Local Taxation of Global Corporation: A Simple Solution

The globalization of world markets has prompted firms' search for benefits of international tax differentials. In this paper we consider a simple world with two countries and two multinationals with a division in each country. Both countries, that differ in market size, use a source-based profit tax on multinationals, who compete à la Cournot in local markets and use profit shifting based on the tax differential. We assess policies aimed to mitigate inefficient tax choices and show that tax harmonization cannot benefit the small country. We then propose a simple revenue sharing mechanism in which countries share equal proportion of their own revenue with each other, and show that revenue sharing increases equilibrium tax rates in each country, reduces the tax differential, and benefits both countries. Lastly we show that contrary to revenue sharing, the tax base equalization formula raises a fundamental equity issue.