Public Finance in the Real World: Through the Lens (Down the Rabbit Hole?) of Transfer Pricing

The current lack of confidence in the international rules for taxing the global profits of multinational enterprises (MNEs) has three underlying causes: (1) tax rules are not universal or natural; (2) taxes must be practical, administrable, and collectible; and (3) tax policy is a domain where national sovereignty and multilateralism are both important and conflictual. As a result, in the real world of public finance, the principles and norms of international tax must be tempered with the need for practicality and respect for national sovereignty. Transfer pricing, which affects how an MNE's global profits are allocated among countries, provides a good illustration of the difficult problem of implementing public finance principles and norms in the real world. Criticisms of the arm's-length principle have led the Organisation for Economic Co-operation and Development to recommend formulary approaches to transfer pricing in the pillar 1 and 2 proposals of its base erosion and profit shifting project. Instead, we propose a solution that draws its inspiration from the distinction made by the International Centre for Settlement of Investment Disputes between "investment" and "trade" that underlies the four-factor Salini test: contribution, assets, risk, and duration. We argue that the Salini test provides useful insights into the conundrum of "source" and a way out of the current lack of confidence in the international tax system. Our work builds on, and pays homage to, Richard Bird's lifelong contributions to public finance.