At A Cost: The Real Effects of Thin Capitalization Rules

IMF Working Papers, February 5, 2021

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Thin capitalization rules (TCRs) aim to mitigate profit shifting by multinational corporations (MNCs) but, by raising the cost of capital for affected affiliates, can also negatively affect real investment.
Using unique panel data on multinational companies in 34 countries during 2006-2014, the authors estimate that the size of this adverse investment effect can be large, and dependent on the statutory corporate tax rate and the tightness of the safe-haven ratio.
Negative investment effects are more pronounced for highly-levered firms for which TCRs are more likely to be binding.

Adverse investment effects of TCRs can be large.
The magnitude of the negative investment effect depends on:
- the statutory corporate tax rate, and
- the tightness of the safe-haven ratio.
Negative investment effects are more pronounced for highly-levered firms (firms for which TCRs are more likely to bind).

Policymakers should weigh the revenue and base-protection benefits of TCRs against potential real-economy costs through higher cost of capital and reduced investment.
Design features that matter include:
- statutory corporate tax rate,
- the safe-haven ratio’s tightness, and
- firm leverage profiles (with highly-levered firms more affected).
Assessment of TCRs should account for distributional effects across firms with different leverage and investment sensitivities.

IMF Working Paper No. 2021/023 — "At A Cost: The Real Effects of Thin Capitalization Rules" by Ruud A. de Mooij and Li Liu, February 5, 2021.