The impact of taxation on international assignment decisions: a principal–agent approach

Abstract

In many industries like consulting or construction, highly qualified employees, i.e., experts or executive managers, have to be assigned to temporary projects. Obviously, the employees’ productivities in the respective projects are crucial for the employer’s optimal assignment decision, but assignment can also be affected by risk-incentive trade-offs. Moreover, taxation can alter the assignment decision, especially if employees are sent abroad as expatriates so that international tax law has to be taken into account. To address these issues simultaneously, we combine a human resource assignment problem with a principal–agent problem of the LEN type. Both wage taxation at the agents’ level and corporate taxation at the principal’s level are integrated. We show that national tax rules, the methods for avoiding double taxation, and the agents’ tax characteristics are important determinants of international assignment decisions. The effects of tax rate variations can be ambiguous and depend on whether the exemption method or the credit method are applied, in particular if agents make differing choices of residence. From a tax policy perspective, the exemption method should be preferred as the tax effects are more transparent and intuitive than under the credit method.

Appendix

Proof of Proposition 6   (1) “If” part: Evaluating (9) for $\tau _1=\tau _2$ and $t_{11}=t_{12}=t_{21}=t_{22}=0$ yields (22).

(2) “Only if” part: By definition, tax neutrality implies the equivalence of optimality conditions (9) and (22) for all $\pi _{ij}$ and $\underline{u}_{i1}=\underline{u}_{i2}$. With $\underline{u}_{i} \equiv \underline{u}_{i1}=\underline{u}_{i2}$, the optimality conditions (9) and (22) are equivalent only if

$$\begin{aligned} (1-\tau _1) \left( \frac{2\underline{u}_1}{1-t_{11}} - \frac{2\underline{u}_2}{1-t_{21}} \right) = (1-\tau _2) \left( \frac{2\underline{u}_1}{1-t_{12}} - \frac{2\underline{u}_2}{1-t_{22}} \right) . \end{aligned}$$

(35)

Rearranging and simplifying this condition yields

$$\begin{aligned} \left( \frac{1-\tau _1}{1-t_{11}} - \frac{1-\tau _2}{1-t_{12}} \right) \underline{u}_1 = \left( \frac{1-\tau _1}{1-t_{21}} - \frac{1-\tau _2}{1-t_{22}} \right) \underline{u}_2 , \end{aligned}$$

(36)

which holds for arbitrary reservation remunerations $\underline{u}_i$ if and only if the terms in parentheses vanish. Thus, the conditions

$$\begin{aligned} (1-\tau _1) (1-t_{12})&= (1-\tau _2) (1-t_{11}) \end{aligned}$$

(37)

and

$$\begin{aligned} (1-\tau _1) (1-t_{22})&= (1-\tau _2) (1-t_{21}) \end{aligned}$$

(38)

hold.

Exploiting these conditions to simplify (9) results in

$$\begin{aligned} (1-\tau _1) \left[ (1-t_{11}) \pi _{11}^2 - (1-t_{21}) \pi _{21}^2 \right] \mathrel {\left\{ \gtreqqless \right\} } (1-\tau _2) \left[ (1-t_{12}) \pi _{12}^2 - (1-t_{22}) \pi _{22}^2 \right] . \end{aligned}$$

(39)

This optimality condition, in turn, is equivalent to (22) for arbitrary productivity parameters $\pi _{ij}$ if and only if

$$\begin{aligned} t_{11}=t_{21}&, t_{12}=t_{22}, \end{aligned}$$

(40)

and

$$\begin{aligned} (1-\tau _1)(1-t_{11})&=(1-\tau _2)(1-t_{12}) . \end{aligned}$$

(41)

Conditions (37) and (41), in turn, imply $\tau _1=\tau _2$ and $t_{11}=t_{12}$, and hence we have shown that tax neutrality holds only if $\tau _1=\tau _2$ and $t_{11}=t_{12}=t_{21}=t_{22}$. As tax neutrality does not hold for $\tau _1=\tau _2$ and $t_{11}=t_{12}=t_{21}=t_{22}>0$, tax neutrality implies $\tau _1=\tau _2$ and $t_{11}=t_{12}=t_{21}=t_{22}=0$.$\square$

Proof of Corollary 1   After exploiting Assumption 2 to simplify condition (9), the proof follows the same lines as that of Proposition 6 and is therefore omitted. The crucial difference is that the equivalence of the simplified condition (9) and condition (22) also holds for $\tau _1=\tau _2$ and $t_{11}=t_{12}=t_{21}=t_{22}>0$. $\square$

Proof of Corollary 2   After exploiting Assumption 3 to simplify condition (9), the proof follows the same lines as that of Proposition 6 and is therefore omitted. The crucial difference is that only conditions (40) and (41) remain. $\square$