax Rates: Statutory vs Effective Tax Rates

 Nominal (or Statutory) Tax Rate:

, o This is the rate imposed by law on taxable income falling within a given tax
bracket.
 Effective Tax Rate:
o The percentage of income actually paid by an individual or a company after
considering tax breaks, concessions, credits, exemptions, incentives, and
exclusions.
Reasons for Differences between Nominal and Effective Tax Rates:
 Special concessions, credits, exemptions, incentives, and exclusions are granted for
economic reasons, leading to variations between nominal and effective tax rates.

Evolution of Corporate Tax Rates

 Trends:
o There has been a significant reduction in statutory corporate tax rates since
1985, especially reinforced in the EU through Eastern enlargement.
o Most countries have also experienced a substantial reduction in effective
corporate tax rates during the same period, indicating strong indications of tax
competition.
o Smaller countries have tended to cut their tax rates more than larger countries,
suggesting asymmetric incentives for different-sized economies.

Reasons for Decreased Corporate Tax Rates:
 Tax Competition:
o Tax competition is the primary explanation for the decrease in corporate tax
rates.
o It is defined as the uncooperative setting of source-based taxes on corporate
income, where countries are influenced by the tax setting behavior of other
nations.
o This leads to a "race to the bottom" in tax rates on corporate income, driven by
the desire to attract investment.
o Governments lower their tax rates in anticipation of firms freely choosing
locations with the lowest tax rates.
o Smaller countries, lacking large domestic markets, rely more heavily on
taxation and thus engage more vigorously in tax competition.

Underlying Issues of Tax Competition:
 Tax competition arises from:
1. The uncooperative setting of tax rates.
2. The mobility of production factors, where firms can freely choose their
location.

 Coordination between countries or constraints on the mobility of capital and labor
would mitigate the race to the bottom phenomenon.


Strategic Interaction in Corporate Tax Rate Setting

 Objective: Investigate if corporate tax rates in one country are influenced by those in
other countries.
 Findings:

, o Positive and significant strategic interaction in statutory tax rates.
o Without tax competition, statutory tax rates would be 12.5 percentage points
higher on average in Western Europe.

Tax Competition Between Countries

 Impact on Government Expenditures:
o Tax competition does not significantly reduce government expenditures.
o Corporate taxes constitute a relatively small share of total government
revenues (5-10% in most countries).
 Effect on Tax Structure:
o Tax competition reduces corporate tax rates and increases tax rates on labor
and consumption.
o Workers and consumers bear the brunt of tax competition through higher taxes
on labor and consumption.
Conclusion:
 Decreasing corporate income tax rates attracts firms, stimulating economic activity
and generating profits within a country.
 Tax havens exemplify extreme tax competition strategies.

Tax Havens

 Definition:
o Countries imposing low or no taxes on income or gains.
 Characteristics:
o Political stability.
o Secrecy in banking and/or commercial matters.
o Favorable disposition to foreign capital.
o Availability of high-level advisory services in tax, legal, and accounting
matters.

 Types of Tax Havens:
o Production Havens:
 Real activity transferred to the tax haven, tangible value added.
Example: Ireland.
o Base Havens:
 Lack of real activity, little or no tax, few Double Tax Treaties (DTTs).
Example: Caribbean and Pacific Islands.
o Treaty Havens:
 Favorable networks of DTTs suitable for intermediate holdings.
Example: the Netherlands.
o Concession Havens:
 Countries offering specific tax incentives or benefits. Example:
Belgian Coordination Centre.
 EU Classification:
o Blacklist for non-compliance with transparency, fair competition, and BEPS
standards.
o Greylist for countries committed to implementing criteria.
 Importance of Lists: