Page 9 - 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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to attract taxable profit from other countries different tax rates, there are more than one
by lowering its tax rate. We can compare this applied tax rates that can be imposed whether
rationale to the economic reality, that countries based on the national region or the type of
who are listed as tax haven countries have the investments. For simplicity, suppose the
relatively smaller size of population (e.g. British country hold two differentiated-rate taxes.
Virgin Islands, Curacao, Luxembourg, Panama). Adjusting the equation (4) formulated earlier,
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after mathematical process , it then becomes
When it comes to lowering corporate
income tax rate, large countries have heavier
consideration compared to smaller countries. With t is part of {t , t , t , ...}
On one side, according to KK model, this policy 2Z 2a 2b 2c
helps to keep tax base to stay in the border, but
We can see now that each of the elements
on the other side, tax revenue is reduced due to
of consumptions level, which are influenced
the lower rate. It becomes even heavier when
by tax, are influenced by differentiated tax
the large country is a developing country. If it
rate. t is used to denote set of tax rate policy
2Z
prefers to keep the rate – which means tax rate
consisting more than one tax rate. Now suppose
differs exists –, its tax base will be still eroded,
country 1 lowers its tax rate. In the normal case,
since profit shifting practices are sensitive
a proportion amount of revenue of t k would
2 2
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to corporate tax rate difference. However,
lost because there would be a movement of
recall that based on ZMW model, under strictly
capital, as much as �, to move from country 2
concave government spending, developing
to country 1. Instead of lowering the tax rate as
countries value public provision highly. Losing
a whole, country 2 can choose just to lower the
tax revenue then affects more significantly for
tax rate for specific region, in which the tax rate
developing countries compared to developed
is t . now, the capital owners have two different
2b
ones. This is why, large developing countries
options between moving the capital to country
usually hold relatively high corporate income
2 or to other region of country 1 that implement
tax (e.g. Indonesia, India, China, Pakistan).
lower tax rate. As a result, part of � will move
Hence, we can see that the conclusion from to the specific region in country 2, and the
KK model is in line with the one that is derived resulting lost is smaller than t k .
2 2
through ZMW model. The similar conclusion
One should remind that, as implied by (18),
of the two also include to the fact that setting
higher level of W can be attained. An amount
uniform rate internationally will harm the 2
of capital who are intended to leave territory
small, low tax country, whereas imposing a
with high level of tax might choose to move
minimum tax anywhere around the area will
instead to other region of the same country that
attain Pareto-improving. The two also provide
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has specialized lower tax rate. This, in result,
us insight that, on one side, tax competition
minimize the amount of capital outflow caused
gives small countries a good deal, while hurting
by tax competition with small countries.
large developing countries. On the other side,
tax coordination will benefit both side of the Practically, differentiated tax rates are
countries, while discouraging profit shifting implemented by forming onshore financial
practices. center in certain areas (or islands) of a country
3.2. Implementing Tax Rate Differentiation (for example Malaysia with Labuan, United
States with Delaware, Spain with Basque, etc).
So far, we get to the knowledge that big-size This way, countries can rationally attract capital
countries tend to be the loser in tax competition inflow while maintaining tax revenue. Putting it
due to its lack of ability to lower its tax rate. under the ZMW and KK frame, this policy helps
But it uses the assumption that each country countries to maximize the welfare from both
can only use single tax rate. Now consider if, private and public goods consumption. Private
given the large size of the countries, the country goods consumption is maintained through
choose to implement two tax rate, namely t capital inflow, while public goods provision
2a
and t , where (t > t ) under assumption that is sustained since one of the tax rate remains
2b
2a
2b
the tax rates are both non-progressive. How unchanged and the tax base is not incentivized
does it affect the preference for big country to to go abroad.
maximize its welfare?
23. W = f (k ) – f' (k )k + ρk + G (t k ) + f (k ) – f' (k )k
2b
2a
2a
2b
2b
2a 2a
2a
2a
2
2b
2b
2a
2a
2a
+ ρk + G (t k ). But for simplification, single subscript ‘2D’ is used
Since now the country can choose to apply 2b 2b 2b 2b
to represent the multiple tax rate.
24. S.M. Ali Abas et al, “A Partial Race to the Bottom: Corporate Tax
22. See B. Bawono Kristiaji, “Incentives and Disincentives of Profit Developments in Emerging and Developing Economies”, IMF Working
Shifting in Developing Countries,” MSc Thesis., Tilburg University, 2015. Paper, No. 12/28 (2012): 3-22.
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