Corporate tax competition and profit shifting in asymmetric size economies : exploring multinational firms’ strategies and government responses

Abstract

In today's globalised economy, Multinational National Enterprises (MNEs) wield significant influence over the economic landscape. The strategic decision of where MNEs locate is a crucial strategic decision, shaped by factors such as market size, tax policies, transfer pricing regulations, and the potential for profit shifting. This dissertation embarks on a comprehensive exploration of this complex landscape and the aim is to provide a nuanced understanding of how asymmetrically sized economies strategically devise fiscal and regulatory policies to attract MNEs. Employing an applied theoretical model, the study examines three distinct scenarios, representing diverse economic contexts. For each scenario, the model systematically determines the optimal location for a profit maximising MNE. This approach yields comprehensive insights into MNEs' strategic decision-making in the face of diverse regulatory landscapes, illuminating how changes in enforcement levels influence their location choices and profit-shifting tactics. Numerical simulations are conducted to validate and strengthen the theoretical framework, demonstrating its effectiveness in capturing real-world scenarios. The model yields compelling insights, particularly highlighting the pivotal role of small countries. The model shows that in the absence of profit shifting opportunities, the MNE will exhibit a consistent preference to set up its plant in the large country. However, the model demonstrates that in a situation where profit shifting opportunities exist, by offering favourable tax rates and a more lenient enforcement regime, the small country can offset and outweigh the advantages of a larger market. This finding challenges conventional assumptions about the inherent advantages of larger markets, emphasising that with the right policies in place, small countries can be formidable players in the global economic landscape. As the research culminates, it is evident that profit shifting and tax competition remain crucial subjects within the domain of international economics. These findings underscore the need for continued exploration and policy refinement to navigate the complexities of the global economic landscape effectively.