Tax competition when firms choose their organizational form: Should tax loopholes for multinationals be closed?

We analyze a sequential game between two symmetric countries when firms can invest in a multinational structure that conferse tax savings. Governments are able to commit to long-run tax discrimination policies before firms' decisions are made and statutory capital tax rates are chosen non-cooperatively. Whether a coordinated reduction in the tax preferences granted to firms is beneficial or harmful for the competing countries depends critically on the elasticity with which the firms organization structure responds to tax discrimination incentives. A model extension with countries of different size shows that small countries are likely to grant more tax preferences than larger ones, along with having lower effective tax rates. (C) 2007 Elsevier B.V. All rights reserved.