Working Paper

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

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.

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

JEL Classification: F23; H26; F14; H25; H32;

https://doi.org/10.17016/FEDS.2017.055

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2017-05

Number: 2017-055

Pages: 37 pages