Tax Competition and Double Tax Treaties with Mergers and Acquisitions

In a two-period tax competition model with provision of local public goods, we analyze efficiency properties of double taxation reliefs incorporating either the exemption method, the tax credit system or the full taxation after deduction system. Foreign direct investments are presumed to be one-way and characterized by long-term mergers and acquisitions. We find that in case of (i) tax revenue maximization the exemption method implies inefficiently low tax rates, whereas the full taxation after deduction system leads to inefficiently low / efficient / inefficiently high tax rates. In case of (ii) welfare maximization each of these tax rules can be efficient. The (limited) tax credit system, however, is shown to always result in inefficiently low / inefficiently high tax rates. A numerical example reveals that no tax regime per se entails efficiency. In case of (i), a ranking of tax systems subject to the Pareto criterion is shown to depend on the parameters of the production function. Regarding (ii) the exemption method is preferable as it is proven to be the least inefficient tax regime.