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Formula apportionment vs. separate accounting: A private information perspective

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  • Gresik, Thomas A.

Abstract

In 2002, the European Commission recommended that member countries use formula apportionment procedures to tax multinational companies. This departure from the standard separate accounting (transfer pricing) approach is an attempt to reduce the costs and distortions associated with auditing transfer prices. Unfortunately, apportionment formulas create their own economic distortions and, contrary to popular belief, they do not eliminate distortions due to asymmetric information between the multinational and the national tax authorities. In this paper, I explicitly model the role of private information in two tax competition games: one in which tax liabilities are calculated under formula apportionment and one in which tax liabilities are calculated under separate accounting and transfer prices are audited. Switching to a formula apportionment system affects the after-tax profit of multinationals and the tax revenues paid by both domestic and foreign firms. The direction and magnitude of the changes depend on the accuracy of the auditing technology and non-monotonically on multinational costs. The switch will have different effects on the tax receipts from domestic and foreign firms.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 54 (2010)
Issue (Month): 1 (January)
Pages: 133-149

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Handle: RePEc:eee:eecrev:v:54:y:2010:i:1:p:133-149

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Web page: http://www.elsevier.com/locate/eer

Related research

Keywords: Formula apportionment Separate accounting Tax competition Private information;

References

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  1. Burbidge, John & Cuff, Katherine & Leach, John, 2006. "Tax competition with heterogeneous firms," Journal of Public Economics, Elsevier, vol. 90(3), pages 533-549, February.
  2. Jack M. Mintz & Michael Smart, 2001. "Income Shifting, Investment, and Tax Competition: Theory and Evidence from Provincial Taxation in Canada," International Tax Program Papers 0402, International Tax Program, Institute for International Business, Joseph L. Rotman School of Management, University of Toronto, revised Apr 2003.
  3. Søren Bo Nielsen & Pascalis Raimondos-Møller & Guttorm Schjelderup, . "Formula Apportionment and Transfer Pricing under Oligopolistic Competition," EPRU Working Paper Series 01-05, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  4. Hans Jarle Kind & Helene Midelfart & Guttorm Schjelderup, 2004. "Corporate Tax Systems, Multinational Enterprises, and Economic Integration," CESifo Working Paper Series 1241, CESifo Group Munich.
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  6. Peter Sørensen, 2004. "Company Tax Reform in the European Union," International Tax and Public Finance, Springer, vol. 11(1), pages 91-115, January.
  7. Cremer, H. & Marchand, M. & Pestieau, P., 1988. "Evading, auditing and taxing: the equity-compliance tradeoff," CORE Discussion Papers 1988027, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  8. Cremer, Helmuth & Gahvari, Firouz, 2000. "Tax evasion, fiscal competition and economic integration," European Economic Review, Elsevier, vol. 44(9), pages 1633-1657, October.
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  10. Michael Devereux, 2004. "Debating Proposed Reforms of the Taxation of Corporate Income in the European Union," International Tax and Public Finance, Springer, vol. 11(1), pages 71-89, January.
  11. Anand, Bharat N. & Sansing, Richard, 2000. "The Weighting Game: Formula Apportionment as an Instrument of Public Policy," National Tax Journal, National Tax Association, vol. 53(n. 2), pages 183-200, June.
  12. Walter Hellerstein & Charles E. McLure, Jr., 2004. "The European Commission's Report on Company Income Taxation: What the EU Can Learn from the Experience of the US States," International Tax and Public Finance, Springer, vol. 11(2), pages 199-220, 03.
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Citations

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Cited by:
  1. Andreas Haufler & Marco Runkel, 2008. "Firms' financial choices and thin capitalization rules under corporate tax competition," Working Papers 0815, Oxford University Centre for Business Taxation.
  2. Kenji Matsui, 2012. "Auditing internal transfer prices in multinationals under monopolistic competition," International Tax and Public Finance, Springer, vol. 19(6), pages 800-818, December.
  3. Dyreng, Scott D. & Lindsey, Bradley P. & Thornock, Jacob R., 2013. "Exploring the role Delaware plays as a domestic tax haven," Journal of Financial Economics, Elsevier, vol. 108(3), pages 751-772.

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