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Firm Responses to International Taxation

Paper Session

Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, M101
Hosted By: American Economic Association
  • Chair: Juan Carlos Suárez Serrato, Duke University and NBER

Taxation and the Allocation of Risk Inside the Multinational Firm

Nadine Riedel
,
Ruhr-University Bochum
Niels Johannesen
,
University of Copenhagen
Johannes Becker
,
University of Muenster

Abstract

This paper provides the first theoretical and empirical analysis of how taxation shapes the joint allocation of risk and profits inside the multinational firm. Theoretically, we show that unconstrained firms optimally allocate all their risk to high-tax countries to maximize risk sharing with governments and all their profits to low-tax countries to minimize expected tax payments. However, transfer pricing rules requiring risk to be compensated with a higher expected return introduce a trade-off: the risk sharing motive to allocate risk to high-tax countries must be balanced against a profit shifting motive to allocate risk to low-tax countries. Empirically, we consistently find that multinational firms disproportionately allocate risk to low-tax countries. This suggests that the intra-firm allocation of risk and profits is effectively constrained by transfer pricing rules and that the profit shifting motive dominates the risk sharing motive. Finally, we show that within-firm differences in risk can account for a significant share of the well-established correlation between profits and tax rates suggesting that risk shifting is a quantitatively important channel for profit shifting. We conclude by discussing the implications for recent policy efforts to curb tax base erosion in high-tax countries.

Taxing Multinationals Beyond Borders: Financial and Locational Responses to CFC Rules

Sarah Clifford
,
University of Oxford

Abstract

Using a large panel dataset on worldwide operations of multinational firms, this paper studies one of
the most advocated anti-tax-avoidance measures: Controlled Foreign Corporation rules. By including
income of foreign low-tax subsidiaries in the domestic tax base, these rules create incentives to move
income away from low-tax environments. Exploiting variation around the tax threshold used to
identify low-tax subsidiaries, we find that multinationals redirect profits into subsidiaries just above
the threshold and change incorporation patterns to place fewer subsidiaries below and more above the
threshold. Roughly half of the resulting increase in global tax revenue accrues to the rule-enforcing
country.

Unintended Consequences of Eliminating Tax Havens

Juan Carlos Suárez Serrato
,
Duke University and NBER

Abstract

Do tax havens reduce domestic economic activity? This paper explores the effects of unilateral efforts to combat profit shifting on domestic investment and employment. We develop a model of multinational investment that shows profit shifting generates tax complementarities between tax havens and high tax countries. We then analyze the effects of the repeal of Section 936 of the Internal Revenue code as a natural experiment that limited profit shifting activities for US multinationals with operations in Puerto Rico. Using data from the Annual Survey of Manufacturers, we show that industries that were more exposed to § 936 reduced investment in the US. We then use Compustat data to show exposed firms shifted investment to foreign affiliates. These investment responses had large effects on local labor markets. We create a measure of exposure to § 936 for each local labor market that exploits the establishment networks of US multinationals. We find that labor markets with a greater exposure experienced a decline in employment and income growth that persisted even after the phase-out of § 936. These results show that unilateral efforts to combat profit shifting may have large unintended consequences on domestic economic growth.

International Transfer Pricing and Tax Avoidance: Evidence from Linked Trade-Tax Statistics in the UK

Li Liu
,
International Monetary Fund

Abstract

This paper employs unique data on export transactions and corporate tax returns of UK multinational firms and finds that firms manipulate their transfer prices to shift profits to lower-taxed destinations. The 2009 tax reform in the UK that shifted the treatment of corporate profits from a worldwide to a territorial system, led to a substantial increase in transfer mispricing. We also provide evidence for a trade creation effect of transfer mispricing, find that transfer mispricing increases with a firm’s R&D intensity and estimate substantial transfer mispricing in countries that are not tax havens and have low-to-medium-level corporate tax rates.
Discussant(s)
Clemens Fuest
,
Ifo Institute
Dhammika Dharmapala
,
University of Chicago
Michael Devereux
,
University of Oxford
Kimberly Clausing
,
Reed College
JEL Classifications
  • H3 - Fiscal Policies and Behavior of Economic Agents
  • F3 - International Finance