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Safe haven or earnings stripping rules: a prisoner’s dilemma?

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  • Zarko Y. Kalamov

    (University of Technology Berlin)

Abstract

Multinational firms use internal debt financing to shift profits from high-tax to low-tax countries. Therefore, governments restrict the deductibility of interest expenses by applying thin-capitalization rules (TCRs). TCRs fall into two main categories: safe haven rules (SHR) and earnings stripping rules (ESR). We analyze the optimal TCR choice in a two-country tax competition model. We show that unilateral replacement of SHR by ESR imposes a negative profit shifting externality on the other country. This effect can explain the recently observed switch from SHR to ESR in many countries. However, ESR may be a dominant strategy even when SHR is socially optimal, i.e., the observed policies of ESR implementation may indicate a prisoner’s dilemma.

Suggested Citation

  • Zarko Y. Kalamov, 2020. "Safe haven or earnings stripping rules: a prisoner’s dilemma?," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(1), pages 38-76, February.
    • Handle: RePEc:kap:itaxpf:v:27:y:2020:i:1:d:10.1007_s10797-019-09545-w
    DOI: 10.1007/s10797-019-09545-w
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    2. Amitrajeet A. Batabyal & Peter Nijkamp, 2022. "Efficient Regional Taxes in the Presence of Mobile Creative Capital," The Review of Regional Studies, Southern Regional Science Association, vol. 52(2), pages 198-209.

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    More about this item

    Keywords

    Thin-capitalization rule; Safe haven rule; Earnings stripping rule; Profit shifting;
    All these keywords.

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H7 - Public Economics - - State and Local Government; Intergovernmental Relations

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