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Sorting into Outsourcing: Are Pro ts Taxed at a Gorilla's Arm's Length?

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  • Bauer, Christian
  • Langenmayr, Dominika

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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Bibliographic Info

Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 12311.

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Date of creation: Sep 2011
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Handle: RePEc:lmu:muenec:12311

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Keywords: outsourcing; profit taxation; transfer pricing; arm's length principle; multinational firms;

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Citations

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Cited by:
  1. Johannes Becker & Ronald B. Davies, 2014. "A Negotiation-Based Model of Tax-Induced Transfer Pricing," CESifo Working Paper Series 4892, CESifo Group Munich.
  2. Bauer, Christian J. & Langenmayr, Dominika, 2013. "Sorting into outsourcing: Are profits taxed at a gorilla’s arm’s length?," Munich Reprints in Economics, University of Munich, Department of Economics 20122, University of Munich, Department of Economics.
  3. Dominika Langenmayr & Andreas Hau fler & Christian J. Bauer, 2013. "Should tax policy favour high or low productivity firms?," Working Papers, Oxford University Centre for Business Taxation 1308, Oxford University Centre for Business Taxation.
  4. Thomas Gresik, 2013. "Allowing Firms to Choose Between Formula Apportionment and Separate Accounting Taxation," CESifo Working Paper Series 4560, CESifo Group Munich.

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