How Does Firm Heterogeneity Affect International Tax Policy

Abstract

Firms - even in a narrowly defined sector - differ vastly in their size and productivity (Bernard, Jensen, Redding and Schott 2007). A firm at the 90th percentile of the productivity distribution produces almost twice as much output with the same inputs as a firm at the 10th percentile of the productivity distribution (Syverson 2011). This empirically observed heterogeneity has become a core element of recent theoretical and empirical research in many sub-disciplines of economics, such as the international trade literature (based on the seminal theoretical contribution by Melitz 2003). Clearly, the heterogeneity of firms is also relevant to the proper and well-targeted design of international corporate tax policy. Nevertheless, the existing theoretical literature on international corporate taxation has largely been confined to settings where all firms are identical. In this contribution we report on the still relatively small strand of theoretical research that incorporates firm heterogeneity into models of tax policy towards mobile, multinational firms. The issues addressed by this strand of research are both positive and normative. The positive questions are whether firm heterogeneity can help to explain the tax reforms that we have observed in recent decades, and whether it can contribute to our understanding of firms’ reactions to tax policy. From a normative perspective, firm heterogeneity raises the question of whether firms with different levels of productivity should be taxed differently under an optimized corporate tax scheme, and what this differentiation should look like.