Corporate tax systems and cross country profit shifting

The paper analyses optimal taxation of corporate profits whengovernments can choose both the rate and the base of the corporationtax, but are constrained to collect a given amount of corporatetax revenue. In a standard two-period model of investment andinternational mobility of portfolio capital only, the optimaltax system allows a full deduction for the costs of capital.When foreign direct investment is permitted, however, and firmscan shift profits between countries through transfer pricing,it will be optimal for each government to distort investmentdecisions in order to reduce tax rates and limit the incentivefor profit shifting.