Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2015/19: The Effect of Tax Havens on Host Country Welfare

Thomas A. Gresik (), Dirk Schindler () and Guttorm Schjelderup ()
Additional contact information
Thomas A. Gresik: Dept. of Economics, University of Notre Dame, Postal: University of Notre Dame , Department of Economics, 434 Flanner Hall, Notre Dame, IN 46556, France
Dirk Schindler: Dept. of Accounting, Auditing and Law, Norwegian School of Economics, Postal: NHH , Department of Accounting, Auditing and Law, Norwegian School of Economics, Helleveien 30, N-5045 Bergen, Norway
Guttorm Schjelderup: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: Multinational corporations can shift income into low-tax countries through transfer pricing and debt financing. While most developed countries use thin capitalization rules to limit the extent to which a subsidiary can be financed with internal debt, a number of developing countries do not. In this paper, we analyze the effect on FDI and host country welfare of thin capitalization rules when multinationals can also shift income via transfer prices. We show that while permissive thin capitalization limits may be needed in developing countries to attract FDI, the amount of debt financing allowed by the permissive limits facilitates more aggressive transfer pricing and results in lower host country welfare.

Keywords: Tax havens; welfare; multinational corporations; FDI; transfer pricing

JEL-codes: F23; H25; O10

35 pages, April 24, 2015

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