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The Role of Transfer Prices in Profit-Shifting by U.S. Multinational Firms : Evidence from the 2004 Homeland Investment Act

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  • Aaron Flaaen

Abstract

Using unique transaction-level microdata, this paper documents profit-shifting behavior by U.S. multinational firms via the strategic transfer pricing of intra-firm trade. A simple model reveals how differences in tax rates, both the corporate tax rates across countries and the dividend repatriation tax rate over time, affect the worldwide profit-maximizing transfer-prices set by firms for intra-firm exports and imports. I test the predictions of the model in the context of the 2004 Homeland Investment Act (HIA), a one-time tax repatriation holiday which generated a discreet change in the incentives for U.S. firms to shift profits to low-tax jurisdictions. Matching individual trade transactions by firm, product, country, mode-of-transport, and month across arms-length and related-party transactions (following Bernard, Jensen, and Schott (2006) ) yields a measure of the transfer-price wedge at a point in time. A difference-in-difference strategy reveals that this wedge responds as predicted by the model: In the period following passage of the HIA, the export transfer price wedge increased in low-tax relative to high-tax countries, while the import transfer price wedge exhibited the opposite behavior. Consistent with the form of tax avoidance known as "round-tripping, the results imply $6 billion USD of under-reported U.S. exports, nearly $7 billion USD of over-reported U.S. imports, and roughly $2 billion USD in foregone U.S. corporate tax receipts.

Suggested Citation

  • Aaron Flaaen, 2017. "The Role of Transfer Prices in Profit-Shifting by U.S. Multinational Firms : Evidence from the 2004 Homeland Investment Act," Finance and Economics Discussion Series 2017-055, Board of Governors of the Federal Reserve System (US).
  • Handle: RePEc:fip:fedgfe:2017-55
    DOI: 10.17016/FEDS.2017.055
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    File URL: https://www.federalreserve.gov/econres/feds/files/2017055pap.pdf
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    References listed on IDEAS

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    Keywords

    Corporate Taxes ; Intra-firm Trade ; Multinational firms ; Profit-Shifting ; Transfer Prices;

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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