Profit Shifting and Unilateral Adoption of Destination-Based Taxes

This paper provides new insights into a key element of the global corporate tax reform agenda: the choice between a source-based and a destination-based corporate tax system. We study the government choice between source-based and destination-based taxes in a two-country model, allowing multinational firms to use transfer pricing to allocate profits across tax jurisdictions. Governments face a trade-off in choosing their tax system: under source-based taxation, high-tax countries suffer from profit shifting but can tax domestic and exporting firms, while under destination-based taxation, exports are untaxed, unlike imports and countries attract profits irrespective of their tax rate. Overall, we show that an exporting country would only unilaterally adopt a destination-based tax if it has a much higher tax rate than the source-based country. An importing country would only use a source-based tax when the exporting country also uses such a tax if both tax rates are close