Corporate Taxation and Multinational Activity

Figure 2: Share of affiliate production with exemption or credit method
(t_i = tj = 0.3; t_i^w = t_j^w = 0.05; δ_i = δj = 0.2; public infrastructure investments)

revenues are high enough to finance public infrastructure, reducing fixed plant
setup costs to compensate the disadvantages of double taxation. Again, the
production decisions of vertical MNEs are nearly unaffected by double taxation.

In the following, we focus on four factor endowment configurations within
the Edgeworth box to derive the effects of the considered tax parameters on
MNE activity.¹⁴ For each of these endowment points and each method of dou-
ble taxation relief (credit, exemption, and deduction), we compare the foreign
affiliate production in the reference case as described in Section 3.4 with a
counterfactual where the taxation parameters of interest are increased by one
percentage point, one at a time. Our parameterization (symmetric tax rates)
is not suitable to illustrate the differential effects of taxation under the credit
method as compared to exemption. Therefore, we allow initial tax rate differ-
entials between domestic and foreign countries in alternative scenarios. The
results are summarized in Table 1.

We consider the following endowment configurations. First, one where coun-
try i is small but the relative factor endowments are identical across countries at
Li/(Li + Lj) = Si/(Si + Sj) = 0.15. There, country i’s foreign affiliate produc-
tion is small, amounting to only 1.65 percent of the world production of X under
tax credit or exemption (there is no MNE activity under deduction at this en-
dowment configuration). Second, at zero relative factor endowment differences,
¹⁴We do not consider any impact of taxation on outbound MNE activity of an unskilled
labor abundant economy, since such an economy does not run foreign affiliates.

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