Economic Theory of the Optimal Taxation of Multinational Profit

Economic Theory of the Optimal Taxation of Multinational Profit

Michael Devereux

Oxford University Centre for Business Taxation


This paper summarises the extensive literature on the optimal tax treatment of international investment, drawing out implications for the optimal taxation of the profit of multinational companies. The aim of taxing multinational profit is taken as given. The considerations in the literature focus on economic efficiency.

The traditional approach has favoured residence-based taxation on the grounds that this would not distort the allocation of investment between countries. A more recent approach favours source-based taxation on the grounds that it would not distort the ownership of capital.

However, neither of these simple approaches convincingly survives translation into a world of multinational companies with economic rent, international portfolio investment, acquisitions and international trade. Aiming to tax solely economic rent offers the possibility of a tax on outbound investment which would be efficient. But in a more complex world, the notions of “residence” and “source” become less well-defined; and when applied to the location of the parent company, or productive activities of affiliates, they are also mobile. This casts doubt on attempting to tax the worldwide income of a parent company, or the local income of an affiliate.

Instead, efficiency requires the tax base to be relatively immobile. This suggests that an efficient tax on profit could be levied in the country in which a company’s goods and services are ultimately sold to a third party.

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