Competition for FDI and Profit Shifting: On the Effects of Subsidies and Tax Breaks

Abstract

We investigate competition for FDI within a region when a foreign multinational firm can profitably exploit differences in statutory corporate tax rates by shifting taxable profits to lower-tax jurisdictions. In such framework we show that targeted tax competition may lead to higher welfare for the region as a whole than lump-sum subsidies when the difference in statutory corporate tax rates and/or their average is high enough. Tax competition is also preferable from an efficiency point of view (overall surplus) by changing the firm's investment decision when profit shifting motivations induce the firm to locate in the (before tax) least profitable country.

Do Tax Rates Encourage Profit Shifts By Multinational Companies In Indonesia?

“…The statutory tax rate can influence a company's profit-shifting efforts by altering its financing sources or transferring assets or products at abnormal prices (Gravelle, 2014). The statutory tax rate has stronger predictive power than the effective average tax rate in indicating the likelihood of multinational companies considering profit-shifting opportunities when choosing subsidiary locations (Amerighi & De Feo, 2014). Furthermore, using an unweighted average of tax rates across all countries where a multinational group operates is considered the most appropriate approach for measuring tax rate differences between countries (Beer & Loeprick, 2015;Bilicka & Seidel, 2020;Johansson et al, 2017b) The study by (Heckemeyer & Overesch, 2017) estimated that a one percent decline in the host country's corporate income tax rate was associated with a 0.80 percent increase in the pretax income of subsidiaries based in that country.…”