Two Tax Policies toward Tax Havens: Effects on Production and Capital Location Decisions

This paper examines the production and capital location effects of two approaches to taxing the incomes of subsidiaries of multinational enterprises (MNEs) in tax haven countries. The United States and the United Kingdom immediately tax “Foreign Base Company Sales Income” (FBCSI) of foreign subsidiaries reselling inventory outside the subsidiary's host country except when it is manufactured in the host country. The second approach used by Canada does not tax any active income earned in the tax haven country. We show that FBCSI induces U.S. MNEs manufacturing their product in the United States to reduce sales arid increase prices in United States. Alternately, they manufacture in the tax haven country, resulting in lower U.S. tax collections, lower quantities, and higher prices. These effects are absent for Canadian MNEs.