﻿ Page 5 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)

Basic HTML Version
Page 5 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)
P. 5

``````DDTC Working Paper 1416
5

The existing  theoretical  research thus needs   to the model.
to be followed by a  series  of empirical proof.
Too  simplified  theory  might  not  just  nullify  the   The profit generated from production function
theoretical relevance, but  could also provide   of country i is then deducted by t . Tax treatment
i
policies that  exacerbate the  problem.  And to   here is  assumed  to depend  only on the location
know what assumptions are relevant, one should   of the investment, as the countries are assumed
understand how to connect the role of theoretical   to use “source”  based principle.  Accordingly,  in
and empirical research.                          equilibrium, all investors  must achieve the same
after-tax rate of return on capital, denoted by ρ. Put
Thus, in this paper, I present  the theoretical   it mathematically,
explanation  in the following  order. First, I
explain  the traditional  but  useful model that  are
broadly used by other researchers to derive more
Here, we should acknowledge that, since capital
contextualized  theory  for  recent  issues.  Second,
is freely mobile, world capital-labor ratio is fixed at
I continue with relaxing  the assumption used
, causing market clearing condition
in the basic  model to get  the theory closer to
practical world. I do it by incorporating two base
of adjusted assumptions, which are: (i) taking into
account the possibilities for firms to shift the profit   Where
without moving the whole capital; (ii) considering
Equation (2)  is necessary  to emphasize  that
the consequence  of implementing  differentiated
capital  and labor can always  choose  place to go
corporate tax rate in dealing with tax competition.
so that  there is balance  in capital  market. Or in
Third, for further case, I make it possible for the
other words, equilibrium  condition can  always
countries to integrate the case when countries
be achieved.  Although  realistically the balance  is
actually can develop the tax  system not only by
never equalized – and will never be –, we believe
determining the tax  rate, but  also  by setting  the
that the flow movement of labor and capital across
regime used in country, which are source principle
border  moves  in a way as continuously nearing
and residence principle. Fourth, with the generated
the equilibrium state. Thus,  (1)  and (2)  jointly
findings,  I  try  to  take  several  policy  implications
determine the amount of capital allocated to each
that can be insightful for policy makers to deal with
country and the common net of return.
tax  competition.  Lastly,  the  paper  is  completed
with the conclusion.                                Now  suggest that  one of country  changes its
tax rate, while the rest (n – number of countries)
2. Basic Model                                   do not. Adjusted equation (1) then holds for n – 1,
which  represents  all  other  countries  that  do  not
When we analyze the capital owner’s behavior,   increase the tax rate, that
we should keep in mind that  the decision  is
governed by the objective to maximize the return.
In formalizing the logical framework of tax policies
and investment decision,  utilizing model built     We can infer from equation (3) that the added
by  Zodrow  and  Mieszkowski  (1986)  and  Wilson   value of increasing one unit of capital is intrinsically
16
(1986)  – or usually mentioned as ZMW model –    determined by the ratio of capital itself in respect
can be a good start to generate insightful ideas.  with  the associated labor  involved in production
process. Put it alternatively, the net return of capital
The model considers a world economy consisting
is generated after deducting it by labor wage and
of n “countries” (i = 1, ... , n) that have investment
tax.  Accordingly, through mathematical  routine
opportunities represented by production function
worked by Zodrow, Mieszkowski, and Wilson, this
f (k ), where k  denotes aggregate capital ratio and
17
1  1       1                                    gives  us a matrix system  from which  following
f   represents  the aggregate  output. Thus,  f (k )
1                                     1  1      conditions follows:
represents that  the amount  of output  produced
is  influenced  by  the  capital  invested  in  the
production. There are other numerous factors that
can also influence the production function, such as
law, bureaucracy, politics etc, but here, the reality
is simplified by removing other irrelevant aspects   An increase in the tax rate in any country i thus
reduces  the capital  employed in the production
function, and thus increases  capital  in all  other
16. Michael Keen and Kai A. Konrad, “The Theory of International Tax
Competition and Coordination,” Max Planck Institute for Tax Law and Public
Finance Working Paper, No. 06 (2014). I partially follow the sequential
step of the modelling in this paper.             17. Ibid.``````
 1   2   3   4   5   6   7   8   9   10