Profit Shifting through Tranfer Pricing: Evidence from 16 OECD Countries (1979-2005)

Abstract

The rise in the number of multinationals enterprises has induces interdependency not only in markets and production across countries but also within multinational groups. Transactions that occur within these groups offer incentives to maximize global profits through profit shifting to tax favorable jurisdictions. Evidence shows that the MNEs take advantage of tax differentials across countries to minimize their global tax liabilities through transfer pricing, this is a cause for great concern for governments since profit shifting significantly reduces their tax revenues. The OECD along with authorities in member and non-member countries have been persistent in combating profit shifting activities through setting regulations and developing income reporting standards such as country-by-country reporting. This study examines 16 OECD countries to present compelling evidence of profit shifting in response to corporate tax differentials. I use the approach employed by Bartelsman and Beetsma (2013) to disentangle the effects of tax rates on profit shifting from those on real economic activity. My estimates suggest that a large portion of revenue is lost from a unilateral increase in combined corporate tax rate. Moreover, the coefficient estimates for the last sub-period under analysis (1998-2005) reveal that the efforts to combat profit shifting are effective.