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Formula apportionment: Factor allocation and tax avoidance

Author

Listed:
  • Eichfelder, Sebastian
  • Hechtner, Frank
  • Hundsdoerfer, Jochen

Abstract

This paper addresses the question of how firms react to tax incentives in a formula apportionment (FA) tax regime. Under FA, profits of all consolidated entities of a business group are summed and then allocated according to a formula based on FA factors. We hypothesize that firms may change the allocation of real production factors and/or manipulate the FA factor through tax avoidance strategies. Analyzing FA tax effects of the German local business tax with payroll expense as the exclusive FA factor, we find empirical evidence consistent with both hypotheses. Regarding the allocation of production factors, we observe significant tax effects on labor input at the intensive margin but not on labor input at the extensive margin. In addition, we find evidence of an indirect FA spillover effect on capital investment. Our findings on tax avoidance proxies are consistent with tax-induced manipulations of payroll expense as FA factor in order to save tax payments.

Suggested Citation

  • Eichfelder, Sebastian & Hechtner, Frank & Hundsdoerfer, Jochen, 2015. "Formula apportionment: Factor allocation and tax avoidance," Discussion Papers 2015/30, Free University Berlin, School of Business & Economics.
  • Handle: RePEc:zbw:fubsbe:201530
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    References listed on IDEAS

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    1. repec:spr:busres:v:11:y:2018:i:1:d:10.1007_s40685-017-0054-y is not listed on IDEAS

    More about this item

    Keywords

    factor allocation; formula apportionment; profit shifting; tax avoidance;

    JEL classification:

    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • H73 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Interjurisdictional Differentials and Their Effects
    • J61 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Geographic Labor Mobility; Immigrant Workers

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