Taxing the Financially Integrated Multinational Firm

This paper develops a theoretical model of corporate taxation in the presence of …nancially integrated multinational …rms. Under the assumption that multinational …rms at least partly use internal loans to …nance foreign investment, we …nd that the optimal corporate tax rate is positive from the perspective of a small, open economy. This …nding contrasts the standard result that the optimal source based capital tax is zero. Intuitively, to the extent that multinational …rms …nance investment in country i with loans from a¢ liates in country j, the burden of corporate taxes in the latter country partly fall on investment and thus workers in the former country. This tax exporting mechanism introduces a scope for corporate taxes, which is not present in standard models of international taxation. Accounting for the internal capital markets of multinational …rms thus represents a way to resolve the tension between standard theory predicting zero capital taxes and the casual observation that countries tend to employ corporate taxes at fairly high rates. Keywords : Corporate taxation, Tax exporting, Multinational …rms, Internal capital markets,