Profit Shifting and Equilibrium Principles of International Taxation

Abstract

We study the choice between source-based and destination-based corporate taxes in a two country model, allowing multinational _rms to use transfer pricing to allocate pro_ts across tax jurisdictions. We show that source-based taxation is a Nash equilibrium for tax revenue maximizing jurisdictions if domestic and foreign _rms generate large revenues. We also show that destinationbased taxes are a Nash equilibrium when _rms generate low revenues, which implies the presence of multiple equilibria. Both the source and the destination principle coexist in equilibrium when domestic and foreign corporate revenues are intermediate. However, the source principle always tax-dominates the destination principle.