Page 16 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)
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DDTC Working Paper 1416

                      policy solely in the competition, the government   far outweighed by the capital inflow. Meanwhile, for
                      should  also attract investment by monetary   bigger-populated countries, it becomes more difficult
                      policy,  which  influence  the  rate  of  return  of   since losing more tax revenue could be very harmful
                      capital.                                      for the welfare of the countries. It thus making them
                                                                    weaker in the ‘race-to-the-bottom’ competition. This
                   5. Conclusion                                    explains  why  small  countries  are  the  ones  who  are
                                                                    reluctant to take united action in tax matters. 43
                      The diverse national  tax system in the world    The generated idea from such work not only open
                   economy  can  influence  the  way  capital  flow  across   larger ground for further research on taxation, but also
                   country  border.  Free  movements  of  capital  have   enlighten us to several relevant policy implications:
                   important  consequence  for  corporate  tax  policy,   first,  considering  the  magnitude  of  impact  from
                   which relates to how the government formulate the tax   lowering  tax  rate  in  affecting  country’s  welfare
                   system. Countries cannot decide tax policies without   with  broad  perspective;  second,  implementing  tax
                   taking  into  account  other  countries’  tax  system.   incentive wisely so that harmful tax competition can
                   Hence, what is at stake for countries now is whether   be prevented; third, creating onshore financial center
                   to keep the delusional tax sovereignty by moving with   with lower tax rate in order to attract capital inflow
                   uncoordinated acts with other countries, or, to admit   without  harming  the  country’s  tax  revenue;  fourth,
                   that the sovereignty is distorted by globalized economy,   for  a  longer-run  purpose,  initiating  tax  coordination
                   thus recognizing that the best way to deal with recent   with  other  countries;  fifth,  linking  tax  policies  with
                   economic situation is by taking coordinated actions.  monetary policies as a complement to each other in
                      We show that from rational  decision making   order to attract capital inflow and minimizing capital
                   process, tax system is tailored in a way to maximize   outflow.
                   a country’s welfare through private goods and public   The theoretical framework developed in this paper
                   goods  consumption.  Without  any  tax  coordination,   gives us rational relevant choices in the perspective
                   Nash equilibrium is not at the pareto maximum state.   of  large  developing  countries.  Thus,  the  generated
                   By increasing tax rate together, every country can gain   idea can also be applied to Indonesia, as one of large
                   better off condition since capital owner is still in the   developing  country.  The  policy  recommendations
                   same preference as before. This action is impossible   suggested in this paper can thus be very helpful for
                   to be taken without agreement between countries. If   the government to deal with the integrated economy
                   such move is only taken by few countries, any other   in maximizing the national welfare.
                   countries can take advantage by keeping their tax rate
                   in order to attract the capital flow into their countries.
                   This enforces the perspective that tax coordination is a
                   better way in dealing with globalized economy.
                      Accordingly,  in  maximizing  society’s  welfare
                   without tax coordination, a country tries to tailor its
                   tax system to attract capital inflow. The function of
                   capital under the framework is to enlarge tax bases and
                   increase job creation, so that both public goods and
                   private  goods  consumption  can  then  be  maximized.
                   We show with Kanbur and Keen (1992) that different
                   tax rate attracts multinational firms to shift their profit,
                   causing the country with higher tax rate losing its tax
                   base. They also show that large country is less able
                   to  deal  with  tax  competition,  since  small  country
                   can  lower  its  tax  rate  without  losing  much  welfare.
                   Then,  through  framework  model  constructed  by
                   Frenkel (1992), we show that the tax regime used by
                   associated countries affects the amount of tax the firms
                   pay, which affects the decision of capital owners in
                   deciding where to put their capital.

                      Countries  with  low  size  of  population  is  better
                   equipped for tax competition. It is mainly because such
                   tax-revenue loss caused by lowering tax rate can be
                                                                    43. 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 (2012). I partially follow the sequential
                   Paper, No. 13 (2013).                            step of the modelling in this paper.
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