Bayesian Persuasion in Tax Competition

Abstract

Multinational enterprises form long supply chains linking subsidiaries in a large number of countries. The latter may provide tax preferences distorting a fair distribution of profit between the subsidiaries. Such a support of profit shifting is elusive for other countries, because no government has a complete view of the global business activity. Hence, truthful communication becomes a chief concern in counteraction to harmful tax competition. To investigate this issue we model intergovernmental information exchange as sequential Bayesian persuasion. We demonstrate how communication promotes tax avoidance through a chain structure and show how countries take their roles in profit shifting schemes. In contrast to public perception, a low tax rate is not a distinct feature of the countries assisting in tax avoidance. Moreover, we show that an agreement on formal information exchange is inefficient for preventing tax avoidance. However, provision of technical support to national tax authorities may be a valid instrument to alleviate the problem.