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Economic Integration and Agglomeration of Multinational Production with Transfer Pricing

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  • Kato, Hayato
  • Okoshi, Hiofumi

Abstract

Do low corporate taxes always favor multinational production in the course of eco- nomic integration? To investigate this, we propose a two-country model in which multi- nationals choose the locations of production plants and foreign distribution affiliates and shift profits between home plants and foreign affiliates by manipulating transfer prices in intra-firm trade. We show that when trade costs are high, plants are concentrated in the low-tax country; surprisingly, this location pattern reverses when they are low. Unlike existing models with single-plant firms, the impact of economic integration is non-monotonic: a fall in trade costs first decreases and then increases the share of plants in the high-tax country, which we empirically confirm. We also analyze tax competition and find that allowing for transfer pricing makes competition tougher. This indicates that international coordination on transfer-pricing regulation can potentially make the world better off.
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  • Kato, Hayato & Okoshi, Hiofumi, 2019. "Economic Integration and Agglomeration of Multinational Production with Transfer Pricing," Discussion Papers in Economics 62013, University of Munich, Department of Economics.
  • Handle: RePEc:lmu:muenec:62013
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    2. Hayato Kato & Toshihiro Okubo, 2022. "The Resilience of FDI to Natural Disasters Through Industrial Linkages," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 82(1), pages 177-225, May.

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    17. Javier Garcia-Bernardo & Petr Janský & Thomas Tørsløv, 2022. "Decomposing Multinational Corporations’ Declining Effective Tax Rates," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 70(2), pages 338-381, June.
    18. Johannes Becker & Ronald B Davies, 2014. "A negotiation-based model of tax-induced transfer pricing," Working Papers 1409, Oxford University Centre for Business Taxation.
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    More about this item

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance

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