Allowing firms to choose between separate accounting and formula apportionment taxation

• Multinationals can choose between separate accounting (SA) or formula apportionment (FA).
• Firms producing an intermediate good predominately for export prefer SA.
• A firm's preference for SA over FA can be non-monotonic in its cost of capital.
• Choice lowers symmetric equilibrium tax rates.
• Choice can increase tax revenues with asymmetric countries and fixed tax rates.

This paper analyzes the effect on firm behavior and national tax revenues of allowing multinational firms to choose to be taxed under separate accounting rules or an apportionment formula. Separate accounting always generates more profitable output and conditional labor demand distortions from tax differentials while either method can generate a more profitable income-shifting distortion. Both low-cost and high-cost firms can prefer separate accounting while medium-cost firms prefer formula apportionment. With symmetric countries, a firm's preferred method generates greater tax revenues in the country with the lower tax rate. With asymmetric countries, a firm's preferred method need no longer generate greater tax revenues in the lower-tax-rate country due to the fact that countries and firms now value tax base distortions differently. With this misalignment of preferences, some firms can choose the preferred method of both countries at fixed tax rates.