Economic Integration and Agglomeration of Multinational Production with Transfer Pricing

Kato, Hayato and Okoshi, Hirofumi (2021): Economic Integration and Agglomeration of Multinational Production with Transfer Pricing.

Abstract

Do low corporate taxes always favor multinational production in the course of eco- nomic integration? To investigate this, we propose a two-country model in which multi- nationals choose the locations of production plants and foreign distribution affiliates and shift profits between home plants and foreign affiliates by manipulating transfer prices in intra-firm trade. We show that when trade costs are high, plants are concentrated in the low-tax country; surprisingly, this location pattern reverses when they are low. Unlike existing models with single-plant firms, the impact of economic integration is non-monotonic: a fall in trade costs first decreases and then increases the share of plants in the high-tax country, which we empirically confirm. We also analyze tax competition and find that allowing for transfer pricing makes competition tougher. This indicates that international coordination on transfer-pricing regulation can potentially make the world better off.

• Item Type: MPRA Paper
• Language: English
• Keywords: Profit shifting; Multinational firms; Intra-firm trade; Trade costs; Foreign direct investment (FDI)
• Subjects: F - International Economics > F1 - Trade > F12 - Models of Trade with Imperfect Competition and Scale Economies ; Fragmentation; F - International Economics > F2 - International Factor Movements and International Business > F23 - Multinational Firms ; International Business; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H25 - Business Taxes and Subsidies; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H26 - Tax Evasion and Avoidance

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