Cross-border loss offset can fuel tax competition

Following recent court rulings, cross-border loss compensation for
multinational firms will likely be introduced, at least in Europe.
This paper analyzes the effects of introducing a coordinated
cross-border tax relief in a setting where multinational firms
choose the size of a risky investment and host countries
endogenously choose tax rates. We show that coordinated
cross-border loss compensation is likely to intensify tax
competition when, following current international practice, the
parent firm's home country bases the tax rebate for a loss-making
subsidiary on its own tax rate. In equilibrium, tax revenue losses
will then be even higher than is implied by the direct effect of
the reform. In contrast, tax competition will be mitigated when the
home country bases its loss relief on the tax rate in the
subsidiary's host country.