A game-theoretic analysis of international tax compliance

Abstract

This paper analyzes the response of low-tax jurisdictions to growing political pressure to comply with international tax avoidance regulations. We develop a game-theoretic model in which a low-tax country attempts to attract multinational companies by offering tax planning and/or an environment conducive to real economic activities. Our analysis reveals that while it is optimal to stigmatize non-compliant jurisdictions, political pressure may backfire by encouraging multinationals to shift their operations to low-tax jurisdictions if the reputational harm on them is not too high. Furthermore, we show that high-tax countries may find it optimal to tolerate aggressive tax planning to a certain extent, particularly when international mobility is high and the reputational harm on offshore substance-based investment is relatively low. These results underscore the complexities of enforcing tax compliance and suggest the need for a nuanced approach to tax regulation.