Job Market Paper

How does transfer-pricing enforcement affect reported profits?

Abstract:
Governments, concerned that they are losing tax revenue to profit shifting by multinational firms, have increasingly put in place regulations designed to make shifting more costly. This paper presents a model that shows that it is possible, and in fact likely, that these regulations actually reduce tax collections. The regulations are designed with a goal of decreasing profit shifting outflows, but they also both decrease profit-shifting inflows and increase the cost of compliance for all firms with related-party transactions. While the reduction in outflows should increase reported profits, the other two effects, the reduction in inflows and the increase in compliance costs, reduce reported profits. Evidence from changes in regulation over time support the predictions of the model. Data from ORBIS on multinational corporations indicate that increased regulation has a negative effect on a multinational firm's reported local profits. Consistent with the model, the effect is more negative for firms with more higher-tax subsidiaries and is less negative for firms with more lower-tax subsidiaries.

© Molly J. Saunders-Scott, 2013