Corporate Taxation and Multinational Activity

Figure 1: Share of affiliate production without corporate taxation

Figure 2 displays the share of foreign affiliate production under the exemp-
tion or credit method.¹¹ In this case, multinational activity is affected only to
a minor extent by corporate taxation (see the small differences between Figures
1 and 2).¹² Only for small countries near the main diagonal we observe less
foreign affiliate activity of horizontal MNEs, resulting from the additional tax
burden for MNEs due to withholding taxes. The foreign affiliate activities of
vertical MNEs located in the North-Western corner of the Edgeworth box are
more or less unaffected by profit taxation.

Compared to tax credit and exemption methods the deduction method is
associated with a higher tax burden on MNEs. Accordingly, the distortion
of multinational activity induced by corporate taxation becomes more evident
under deduction. Figure 3 illustrates that the foreign activity of horizontal
MNEs is significantly reduced as compared to the case of the exemption and the
credit method, especially for small countries.¹³ In small economies, firms choose
serving the foreign markets via exports since double taxation reduces foreign
affiliate profits required to cover the fixed costs abroad. However, if the home
country is large enough and tax revenue is used to finance public infrastructure,
horizontal MNEs come into existence even under deduction. In this case, tax

upon request but are suppressed here for the sake of brevity.

¹¹Note that we assume symmetric tax rates in the initial equilibrium so that the exemption
and the credit methods have an identical effect.

¹² See also Figure 5 in the Appendix, displaying the difference between the surfaces in Figure
2 and Figure 1.

¹³This can be also seen from the differential plot in the Appendix (Figure 6).

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