Alternatives to the current system of separate tax accounting, such as the proposed Common Consolidated Corporate Tax Base in Europe, would apportion a firm’s worldwide profits using formulas based on the location of employment, capital or sales. This paper offers a new method of evaluating the accuracy of these apportionment rules and the ownership distortions they create. Evidence from European company accounts indicates that apportionment formulas significantly misattribute income, since employment and other factors on which they are based do a very poor job of explaining a firm’s profits. For example, the magnitude of property, employment and sales explains less than 22 percent of the variation in profits between firms, and the prediction estimates from using such a formula exceed half of predicted profits 64% of the time, and exceed twice predicted income 11% of the time. As a result, the use of formulas rewards or punishes international mergers and divestitures by reallocating taxable income between operations in jurisdictions with differing tax rates. The associated ownership distortion is minimized by choosing factor weights to minimize weighted squared prediction errors, for which, based on the European evidence, labor inputs should play little if any role in allocation formulas. But even a distortion-minimizing formula creates large incentives for inefficient ownership reallocation due to the enormous variation in profitability that is unexplained by formulary factors, implying that significant resource allocation costs would accompany European adoption of formulary apportionment methods.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
15185.
Length: Date of creation: Jul 2009 Date of revision: Handle: RePEc:nbr:nberwo:15185
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Find related papers by JEL classification: F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
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Alan J. Auerbach & David Reishus, 1988.
"The Effects of Taxation on the Merger Decision,"
NBER Chapters,
in: Corporate Takeovers: Causes and Consequences, pages 157-190
National Bureau of Economic Research, Inc.
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