We analyse tax competition between two countries of unequal size trying to attract a foreign-owned monopolist. When national governments have only a lump-sum profit tax (subsidy) at their disposal, but face exogenous and identical transport costs for imports, then both countries will be willing to offer a subsidy to the firm. At the same time, the firm prefers to locate in the larger market where it will be able to charge a higher producer price. In equilibrium the large country receives the investment and may even be able to charge a positive tax, if the difference in the sizes of the national markets is sufficiently great. The profit tax paid in equilibrium rises further if countries are given an additional instrument of either a tariff or a consumption tax.

No abstract

Thin capitalization rules have become an important element in the corporate tax systems of developed countries. This paper sets up a model where national and multinational firms choose tax-efficient financial structures and countries compete for multinational firms through statutory tax rates and thin capitalization rules that limit the tax-deductibility of internal debt flows. In a symmetric tax competition equilibrium each country chooses inefficiently low tax rates and inefficiently lax thin capitalization rules. We show that a coordinated tightening of thin capitalization rules benefits both countries, even though it intensifies competition via tax rates. When countries differ in size, the smaller country not only chooses the lower tax rate but also the more lenient thin capitalization rule.

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We analyze a sequential game between two symmetric countries when firms can invest in a multinational structure that confers tax savings. Governments are able to commit to long-run tax discrimination policies before firms' decisions are made and before statutory capital tax rates are chosen non-cooperatively.Whether a coordinated reduction in the tax preferences granted to mobile firms is beneficial or harmful for the competing countries depends critically on the elasticity with which the firms' organizational structure responds to tax discrimination incentives. The model can be applied to recent policy initiatives that aim at a ban on preferential tax regimes and at reducing the profit shifting opportunities for multinational firms.