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Optimal fiscal barriers to international economic integration in the presence of tax havens

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  • Johannesen, Niels

Abstract

This paper develops a model where firms can shift profits to tax havens by means of intra-firm loans and countries can protect themselves against profit shifting by taxing cross-border interest flows. The model considers two countries with a scope for welfare improving economic integration. The first-best tax system has two important characteristics: (i) the tax rate on interest flows to the other country is zero to ensure the optimal level of economic integration; (ii) the tax rate on interest flows to tax havens is high enough to deter profit shifting to tax havens. In second-best environments, countries face a trade-off between economic integration and protection against tax havens, which causes protection to be suboptimally low. The key to the result is that economic integration makes it easier for multinational firms to circumvent taxes on interest payments to tax havens with conduit loans. The paper thus provides an explanation for the empirical puzzle that many countries do not tax interest payments to tax havens despite the scope for profit shifting.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 96 (2012)
Issue (Month): 3 ()
Pages: 400-416

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Handle: RePEc:eee:pubeco:v:96:y:2012:i:3:p:400-416

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Web page: http://www.elsevier.com/locate/inca/505578

Related research

Keywords: Tax competition; Profit shifting; Tax havens; Tax planning; Withholding taxes; Economic integration;

References

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  1. Niels Johannesen, 2010. "Taxing the Financially Integrated Multinational Firm," EPRU Working Paper Series 2010-12, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
  3. Qing Hong & Michael Smart, 2007. "In Praise of Tax Havens: International Tax Planning and Foreign Direct Investment," CESifo Working Paper Series 1942, CESifo Group Munich.
  4. Mihir A. Desai & C. Fritz Foley & James R. Hines, 2004. "A Multinational Perspective on Capital Structure Choice and Internal Capital Markets," Journal of Finance, American Finance Association, vol. 59(6), pages 2451-2487, December.
  5. Nicolas Marceau & Steeve Mongrain & John D. Wilson, 2007. "Why Do Most Countries Set Higher Tax Rates on Capital?," Discussion Papers dp07-09, Department of Economics, Simon Fraser University.
  6. Buettner, Thiess & Wamser, Georg, 2013. "Internal Debt And Multinational Profit Shifting: Empirical Evidence From Firm-Level Panel Data," National Tax Journal, National Tax Association, vol. 66(1), pages 63-95, March.
  7. Luc Laeven & Harry Huizinga & Gaetan Nicodeme, 2007. "Capital Structure and International Debt Shifting," IMF Working Papers 07/39, International Monetary Fund.
  8. Yeaple, Stephen & Helpman, Elhanan & Melitz, Marc, 2004. "Export versus FDI with Heterogeneous Firms," Scholarly Articles 3229098, Harvard University Department of Economics.
  9. Joel Slemrod & John D. Wilson, 2006. "Tax Competition With Parasitic Tax Havens," NBER Working Papers 12225, National Bureau of Economic Research, Inc.
  10. Fred Ramb & Alfons J. Weichenrieder, 2005. "Taxes and the Financial Structure of German Inward FDI," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 141(4), pages 670-692, December.
  11. Jack Mintz, 2004. "Conduit Entities: Implications of Indirect Tax-Efficient Financing Structures for Real Investment," International Tax and Public Finance, Springer, vol. 11(4), pages 419-434, 08.
  12. Johannesen, Niels, 2010. "Imperfect tax competition for profits, asymmetric equilibrium and beneficial tax havens," Journal of International Economics, Elsevier, vol. 81(2), pages 253-264, July.
  13. Cremer, Helmuth & Gahvari, Firouz, 2000. "Tax evasion, fiscal competition and economic integration," European Economic Review, Elsevier, vol. 44(9), pages 1633-1657, October.
  14. Desai, Mihir A. & Foley, C. Fritz & Hines, James Jr., 2006. "The demand for tax haven operations," Journal of Public Economics, Elsevier, vol. 90(3), pages 513-531, February.
  15. Janeba, Eckhard & Peters, Wolfgang, 1999. "Tax Evasion, Tax Competition and the Gains from Nondiscrimination: The Case of Interest Taxation in Europe," Economic Journal, Royal Economic Society, vol. 109(452), pages 93-101, January.
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Citations

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Cited by:
  1. Niels Johannesen, 2012. "Cross-border hybrid instruments," EPRU Working Paper Series 2012-02, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  2. Haufler, Andreas & Runkel, Marco, 2012. "Firms' financial choices and thin capitalization rules under corporate tax competition," European Economic Review, Elsevier, vol. 56(6), pages 1087-1103.
  3. Dominika Langenmayr & Andreas Haufler & Christian Josef Bauer, 2012. "Should Tax Policy Favor High- or Low-Productivity Firms?," CESifo Working Paper Series 4034, CESifo Group Munich.
  4. Neils Johannesen, 2012. "Strategic Line Drawing between Debt and Equity," Working Papers 1203, Oxford University Centre for Business Taxation.
  5. Shafik Hebous & Vilen Lipatov, 2012. "A Journey from a Corruption Port to a Tax Haven," Working Papers 1204, Oxford University Centre for Business Taxation.
  6. Shafik Hebous, 2011. "Money at the Docks of Tax Havens: A Guide," CESifo Working Paper Series 3587, CESifo Group Munich.

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