Strategic Trade Policy through the Tax System

Becker J.


Abstract
If conventional instruments of strategic trade policy are unavailable, the system of foreign profit taxation and transfer price guidelines may serve as surrogate policy instruments. In this paper, I consider a model where firms from two countries compete with each other on a market in a third country. Both firms have affiliates in the third country where (part of) the production takes place. I analyse optimal policy choices of the firms' residence countries aiming at strategically manipulating the competitiveness of their firms. I show that, first, countries prefer the tax exemption system over the tax credit system if there is no intra-firm trade. Second, if the headquarters provide inputs for production in the affiliate, countries prefer the tax exemption system if the transfer price for these inputs is close to the headquarters' variable cost and if the residence country's tax rate is high. However, if transfer prices are high and the residence country's tax rate is low, I show that the tax credit system is an optimal tax policy choice for both countries. From a policy perspective, the view that the tax exemption system is generally the best policy response if domestic firms' competitiveness is a policy goal has to be qualified. © 2014 John Wiley & Sons Ltd.



Publication type
Article in Journal

Peer reviewed
Yes

Publication status
Published

Year
2014

Journal
World Economy

Volume
37

Issue
9

Start page
1237

End page
1246

Language
English

ISSN
1467-9701

DOI

Full text

Affiliation
Westfälische Wilhelms-Universität Münster