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

  • Johannesen, Niels

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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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
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505578

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  1. Nicolas Marceau & Steeve Mongrain & John D. Wilson, 2007. "Why Do Most Countries Set High Tax Rates on Capital?," Cahiers de recherche 0711, CIRPEE.
  2. Huizinga, Harry & Laeven, Luc & Nicodeme, Gaetan, 2008. "Capital structure and international debt shifting," Journal of Financial Economics, Elsevier, vol. 88(1), pages 80-118, April.
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  4. Mihir A. Desai & C. Fritz Foley & James R. Hines, Jr., 2003. "A Multinational Perspective on Capital Structure Choice and Internal Capital Markets," NBER Working Papers 9715, National Bureau of Economic Research, Inc.
  5. Cremer, Helmuth & Gahvari, Firouz, 2000. "Tax evasion, fiscal competition and economic integration," European Economic Review, Elsevier, vol. 44(9), pages 1633-1657, October.
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  7. Qing Hong & Michael Smart, 2006. "In praise of tax havens: International tax planning and foreign direct investment," Working Papers tecipa-265, University of Toronto, Department of Economics.
  8. Yeaple, Stephen & Helpman, Elhanan & Melitz, Marc, 2004. "Export versus FDI with Heterogeneous Firms," Scholarly Articles 3229098, Harvard University Department of Economics.
  9. 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.
  10. Slemrod, Joel & Wilson, John D., 2009. "Tax competition with parasitic tax havens," Journal of Public Economics, Elsevier, vol. 93(11-12), pages 1261-1270, December.
  11. 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.
  12. 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.
  13. 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.
  14. 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.
  15. 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.
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