Limiting Profit Shifting in a Model with Heterogeneous Firm Productivity

Abstract

This paper analyzes measures that limit firms' profit shifting activities in a model that incorporates heterogeneous firm productivity and monopolistic competition. Such measures, e.g. thin capitalization rules, have become increasingly widespread as governments have reacted to growing profit shifting activities of multinational companies. However, besides limiting profit shifting, such rules entail costs. As the regulations can only focus on the means to shift profits, not on profit shifting itself, they impose costs on all firms, no matter whether these firms shift profits abroad or not. In the model, these costs force some firms to exit the market. Thus, as this makes the remaining firms more profitable, regulations to limit profit shifting may even increase the aggregate amount of profits shifted abroad. From a welfare point of view, it may even be optimal no to limit profit shifting at all.

Profit Shifting, Employee Pay, and Inequalities: Evidence from US-Listed Companies

“…The correlation between firm size/productivity and presence in OFCs directly echoes with the profit shifting literature, according to which only the largest and most productive MNEs engage in aggressive tax planning and tax-motivated income shifting (Krautheim and Schmidt-Eisenlohr, 2011;Langenmayr, 2015). They form an inner circle of superstar firms big enough to generate a substantial share of overall profits, artificially shift profits across borders, and drive macroeconomic aggregates (Di Giovanni, Levchenko, and Mejean, 2017; Guvenen et al, 2017;Bricongne et al, 2021).…”

“…It is for instance worth recalling that Caterpillar paid PricewaterhouseCoopers $55 million for developing its tax dodging strategy (US Senate Permanent Subcommittee on Investigations, 2014). For this reason, only the largest MNEs can find profitable to pay these costs and undertake such activities through tax haven subsidiaries (Krautheim and Schmidt-Eisenlohr, 2011;Langenmayr, 2015;Gumpert, Hines, and Schnitzer, 2016;Jones, Temouri, and Cobham, 2018;Bilicka, Devereux, and Guceri, 2020). 4…”