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Sorting into Outsourcing: Are Profits Taxed at a Gorilla's Arm's Lenght?

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  • Christian J. Bauer
  • Dominika Langenmayr

Abstract

This article analyzes profit taxation according to the arm's length principle in a new model where heterogeneous firms sort into foreign outsourcing. We show that multinational firms are able to shift profits abroad even if they fully comply with the tax code. This is because, in equilibrium, intra-firm transactions occur in firms that are better than the market at input production. Transfer prices set at market values following the arm's length principle thus systematically exceed multinationals' marginal costs. This allows for a reduction of tax payments with each unit sold. The optimal organization of firms hence provides a new rationale for the empirically observed lower tax burden of multinational corporations.

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File URL: http://www.bgpe.de/texte/DP/104_BauerLangenmayr.pdf
File Function: First version, 2011
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Bibliographic Info

Paper provided by Bavarian Graduate Program in Economics (BGPE) in its series Working Papers with number 104.

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Length: 27 pages
Date of creation: Sep 2011
Date of revision:
Handle: RePEc:bav:wpaper:104_bauerlangenmayr

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Web page: http://www.bgpe.de/
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Keywords: outsourcing; profit taxation; transfer pricing; arm's length principle; multinational firms;

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References

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Citations

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Cited by:
  1. Langenmayr, Dominika & Haufler, Andreas & Bauer, Christian J., 2012. "Should tax policy favor high- or low-productivity firms?," Discussion Papers in Economics 14277, University of Munich, Department of Economics.
  2. Thomas Gresik, 2013. "Allowing Firms to Choose Between Formula Apportionment and Separate Accounting Taxation," CESifo Working Paper Series 4560, CESifo Group Munich.
  3. Bauer, Christian & Langenmayr, Dominika, 2011. "Sorting into Outsourcing: Are Pro ts Taxed at a Gorilla's Arm's Length?," Discussion Papers in Economics 12311, University of Munich, Department of Economics.
  4. Christian J. Bauer & Dominika Langenmayr, 2011. "Sorting into Outsourcing: Are Profits Taxed at a Gorilla's Arm's Lenght?," Working Papers 104, Bavarian Graduate Program in Economics (BGPE).

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