We examine which tax allocation system leads to more severe distortions with respect to locational investment decisions. We consider separate accounting (SA) and formula apportionment (FA). The effects of both systems have been hotly debated in Europe in the past years. The reason is that the EU Member States are striving to implement a common European tax system that would lead to a switch from SA to FA. While existing studies focus primarily on the impact of taxes on locational decisions under either SA or FA, the main innovation of this paper is that it compares both systems with regard to the level of distortions they induce. We compare the optimal pre-tax investment decision with the optimal after-tax investment decision and infer from the difference in the allocation of investment funds which tax allocation system causes more severe distortions. We assume that the multinational group (MNG) has comprehensive book income shifting opportunities under SA. We find that the investment incentives under SA are opposed to those under FA for a profitable investment project. Whereas under SA as much as possible should be invested in a high-tax country, under FA as much as possible should be invested in a low-tax country. The distortions of locational investment decisions tend to be more severe under SA than under FA if a greater share of investment funds is to be invested in a low-tax country from a pre-tax perspective and the investment is profitable. Vice versa, locational decisions may be more distorted under FA if the optimal pre-tax investment decision requires investing a major share of funds in the high-tax country. In contrast to the often stated insensitivity of FA towards income shifting, we find the introduction of a tax allocation system based on FA in Europe could lead to a severe shift of economic substance to low-tax countries. The results of this paper are of particular interest for European policy makers and MNGs as our findings may induce European MNGs to reassess their recent locational investment decisions in the face of a potential future change in the applied tax allocation system. (authors' abstract) / Series: WU International Taxation Research Paper Series

Formulary apportionment is an intensively debated mechanism for allocating tax base within multinational groups. Systems under which the formula is identical in all jurisdictions and systems under which jurisdictions can determine the weights on the formula factors individually can be observed. The latter systems produce uncertainty about the overall tax-liable share of the future group tax base. Counter-intuitively, I identify scenarios under which increased uncertainty leads to higher expected future group income. My results provide helpful insights for firms and policy makers debating the specific design of a formulary apportionment system. (author's abstract) / Series: WU International Taxation Research Paper Series

In this paper, we test one of the fundamental assumptions in the tax competition literature, namely, that a country's taxable income depends on the tax policies pursued in the domestic and in neighbouring countries. Based on a panel of annual data of 14 western European countries spanning the period 1982 to 2004, we show that the common trend in falling corporate income tax (CIT) rates can in part be explained by the existence of fiscal externalities in the form of international resource flows. Our results confirm the presumption put forward in recent empirical tax reaction function studies, that interdependent tax setting behaviour is evidence of tax competition. However, taxable corporate income is shown to react inelastically to domestic and to foreign tax rates. Thus, the observed rise in CIT revenues in Europe between 1982 and 2004 cannot be explained by the trend in falling CIT rates. Moreover, we find that large countries' tax bases are more responsive to neighbouring countries' tax policies, which is in contrast to the classic asymmetric tax competition literature. (author´s abstract) / Series: Discussion Papers SFB International Tax Coordination

In this paper, we test one of the fundamental assumptions in the tax competition literature, namely, that a country's taxable income depends on the tax policies pursued in the domestic and in neighbouring countries. Based on a panel of annual data of 14 western European countries spanning the period 1982 to 2004, we show that the common trend in falling corporate income tax (CIT) rates can in part be explained by the existence of fiscal externalities in the form of international resource flows. Our results confirm the presumption put forward in recent empirical tax reaction function studies, that interdependent tax setting behaviour is evidence of tax competition. However, taxable corporate income is shown to react inelastically to domestic and to foreign tax rates. Thus, the observed rise in CIT revenues in Europe between 1982 and 2004 cannot be explained by the trend in falling CIT rates. Moreover, we find that large countries' tax bases are more responsive to neighbouring countries' tax policies, which is in contrast to the classic asymmetric tax competition literature. (author's abstract) / Series: Department of Economics Working Paper Series