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Safe Haven vs. Earnings Stripping Rules: a Prisoner Dilemma?

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  • Kalamov, Zarko Y.

Abstract

Internal debt financing can be used by multinational firms to shift profits from high-tax to low-tax countries. Governments apply thin capitalization rules (TCRs), which limit the deductibility of interest expenses, to restrict this behavior. TCRs fall in two main categories: safe haven rules and earnings stripping rules. We derive the locally and the socially optimal type of TCR in a general equilibrium two country model. A unilateral switch from safe haven to earnings stripping rules is welfare improving, because it allows governments to tax at different effective rates domestic and multinational firms. Thus, we provide an explanation for the recently observed trend to replace safe haven rules with earnings stripping rules. Depending on the degree of transfer price manipulation undertaken by multinational enterprises, a prisoner dilemma result emerges, as local governments may have a dominant strategy to choose earnings stripping, even when it is not mutually welfare maximizing.

Suggested Citation

  • Kalamov, Zarko Y., 2015. "Safe Haven vs. Earnings Stripping Rules: a Prisoner Dilemma?," EconStor Preprints 110895, ZBW - Leibniz Information Centre for Economics.
    • Handle: RePEc:zbw:esprep:110895
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    File URL: https://www.econstor.eu/bitstream/10419/110895/1/Safe%20Haven%20vs.%20Earnings%20stripping%20rules%20-%20a%20Prisoner%20Dilemma.pdf
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    References listed on IDEAS

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    12. Valeria Merlo & Georg Wamser, 2015. "Debt Shifting and Thin-capitalization Rules," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 12(04), pages 27-31, January.
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    Cited by:

    1. Mardan, Mohammed, 2017. "Why countries differ in thin capitalization rules: The role of financial development," European Economic Review, Elsevier, vol. 91(C), pages 1-14.
    2. Gresik, Thomas A. & Schindler, Dirk & Schjelderup, Guttorm, 2017. "Immobilizing corporate income shifting: Should it be safe to strip in the harbor?," Journal of Public Economics, Elsevier, vol. 152(C), pages 68-78.

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    More about this item

    Keywords

    thin capitalization rules; safe haven rules; earnings stripping rules; profit shifting;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H7 - Public Economics - - State and Local Government; Intergovernmental Relations
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business

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