DP17801 Profit Shifting Frictions and the Geography of Multinational Activity
International tax rules are commonly viewed as obsolete as multinational corporations exploit loopholes to move their profits to tax havens. This paper uncovers how international tax reforms can curb profit shifting and impact real income and welfare across nations.
We build a model of international corporate tax avoidance under imperfect competition that disentangles profits that stem from real economic activity from paper profits that are booked in tax havens. Our framework delivers a set of ``triangle identities'' through which we recover bilateral profit-shifting flows. Using different data sources ranging from publicly available to firm-level datasets, we find an elasticity of paper profits that is three times larger than the elasticity of the tax base. In our quantitative model, a global minimum tax increases welfare by inducing higher tax revenues and public good provision. It also encourages countries to raise their statutory corporate tax rates as it effectively reduces tax competition. Instead, a border adjustment tax (BAT) that eliminates profit shifting distorts multinational production and may result in welfare losses. A tax reform in the spirit of the destination-based cash-flow tax, combining a BAT with a reduction in the corporate income tax rate may induce efficiency gains at the expense of public good provision.
