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,
                                                                                               23
                                                                       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
                                                    22
                      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
                                                                                                 24
                                                                       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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