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Taxation of Foreign Profits with Heterogeneous Multinational Firms

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  • Johannes Becker

Abstract

Recent empirical studies find that foreign direct investment (FDI) by a multinational firm is not associated with a reduction of the firm’s domestic activities. As it is often argued, this finding may imply that a country should not tax the firm’s foreign profit income since this reduces foreign investment without benefitting the domestic economy. The paper analyzes this argument using a model with heterogeneous multinational firms which serve a foreign market through exports or FDI. If a firm switches from exporting to FDI, domestic activity and tax payments may decrease, stay constant or even rise due to intra-firm trade. It turns out that, in all three cases, the optimal tax system implies full taxation after deduction of foreign tax payments. If the country accounts for the effects of its policy on the foreign price level, the case for taxing foreign income becomes even stronger. From a global point of view, the nationally optimal tax rate on repatriated foreign profits is inefficiently high. In contrast to the standard literature, the globally optimal tax system requires a lower tax rate than under the tax credit system which, under certain circumstances, may imply exempting foreign income from tax.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2899.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2899

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Keywords: corporate taxation; foreign profits; multinational firms;

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References

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  1. Bucovetsky, Sam & Wilson, John Douglas, 1991. "Tax competition with two tax instruments," Regional Science and Urban Economics, Elsevier, vol. 21(3), pages 333-350, November.
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  7. Mintz, Jack & Tulkens, Henry, 1996. "Optimality properties of alternative systems of taxation of foreign capital income," Journal of Public Economics, Elsevier, vol. 60(3), pages 373-399, June.
  8. Helen Simpson, 2009. "Investment abroad and adjustment at home: evidence from UK multinational firms," Working Papers, Oxford University Centre for Business Taxation 0903, Oxford University Centre for Business Taxation.
  9. Dhammika Dharmapala & C. Fritz Foley & Kristin J. Forbes, 2011. "Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act," Journal of Finance, American Finance Association, vol. 66(3), pages 753-787, 06.
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  13. Keen, Michael & Piekkola, Hannu, 1997. " Simple Rules for the Optimal Taxation of International Capital Income," Scandinavian Journal of Economics, Wiley Blackwell, vol. 99(3), pages 447-61, September.
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  15. Michael P Devereux, 2008. "Taxation of Outbound Direct Investment: Economic Principles and Tax Policy Considerations," Working Papers, Oxford University Centre for Business Taxation 0824, Oxford University Centre for Business Taxation.
  16. Hines, James R. Jr., 2008. "Foreign Income and Domestic Deductions," National Tax Journal, National Tax Association, vol. 61(3), pages 461-75, September.
  17. Michael P Devereux, 2007. "The Impact of Taxation on the Location of Capital, Firms and Profit: a Survey of Empirical Evidence," Working Papers, Oxford University Centre for Business Taxation 0702, Oxford University Centre for Business Taxation.
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Cited by:
  1. Davies, Ronald B., 2013. "The silver lining of red tape," Journal of Public Economics, Elsevier, vol. 101(C), pages 68-76.
  2. Matthew Cole, 2011. "Not all trade restrictions are created equally," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 147(3), pages 411-427, September.
  3. Johannes Becker & Clemens Fuest, 2011. "The taxation of foreign profits — The old view, the new view and a pragmatic view," Intereconomics: Review of European Economic Policy, Springer, vol. 46(2), pages 92-97, March.
  4. Michael Devereux & Clemens Fuest & Ben Lockwood, 2013. "The Taxation of Foreign Profits: a Unified View," Working Papers, Oxford University Centre for Business Taxation 1303, Oxford University Centre for Business Taxation.
  5. Johannes Becker, 2010. "Strategic Trade Policy through the Tax System," CESifo Working Paper Series 3066, CESifo Group Munich.

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