Transfer Pricing Regulation and Tax Competition

Author Name Jay Pil CHOI (Michigan State University) / FURUSAWA Taiji (University of Tokyo) / ISHIKAWA Jota (Faculty Fellow, RIETI)
Creation Date/NO. April 2020 20-E-035
Research Project Analyses of Offshoring
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The paper analyzes multinational enterprises' incentives to manipulate internal transfer prices to take advantage of tax differences across countries, and implications of transfer-pricing regulations as a countermeasure against such profit shifting. We find that tax-motivated foreign direct investment (FDI) may entail inefficient internal production but may benefit consumers. Thus, encouraging transfer-pricing behavior to some extent can enhance social welfare. Furthermore, we consider tax competition between two countries in order to explore the interplay with transfer-pricing regulations. We show that the FDI source country will be willing to set a higher tax rate and tolerate some profit shifting to a tax haven country if the regulation is tight enough. We also indicate a novel mechanism through which it is the larger country that undertakes tax-motivated FDI, the pattern we often observe in reality.

Forthcoming: Jay Pil Choi, Furusawa, Taiji, and Ishikawa, Jota. "Transfer pricing regulation and tax competition," Journal of International Economics.