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This paper analyzes the relevance of firm losses for tax revenues and welfare when switching from separate accounting (SA) to a system of tax base consolidation with formula apportionment (FA). We find that a system change unambiguously decreases tax revenues in the short run due to the cross-border loss offset inherent in FA. In the medium run, tax revenues are still larger under SA than FA if the probability of incurring losses and the costs of profit shifting are sufficiently small. However, this changes in the long run. Under the aforementioned conditions, a switch from SA to FA is beneficial if both the firms and governments are able to adjust their behavior after the system switch. Further, we show that a higher weight of input shares in the apportionment formula may mitigate tax competition because, contrary to output factors, input factors provide an insurance against tax revenue shortfalls due to loss-making affiliates.
