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

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DDTC Working Paper 1416
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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
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(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
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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.
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