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Multinational Firms' Heterogeneity in Tax Responsiveness: The Role of Transfer Pricing

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  • Céline Azémar
  • Gregory Corcos

Abstract

Abstract In this paper we show that the ability of multinational firms to manipulate transfer prices affects the tax sensitivity of foreign direct investment (FDI). We offer a model of international capital allocation where firms are heterogeneous in their ability to manipulate transfer prices. Perhaps paradoxically, we show that the ability to shift profits can make parent companies' investment more sensitive to host-country tax rates, as long as investors expect fiscal authorities to use price and profit detection methods. We then offer a comprehensive empirical study to test our predictions in the case of Japanese FDI. We exploit the finding that the unobservable ability to manipulate transfer prices is correlated with whole ownership of affiliates and R&D expenditure. Based on country, parent firm and sector characteristics, we estimate an investment equation on a sample of 3,614 Japanese affiliates in 49 emerging countries. We obtain a greater semi-elasticity of investment to the statutory tax rate in affiliates that are wholly-owned and that have R&D-intensive parents. We interpret these results as indirect evidence that abusive transfer pricing is one of the determinants of FDI activity. Copyright 2009 The Authors. Journal compilation 2009 Blackwell Publishing Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal World Economy.

Volume (Year): 32 (2009)
Issue (Month): 9 (09)
Pages: 1291-1318

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Handle: RePEc:bla:worlde:v:32:y:2009:i:9:p:1291-1318

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References

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  1. Theodore H. Moran & Edward M. Graham & Magnus Blomstrom, 2005. "Does Foreign Direct Investment Promote Development?," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 3810.
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  8. Andrew B. Bernard & J. Bradford Jensen & Peter K. Schott, 2006. "Transfer Pricing by U.S.-Based Multinational Firms," NBER Working Papers 12493, National Bureau of Economic Research, Inc.
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  15. Hines, James R. Jr., 1999. "Lessons from Behavioral Responses to International Taxation," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 305-22, June.
  16. Kant, Chander, 1990. "Multinational firms and government revenues," Journal of Public Economics, Elsevier, vol. 42(2), pages 135-147, July.
  17. Azémar, Céline & Delios, Andrew, 2008. "Tax competition and FDI: The special case of developing countries," Journal of the Japanese and International Economies, Elsevier, vol. 22(1), pages 85-108, March.
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Cited by:
  1. Céline Azémar, 2008. "International corporate taxation and US multinationals' behaviour: an integrated approach," Working Papers 2009_03, Business School - Economics, University of Glasgow.

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