Firms' financial choices and thin capitalization rules under corporate tax competition

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.

Anti profit-shifting rules and foreign direct investment

“…The theoretical literature on profit shifting has emphasized that opportunities for tax planning might help to establish a preferential tax regime that has positive implications for tax revenues in a context of tax competition (e.g., Keen, 2001;Janeba and Smart, 2003;Peralta, Wauthy and van Ypersele, 2006;Bucovetsky andHaufler, 2008, Becker andFuest, 2012). A similar argument has been discussed in the theoretical 1 literature on the role of tax havens in tax competition (e.g., Slemrod andWilson, 2008, Hong andSmart, 2010;Haufler and Runkel, 2012). From this perspective, profit-shifting restrictions may exert adverse effects on foreign direct investment and may raise the sensitivity of foreign direct investment with respect to the host-country's corporation tax rate.…”

Limiting Profit Shifting in a Model with Heterogeneous Firm Productivity

“…The economy of the home market comprises two sectors. One of them is a numeraire sector, in which a homogeneous good is produced with a single factor (labor) under perfect competition using a 6 Another paper specifically analyzing such a measure, namely a thin capitalization rule, is Haufler and Runkel (2008). In contrast to this paper, the firms' internationalization decision is not endogenous in the model; instead, it is assumed that only some firms are active internationally.…”

Population dynamics of tax avoidance with crowding effects

“…Hence, in part, countries could compete over the laxness of the tax law rather than over tax rates. Indeed, countries like the United States, Spain and Ireland recently weakened or abolished their thin capitalisation rules (Haufler & Runkel, 2012). This shows that governments basically have incentives to laxen their tax laws, if possible.…”