Working Paper: CEPR ID: DP10512
Authors: Michael P. Devereux; Clemens Fuest; Ben Lockwood
Abstract: This paper synthesizes and extends the literature on the taxation of foreign source income in a framework that covers both greenfield and acquisition investment, and a general constraint linking investment at home and abroad for the multinational by introducing a cost of adjustment for the mobile factor. Unless the cost of adjustment is zero, the domestic tax on foreign-source income should always be set to ensure the optimal allocation of the mobile factor between domestic and foreign assets and should follow the classical rules in the literature; national optimality requires the deduction rule, and global optimality requires the credit rule. Only in the zero-cost case does exemption become optimal. Allowances can be set so as to ensure that domestic and foreign asset purchases are undistorted by the tax system: this requires a cash-flow tax on domestic investment in the greenfield case, and a cross-border cash flow tax on foreign investment in both cases. These basic results extend to various extensions of the model, notably (i) when a profit-shifting motive is present; (ii) to some extent, when a corporate income tax is in place. The introduction of tax administration costs into the model can explain the empirical trend towards use of the exemption regime.
Keywords: Corporate Taxation; Multinational Firms; Repatriation
JEL Codes: F23; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic tax on foreign-source income (F38) | Optimal allocation of the mobile factor between domestic and foreign assets (F20) |
| National optimality requires a deduction rule (H21) | Investment efficiency (G11) |
| Global optimality requires a credit rule (C61) | Investment efficiency (G11) |
| Cost of adjustment not zero (F16) | Tax regimes influence the level of foreign investment (F21) |
| Tax administration costs (H26) | Trend towards exemption regimes (H26) |