International enforcement cooperation and leadership against profit shifting

Market asymmetry between large and small countries induces tax gap that triggers profit shifting and base erosion from multinationals. Tax enforcement is the alternative to tax coordination to limit profit shifting. However, the lack of enforcement coordination makes the fight against profit shifting less effective. We consider a game in which countries differ both in (market) size and enforcement productivity (enforcement elasticity of tax revenue). Countries seek to maximize welfare (tax revenue net of enforcement cost), choosing first their enforcement level to limit profit shifting before competing in taxes. We find that enforcement leadership Pareto dominates simultaneous enforcement choices, and that the low-enforcement productivity country would be the leader. In line with the OECD/G20 BEPS project, we analyze the scope for international enforcement cooperation. We establish that Nash bargaining over enforcements (with countries competing in taxes) induces higher enforcement, tax and revenue for each country, and that the benefit of enforcement cooperation is larger for the low-enforcement productivity country. We then analyze the minimum tax reform showing that it achieves a Pareto improvement both under cooperative and non-cooperative enforcement.