The taxation of foreign profits: A unified view

Devereux, Michael, Clemens, Fuest and Lockwood, Ben (2015) The taxation of foreign profits: A unified view. Journal of Public Economics, 125. pp. 83-97.

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This paper synthesizes and extends the literature on the taxation of foreign source income in a framework that covers both greenfield and acquisition investment, and a general constraint linking investment at home and abroad for the multinational by introducing a cost of adjustment for the mobile factor. Unless the cost of adjustment is zero, the domestic tax on foreign-source income should always be set to ensure the optimal allocation of the mobile factor between domestic and foreign assets and should follow the classical rules in the literature; national optimality requires the deduction rule, and global optimality requires the credit rule. Only in the zero-cost case does exemption become optimal. Allowances can be set so as to ensure that domestic and foreign asset purchases are undistorted by the tax system: this requires a cash-flow tax on domestic investment in the greenfield case, and a cross-border cash flow tax on foreign investment in both cases. These basic results extend to various extensions of the model, notably: (i) when a profit-shifting motive is present; and (ii) to some extent, when a corporate income tax is in place. The introduction of tax administration costs into the model can explain the empirical trend towards the use of the exemption regime.

Item Type: Article
Subject(s): Taxation
Date Deposited: 05 Oct 2018 12:19
Last Modified: 07 Nov 2018 16:46

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