The Impact of Tax Uncertainty on Irreversible Investment

Tax legislation, fiscal authorities, and tax courts create tax uncertainty by frequent tax reforms and various different interpretations of the tax law. Moreover, investors generate model-specific tax uncertainty by using simplified models that anticipate the actual tax base incorrectly. I analyze the effects of stochastic taxation on investment behavior in a real options model. The investor holds an option to invest in an irreversible project with stochastic cash flows. To cover the effects of both tax base and tax rate uncertainty, the investment’s tax payment is modelled as a stochastic process. Increased tax uncertainty has an ambiguous impact on investment timing. The view that tax uncertainty depresses real investment is rejected. A higher expected tax payment delays investment. A higher tax rate on interest income affects investment timing ambiguously.tax uncertainty, capital budgeting, real options, investment incentives

The Impact of U.S. GILTI and FDII Regimes on Taxation of Intangible Income, Cross-Border Tax Planning, and International Taxation

This study examines the GILTI and FDII regimes, which were enacted as part of the comprehensive U.S. tax reform called the Tax Cuts and Jobs Act (TCJA) in late 2017. The study focuses on how the income generated from intangibles is taxed under these regimes and how the regimes affect U.S. MNEs and their cross-border tax planning. In addition, the regimes are analyzed from European point of view and in light of international tax and trade policies. Finally, attention is paid to how the regimes could influence the development of international taxation. Under the FDII provision, foreign income derived from intangibles is effectively taxed at the rate of 13.125% instead of the statutory corporate tax rate of 21%. On the other hand, pursuant to the GILTI provision, income of CFCs exceeding the deemed annual 10% routine return on tangible assets is effectively taxed at the rate of 10.5% at the level of the U.S. shareholder unless the same income has already been effectively taxed at a sufficient rate in foreign jurisdiction. Hence, the regimes aim to incentivize the holding of intangibles in the U.S. and encourage U.S. MNEs to export intangible-related goods and services. On the other hand, the regimes aim to discourage the offshoring of intangibles. It is however discovered in the study that, because the FDII and GILTI are calculated based on assumptions, the regimes also affect decisions on the location of tangible assets. In addition, the impact of the regimes on cross-border tax planning depends on several other features such as uncertainties relating to the permanence of the regimes and tax incentives provided by other countries. There have been doubts whether the FDII regime violates international commitments and constitutes a harmful tax regime or a prohibited export subsidy. For now, the FDII regime has not been challenged in the WTO but it is under peer review in the OECD Forum on Harmful Tax Practices. Due to its innovative approach, the FDII regime significantly deviates from other equivalent measures. Thus, it is impossible to say with certainty whether the regime ultimately constitutes a breach of international commitments. Ultimately, the GILTI provision is examined with regard to the development of international taxation. First, it has been considered that the GILTI regime has already partly resolved challenges relating to taxation of digital economy. Second, the GILTI provision has served as inspiration for the income inclusion rule, a kind of minimum global tax, which was recently proposed by the OECD. The GILTI and FDII regimes have given rise to much discussion around the development of international taxation and tax competition, and it is certain that the discussion will continue in the future. It remains to be seen how the GILTI and FDII regimes will ultimately affect the outcome of these discussions

Tax Havens and Multinational Corporate Income Tax Avoidance

Honorable mention for 2019. Project completed for course ECON 350. Supporting faculty: Akila Weerapan

Tax Competition with Formula Apportionment: The Interaction between Tax Base and Sharing Mechanism

The EU Commission is advocating a common consolidated tax base for the corporate income tax, accompanied by a revenue sharing mechanism based on formula apportionment. We analyse tax competition in such a regime, focussing on the interaction between the definition of the tax base and the apportionment method. Tax competition leads to suboptimally low tax rates if and only if the investment elasticity of the tax base is lower than the investment elasticity of the apportionment factor. For any apportionment method a change in the definition of the tax base can turn a race-to-the-bottom in tax competition into a race-over-the-top.tax competition, formular apportionment, corporate income tax

Multinationals, Minority Ownership and Tax-Efficient Financing Structures

This paper presents a theory model that simultaneously accounts for the financing decisions and ownership structure in affiliates of multinational firms. We find that affiliates of multinationals have higher internal and overall debt ratios and lower rental rates of physical capital than comparable domestic firms. We also show that affiliates with minority owners have less debt than wholly owned affiliates and a less tax-efficient financing structure. The latter is due to an externality whereby minority ownership dampens the incentive to avoid taxes through the use of internal debt.multinationals, tax-efficient financing structures, minority ownership

Profit Shifting in the EU: Evidence from Germany

The paper considers profit shifting behavior using data on German inbound and outbound FDI. It finds an empirical correlation between the home country tax rate of a parent and the net of tax profitability of its German affiliate that is consistent with profit shifting behavior. For profitable affiliates that are directly owned by a foreign investor the evidence suggests that a 10 percentage point increase in the parent's home country tax rate leads to roughly half a percentage point increase in the profitability of the German affiliate. On the outbound side of German FDI, the data provides some evidence that tax rate changes in the host country lead to a stronger change in after-tax profitability for affiliates that are wholly owned, which may reflect the larger flexibility of these firms in carrying out tax minimizing behavior without interference of minority owners.foreign direct investment, profit shifting, tax avoidance, multinational enterprise

Expansion of Higher Education and Time-Consistent Taxation

This paper analyzes educational choices and political support for subsidies to higher education in the presence of a time-consistency problem in income redistribution. There may be political support for so generous subsidization that it motivates the median voter to obtain higher education. As a result of increasing own income, the median voter prefers in the future lower taxes than without higher education. Therefore, the expansion of participation in higher education during the second half of the 20th century may have partly been driven by the aim to limit the political support for overly generous income redistribution.education, time-consistency problem, voting, subsidies to education

Multinational Capital Structure and Tax Competition

This paper analyzes tax competition when welfare maximizing jurisdictions levy source-based corporate taxes and multinational enterprises choose tax-efficient capital-to-debt ratios. Under separate accounting, multinationals shift debt from low-tax to high-tax countries. The Nash equilibrium of the tax competition game is characterized by underprovision of publicly provided goods. Under formula apportionment, the country-specific capital-to-debt ratio of a multinational’s affiliate is independent of the jurisdiction’s tax rate. Public good provision is either too large or too small. If the debt externality is not negative, there is clearly underprovision under formula apportionment.multinational enterprises, financial policy, profit shifting, corporate taxation, tax competition