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1 Ec426 Lecture 9 International Issues in Taxation 1 © Jonathan Leape, 2011 Ec426 Public Economics Lecture 9: International Issues in Taxation 1. Introduction 2. Empirical evidence on incentive effects 3. Globalisation and tax policy 4. Alternative systems for taxing cross-border investment 5. Economic efficiency 6. Non-cooperative tax policy interaction (tax competition) 7. Cooperative tax policy interaction (tax coordination and tax harmonisation) 8. Implications for tax policy Ec426 Lecture 9 International Issues in Taxation 2 © Jonathan Leape, 2011 1. Introduction ____________________________ investment and transactions have grown exponentially since 1990. Tax policy can have a decisive influence on the level and pattern of foreign investment Tax policy towards investment can be a critical determinant of economic growth. 2 Ec426 Lecture 9 International Issues in Taxation 3 © Jonathan Leape, 2011 2. Empirical evidence on incentive effects Tax effects on FDI: Summary – Time series evidence – _________________________ evidence Data – Aggregate data on FDI – US Bureau of Economic Analysis US multinational foreign affiliates by country – Consolidated financial accounts Compustat – Unconsolidated accounting data with ownership Raw BEA data, Bundesbank, Amadeus (EU) Ec426 Lecture 9 International Issues in Taxation 4 © Jonathan Leape, 2011 Wheeler and Mody (92) Hines (96) Grubert & Mutti (91) Hines and Rice (94) Swenson (94) Devereux and Lockwood(06) Devereux and Lockwood(06) Cross-section allocation of MNE capital by location or industry Altshuler et al (01) Grubert and Mutti (00) Buettner and Ruf (06) Cummins and Hubbard (95) Cross-section allocation of MNE capital by affiliate Kemsley (98)Devereux and Griffith (98) Location choices of multinationals Billington (99) Pain & Young(96) Devereux and Freeman (95) Panel FDI Hartman (84) Boskin and Gale (87) Newlon (87) Young (88) Murthy (89) Slemrod (90)Time series FDI OtherAverage Tax RateEATREMTR Source: Devereux, 2006 3 Ec426 Lecture 9 International Issues in Taxation 5 © Jonathan Leape, 2011 Summary of evidence on location choice versus level of investment: (Devereux, 2006) Discrete location choices depend significantly on measures of ________________ tax rates Conditional on location, investment choices not significantly influenced by tax Allocation of multinationals’ capital across countries dominated by ___________________________ 2. Empirical evidence, continued Ec426 Lecture 9 International Issues in Taxation 6 © Jonathan Leape, 2011 2. Empirical evidence, continued Tax avoidance: Evidence of tax effects (Desai & Hines, 2003) – Aggregate evidence by country – Firm-level (micro) evidence Tax avoidance: _________________________ – Subsidiary in high tax country reduces taxable profits by overpaying parent for imports and undercharging for exports – Evidence: Higher local tax rates associated with higher __________________ with parent companies 4 Ec426 Lecture 9 International Issues in Taxation 7 © Jonathan Leape, 2011 2. Empirical evidence, continued Tax avoidance: _______________________ Bartelsman & Beetsma (JPubE, 2003) 16 OECD countries, 1980s & 1990s Examined value-added and wage bill Findings: Tax rises lead to decreases in _______________ but not, to the same extent, in wage bill For one percentage point rise in corporate tax rate, 70% of possible revenues lost through _____________________. Ec426 Lecture 9 International Issues in Taxation 8 © Jonathan Leape, 2011 2. Empirical evidence, continued Tax avoidance: ____________________________ – Subsidiary in high tax country reduces taxable profits by increasing leverage (debt) – Evidence: higher local tax rates associated with higher __________________ ratios 5 Ec426 Lecture 9 International Issues in Taxation 9 © Jonathan Leape, 2011 Corporate tax burdens – rates and compliance costs Source: The Economist, 18 th November 2006 Ec426 Lecture 9 International Issues in Taxation 10 © Jonathan Leape, 2011 Ec426 Lecture 9 International Issues in Taxation 10 3. Globalisation and tax policy Globalisation, and the geographical separation of owners and investment projects, raises important issues: – Where is profit generated? – What is the appropriate link between corporate and personal taxes? End of _____________________? – How do taxes affect discrete investment location choices? –Tax ______________________ See Auerbach, Devereux and Simpson (2010) “Taxing corporate income”, Mirrlees, ch.9 6 Ec426 Lecture 9 International Issues in Taxation 11 © Jonathan Leape, 2011 Ec426 Lecture 9 International Issues in Taxation 11 3. Globalisation and tax policy Increased tax competition as the tax base becomes more geographically _______________ and hence more sensitive to tax differentials – Tax competition for _____________ – Tax competition for financial and commercial activities. – Tax competition for skilled labour. See Owens (1993) “Globalisation: The Implications for Tax Policies”, Fiscal Studies, 14:3, 21-44 Ec426 Lecture 9 International Issues in Taxation 12 © Jonathan Leape, 2011 3. Globalisation and tax policy, continued Increased difficulty in taxing activities outside a country’s jurisdiction – because of the increased _______________ of such transactions and of their changing nature. – Tax competition and interest-bearing assets. – Globalisation and the division of the tax base of multi-national enterprises. 7 Ec426 Lecture 9 International Issues in Taxation 13 © Jonathan Leape, 2011 ____________ principle: Capital income is taxed only in the country in which it is produced (foreign source income is tax-exempt). Tax on capital income is independent of the residence (nationality) of the investor. _____________ principle: Capital income is taxed in the country of residence of the investor (firm? shareholder?), double taxation is avoided by granting credits against any foreign taxes paid. Tax on capital income is independent of where the investment is located. International experience: – In theory, almost all EU countries apply the residence principle. – In practice, most systems are hybrids of source and residence. – Shift towards source principle? 4. Alternative systems for taxing cross-border investment Ec426 Lecture 9 International Issues in Taxation 14 © Jonathan Leape, 2011 5. Economic efficiency: International production efficiency result Model: Fisher two-period model of savings and investment small open economy (Sinn, 1987, Slemrod, 1988, Giovannini, 1989) __________________ taxation 1. Production is distorted, since investors allocate capital at home only up to the point where marginal return on domestic investment net of taxes equals world interest rate. 2. Savings is ___________________, since intertemporal terms of trade faced by savers equal world interest rate. w r MRT w r f f MRT w LK w L K LK    ,, )1(  w CC rU U MRS   1 1 2 1 , 21 8 Ec426 Lecture 9 International Issues in Taxation 15 © Jonathan Leape, 2011 ___________________ taxation 1. Production decisions are undistorted by tax. 2. Savings is _______________, since intertemporal terms of trade faced by savers equals world interest rate after tax. w r f f MRT w L K LK  , )1(1 1 2 1 , 21    w CC rU U MRS 5. Economic efficiency: International production efficiency result Ec426 Lecture 9 International Issues in Taxation 16 © Jonathan Leape, 2011 5. Economic efficiency International production efficiency result : If there are no constraints on the menu of taxes available to government, the optimal set of taxes is one that does not distort production decisions: an optimal tax structure maximises output, which is then divided between consumption and government spending. ____________________________ version of the production efficiency theorem of Diamond-Mirrlees, 1971. 9 Ec426 Lecture 9 International Issues in Taxation 17 © Jonathan Leape, 2011 5. Economic efficiency BUT, firms and investment locations are _______________ We need to define: Criteria for economic efficiency 1) Capital export neutrality (CEN): Requires that a company's decision about _____________ to invest is not distorted by tax. _________________-specific economic rents Residence-based taxation achieves CEN without international coordination ______________ required for source taxation to achieve CEN Ec426 Lecture 9 International Issues in Taxation 18 © Jonathan Leape, 2011 5. Economic efficiency Criteria for economic efficiency 2) Capital import neutrality (CIN): Requires that companies investing or selling in the same market should face the __________________________. _________________-specific economic rents Source-based taxation achieves CIN without international coordination Residence taxation with foreign tax credits or exemption of foreign-source income can achieve CIN with _____________. 10 Ec426 Lecture 9 International Issues in Taxation 19 © Jonathan Leape, 2011 Ec426 Lecture 9 International Issues in Taxation 19 5. Economic efficiency Criteria for economic efficiency 3) Capital ownership neutrality (CON): Requires that tax systems do not distort the pattern of ownership of capital assets (Desai and Hines, 2003a,b) Evidence on FDI and acquisitions ______________________-specific economic rents CON holds iff CIN holds CON and CIN are achieved if foreign income is exempt or if it is taxed (possibly at different rates) but with ________________________________. Ec426 Lecture 9 International Issues in Taxation 20 © Jonathan Leape, 2011 5. Economic efficiency Production by an inefficient company Production by the least- cost company (CIN holds) Company Efficient location of investment (CEN holds) Inefficient location of investment Location of production Tax system based on Residence Tax system based on Source Economic rents arising from: