Abstract
This paper examines how restrictions on the tax-deductibility of interest cost affect location choices of multinational corporations (MNCs). Many countries have introduced so-called thin-capitalization rules (TCRs) to prevent MNCs from shifting tax base to countries with lower tax rates. As of 2012, in our sample of 172 countries, 61 countries have implemented a TCR. Using information on nearly all new foreign investments of German MNCs, we provide a number of new and interesting insights in how TCRs affect the decision of where to locate foreign entities. These results include estimates of own- and cross-elasticities of location choice and also novel results on the relative importance of tax base vs. tax rate effects. We finally provide estimates for different uncoordinated as well as coordinated policy scenarios.
Highlights
Policymakers all over the world increasingly respond to public outrage about how little taxes are payed by multinational corporations (MNCs) like Apple, Amazon, Google, Facebook, Microsoft, or Starbucks
This government action is supported by the OECD report on base erosion and profit shifting (BEPS) published in 2013, in which the OECD raises concerns about corporate tax revenue losses, recognizing that profit shifting by MNCs is “a pressing and current issue for a number of jurisdictions” (OECD, 2013a, p. 5)
The purpose of this paper is to assess the impact of thin‐capitalization rules (TCRs) on the location of multinational firms’ foreign affiliates
Summary
Policymakers all over the world increasingly respond to public outrage about how little taxes are payed by multinational corporations (MNCs) like Apple, Amazon, Google, Facebook, Microsoft, or Starbucks. Our paper is related to prior work on the impact of corporate taxation on the location decision of MNCs. The large majority of papers on corporate taxation and firm activity analyze corporate tax rate effects on marginal investment decisions TCR implies a higher effective tax rate This leads us to the following prediction: Hypothesis A laxer TCR (a higher Θ) implemented by a given country reduces the average tax burden faced by MNCs in that country and increases the probability that firms choose that country as a host location. To highlight that firms may face different safe‐haven thresholds and statutory tax rates in the same country (because firm’s first location choices occur in different years), we index the variables Θ and τ by ij.
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