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INTERNATIONAL CORPORATE TAX AVOIDANCE: A REVIEW OF THE CHANNELS,

MAGNITUDES, AND BLIND SPOTS: International Corporate Tax Avoidance: A
Review

Article in Journal of Economic Surveys · January 2019

DOI: 10.1111/joes.12305

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 WP/18/168

International Corporate Tax Avoidance: A Review of the

Channels, Magnitudes, and Blind Spots

by Sebastian Beer, Ruud de Mooij, and Li Liu

© 2018 International Monetary Fund WP/18/168

IMF Working Paper

Fiscal Affairs Department

International Corporate Tax Avoidance: A Review of the Channels, Effect Sizes, and
Blind Spots

Prepared by Sebastian Beer, Ruud de Mooij, and Li Liu

Authorized for distribution by Michael Keen

July 2018

IMF Working Papers describe research in progress by the author(s) and are published to
elicit comments and to encourage debate. The views expressed in IMF Working Papers are
those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board,
or IMF management.

Abstract
This paper reviews the rapidly growing empirical literature on international tax avoidance by
multinational corporations. It surveys evidence on main channels of corporate tax avoidance
including transfer mispricing, international debt shifting, treaty shopping, tax deferral and
corporate inversions. Moreover, it performs a meta analysis of the extensive literature that
estimates the overall size of profit shifting. We find that the literature suggests that, for the
most recent year, a 1 percentage-point lower corporate tax rate compared to other countries
will expand before-tax income by 1.5 percent—an effect that is larger than reported as the
consensus estimate in previous surveys and tends to be increasing over time. The literature
on tax avoidance still has several unresolved puzzles and blind spots that require further
research.

JEL Classification Numbers: F23, H25

Keywords: Corporate taxation; Multinationals; Profit shifting; International tax avoidance;

Meta analysis.

Author’s E-Mail Address: [email protected]; [email protected]; [email protected]

 3

Contents Page

ABSTRACT...............................................................................................................................2

I. INTRODUCTION ..................................................................................................................4

II. INTERNATIONAL TAX AVOIDANCE–THE ISSUE.......................................................5

A. Brief Overview of the International Tax Architecture ..............................................5
B. Main Channels of International Tax Avoidance .......................................................6
C. How Effective are Anti-Avoidance Regulations? ...................................................10

III. A NEW CONSENSUS ON TAX-MOTIVATED PROFIT SHIFTING ...........................11

A. Data and Descriptive Statistics ...............................................................................13
B. Synthesis of Primary Estimates: Meta-Regression .................................................15
C. Efficient Estimation.................................................................................................17
D. Main Findings .........................................................................................................19
E. Simulation of Revenue Effects ................................................................................25

IV. DISCUSSIONS AND CONCLUSION .............................................................................28

Tables
1. Estimated Semi-Elasticity of Pre-Tax Profits ......................................................................13
2. Baseline Results ...................................................................................................................21
3. Robustness Checks...............................................................................................................23
4. Evidence on publication bias ...............................................................................................25
5. Estimated Revenue Losses ...................................................................................................26

Figures
1. Semi-Elasticity Estimates over Time ...................................................................................15
2. Unconditional Semi-Elasticity Estimates ............................................................................19
3. Graphical evidence for publication bias ..............................................................................24
4. Country-Specific Estimates of Fiscal Impact ......................................................................27

Appendix
1. Descriptive Overview of Included Studies ..........................................................................41
2. Comparison to Heckmeyer and Overesch (2017) ................................................................42
3. Estimating Tax-Motivated Profit Shifting: Theoretical Underpinnings ..............................44

Appendix Table
1. Comparison to HO .............................................................................................................442

References ................................................................................................................................31
 4

I. INTRODUCTION1

Tax avoidance by multinational corporations (MNCs) has been on top of the international tax
policy agenda since the global financial crisis. The tight fiscal constraints in the aftermath of
the crisis amplified long-standing concerns in many countries that large MNCs pay very low
effective tax rates. Moreover, the revelation of aggressive avoidance schemes in Luxleaks
and more recently the Paradise papers have reinforced the public disquiet about the
unfairness of the low effective taxation of some MNCs. These concerns have led to major
new international initiatives to curb international tax avoidance – most notably the
G20/OECD initiative on base erosion and profit shifting (OECD, 2015). Their aim is to
develop approaches that limit the opportunities for MNCs to artificially shift profits and thus
to enhance revenue mobilization.

This paper offers a survey of the empirical literature on international tax avoidance. The
latter is defined as the international reallocation of profits by an MNC in response to tax
differences between countries, with the aim to minimize the global tax bill. Hence, we ignore
reallocation of real capital in response to tax. This survey goes beyond discussing studies
assessing the overall magnitude of profit shifting and include those on the importance of
specific channels, especially the most commonly adopted ones such as transfer mispricing,
strategic location of intellectual property (IP), international debt shifting, and treaty
shopping. It also discusses tax avoidance devices that are unique to worldwide taxation
systems, such as corporate inversions/headquarter relocation, and tax deferral. Moreover, it
summarizes empirical evidence on the effectiveness of a range of targeted anti-avoidance
measures, which have been put in place to curb tax avoidance.

This paper extends earlier literature reviews by e.g. Dharmapala (2014), Hines (2014) and
OECD (2015) in three important ways. First, we place a variety of empirical tax avoidance
studies into a systematic framework of the current international tax architecture. Second,
within this framework, we broaden the review’s scope, as the number of studies on tax
avoidance has been rapidly expanding in recent years. We survey empirical evidence on six
main channels of international tax avoidance.

Finally, we perform a meta-analysis of studies estimating the magnitude of total profit

shifting to derive a consensus estimate of the tax sensitivity of MNC’s reported profits to tax
rates. The meta-analysis extends earlier work by Heckemeyer and Overesch (2017) by almost
doubling the sample size of primary estimates,2 reducing specification bias, and adopting an
enhanced identification approach that corrects for within-study correlation of primary
estimates. Our results suggest that a semi-elasticity of reported pre-tax profits with respect to
international tax differential of unity is a good reflection of the literature. This means that a 1
percentage point larger tax rate differential reduces reported pre-tax profits of an affiliate by

1
We thank Jan Brueckner, Vitor Gaspar, Niels Johannesen, Michael Keen, Kun Kim, Joel Slemrod, and
participants at the IMF “Evaluating Tax Reform” conference and Fiscal Affairs Department seminar for helpful
comments. We are grateful to Jost Heckmeyer and Michael Overesch for sharing their dataset for replication
purposes. Any remaining errors are our own.
2
We include 11 additional studies and 199 additional primary estimates.
 5

1 percent. The estimate is larger than the consensus semi-elasticity of 0.8 in Heckemeyer and
Overesch (2017). We further complement Heckemeyer and Overesch (2017) by providing
new insights into the importance of controlling for the scale of real activities in estimating
the consensus semi-elasticity estimate: excluding this control introduces upward bias in the
consensus semi-elasticity by inflating it to around 1.4. Moreover, we find that the semi-
elasticity has increased over time and that a value of around 1.5 applies to the most recent
years. The insight is extremely important for the policy debate on profit shifting and for the
calibration of models that account for tax avoidance. Using this estimate, we illustrate the
revenue impact of tax avoidance for 81 countries.

The rest of this paper is organized as follows. Section II provides a broad overview of
international tax avoidance, elaborating on the current international tax architecture,
discussing empirical evidence on various avoidance channels, and elaborating on the impact
of specific anti-avoidance measures. Section III reviews the literature on the overall size of
profit shifting and provides a meta-analysis. It derives a consensus semi-elasticity and
illustrates its implications for government revenue. Finally, Section IV discusses a number of
puzzles and blind spots in the literature. It points to research that would be needed to further
advance our understanding of international corporate tax avoidance in the future.

II. INTERNATIONAL TAX AVOIDANCE–THE ISSUE

A. Brief Overview of the International Tax Architecture

The tax treatment of MNCs is determined by the international tax framework, which is a
myriad of domestic legislations and a wide network of bilateral and multilateral tax treaties.
The framework relies largely on separate accounting, which means that taxation of an MNC
group is at the level of individual subsidiaries that operate in different countries. Each
country has a right to tax the income assigned, based on its domestic law and tax treaty
obligations.

When can a country tax MNCs? MNCs generate income in two main ways: selling
products or services, and investing their cash on hand. The former is typically known as
active income, and the latter, passive. The taxing rights of a country over MNC income are
based on the source of the income and the residence of the corporate taxpayer.

Source refers to where investment and production take place and is largely determined by the
physical presence of labor and/or capital. Certain thresholds must be met to define a
permanent establishment (PE), which determines whether a source country can tax a foreign
company or not. Residence refers to the place where the company receiving the income is
deemed to have its primary location. Common tests for this are where the company is
incorporated or effectively managed. Following international convention, source countries
have primary taxing rights over the active business income of foreign PEs while residence
countries retain the right to tax passive income.

How does a country tax MNC earnings? Two alternative systems determine the taxation of
active business income of MNCs. Under a territorial system (used e.g. in Europe and Japan),
residence countries exempt foreign earnings of MNCs so that their active business income is
 6

only taxed in the source country. Under a worldwide system (used e.g. in the BRICS and
until recently the U.S.), the residence country retains the right to tax active income from all
source countries. Double taxation is typically avoided by the residence country granting a
non-refundable foreign tax credit against its own tax, so that the residence tax is limited to
the excess of the residence country’s effective tax rate over that in the source country.

In practice, the distinction between worldwide and territorial systems is not as clear-cut.
Some provisions in existing systems, such as the deferral of dividend tax obligation until
repatriation or the use of excess credits from high-tax countries to offset taxes on dividends
from low-tax countries (cross-crediting), tend to soften the bite of worldwide taxation
(Matheson et al, 2014). Other measures, such as Controlled Foreign Company rules (CFC),
extend domestic taxation rights for both worldwide and territorial systems by taxing foreign
passive income immediately.3

Withholding taxes also blur the clean allocation of passive income between source and
residence countries. Many source countries impose withholding taxes on outbound income
payments, such as interest, royalties and dividends. While residence countries typically
provide some relief through foreign tax credits, unilateral endeavors to prevent double
taxation are often imperfect and withholding taxes can “stick” on cross-border income flows.
Double tax treaties (DTTs), by specifying maximum withholding tax (WHT) rates which are
often lower than the domestic WHT rates and sometimes down to zero, tend to limit source
country’s taxing right on cross-border passive income flows.4 In this context, withholding
taxation becomes a bilateral instrument to divide revenues between countries.

B. Main Channels of International Tax Avoidance

Avoidance of source country taxation. Within the international tax framework, MNCs can
use a wide array of techniques to shift profits between entities in the group to minimize their
overall corporate tax liability. These techniques can be entirely legal, in which case they are

3
The 2017 Tax Cuts and Jobs Act (TCJA) has created a hybrid system in the U.S. By exempting foreign
earnings of U.S. MNCs from additional U.S. tax upon repatriation, the TCJA has in principle moved the U.S. to
territoriality. On the other hand, the TCJA, in the Global Intangible Low Taxed Income (GILTI) provision,
imposes a minimum on overseas income that is in excess of 10 percent of the return on tangible assets.
Specifically, it taxes at the standard U.S. CIT rate, and on accrual, the income of U.S. CFC’s earned in all
foreign jurisdictions that exceeds 10 percent of qualified business asset investment (i.e., the depreciated value of
tangible fixed assets of those controlled foreign corporations)—but with a deduction for 50 percent of that
income. Credit is also given for 80 percent of the foreign tax paid on such income. The effect is to impose a
minimum rate of 10.5 percent on GILTI income (when no tax is paid abroad) with the U.S. liability wholly
eliminated if the average foreign tax rate paid is at least 13.125 percent. In this respect, the U.S. still maintains
some element of worldwide taxation.

4
Moreover, by stipulating that foreign withholding tax payments are creditable against the domestic tax
liability, DTTs often imply that the WHT is irrelevant for the MNC’s final tax obligation.

(continued…)
 7

referred to as tax avoidance—as opposed to tax evasion, which is illegal.5 The precise
channels of tax avoidance can vary, depending on the specific features of national tax
systems and treaty networks. For instance, taxation in source countries can be minimized by;6
(i) transfer mispricing (stretching, violating or exploiting weaknesses in the arm’s length
principle); (ii) strategic location of management of intellectual property (IP) to low-tax
countries to reduce taxes on associated income; (iii) debt shifting through intracompany loans
(excessive borrowing in high-tax countries and lending to low-tax countries); (iv) treaty
shopping (exploiting treaty networks to route income so as to avoid tax); (v) risk transfer
(conducting operations in high tax jurisdictions on a contractual basis to limit profits
attributable there); (vi) avoiding PE status; and (vii) locating asset sales in low-tax
jurisdictions (to avoid taxes on the capital gains).

Avoidance of residence country taxation. Worldwide systems can serve as a backstop for
the avoidance of source taxes, since income will ultimately be subject to repatriation taxes in
the residence country. However, residence taxation can also be avoided. One way is by the
artificial use of tax deferral (delaying payment to the parent, sometimes indefinitely).
Alternatively, the firm can avoid resident status through corporate inversion (changing
residence to escape repatriation taxes or CFC rules) or by choosing the location of a new
residence in a country that operates a territorial system.

The rest of this section reviews existing empirical evidence on the main channels of
international tax avoidance. The literature review is confined to channels where available
data allows identifying the behavioral effects of the international tax systems. Systematic
evidence on other channels is largely absent.

1. Transfer Mispricing

The valuation of intra-company transactions within an MNC affects the global allocation of
the tax base between source and residence countries. Most countries use the arm’s length
principle, which stipulates that internal prices between related parties should resemble prices
that would prevail between independent parties. Yet, despite extensive OECD and UN
Guidelines, there may be significant room for subjective interpretation. Conceptually, there
may even be no “correct” arms-length price if there are no comparable third-party
transactions. Given these weaknesses in the implementation of the arms-length’ principle,
MNCs may be able to charge artificially low prices for exports sold from high-tax to low-tax
countries, or artificially high prices for inputs coming from low-tax countries, to reduce their
global tax liability.7

5
However, the dividing line is often unclear, and there are plenty of cases/disputes in differentiating tax evasion
from tax avoidance.
6
Taxes in high-tax locations can also be avoided by changing the location of foreign direct investment (FDI).
This paper, however, focuses only on tax avoidance through profit shifting, not through a change in the location
of real capital (for a survey of taxation and FDI, see e.g. De Mooij and Ederveen 2008).
7
Transfer mispricing has also implications for national accounts statistics and the measurement of GDP growth,
see e.g. Guvenen et al (2017).
 8

The literature provides ample evidence for the presence of tax-motivated transfer mispricing.
Earlier empirical studies show that at the aggregate level, differences in the statutory
corporate tax rate between the US and its trading partners substantially influence the balance
and pattern of intra-firm trade in the US (Clausing, 2001, 2006). Later studies provide more
direct evidence, showing that the price wedge between the arm's-length price for unrelated
transactions and the transfer price for related-party transactions varies systematically with
corporate tax rate differentials faced by MNCs in the U.S. (Clausing, 2003; Bernard et al,
2006; Flaaen, 2016), Denmark (Cristea and Nguyen, 2016), France (Davies et al., 2017),
Germany (Hebous and Johannesen, 2015), and the UK (Liu et al, 2017). The size of the
effect, however, differs between studies, reflecting possible differences between countries,
sectors and firms, as well as in the empirical sample and estimation methods. Overall, the
estimated semi-elasticity (i.e. the percentage increase in the transfer price of exports in
response to a 1 percentage point reduction in the tax rate differential to lower-taxed
countries) ranges between 0.5 and 6.

2. Strategic Location of IP

Another way to reduce the global tax of an MNC is by strategically moving valuable IPs to
low-tax affiliates. Companies can conduct their research and development (R&D) activities
in one country, but transfer the ownership of the patent that is subsequently created to
another country where the resulting income streams will be taxed at a lower rate.8 As, there is
often no comparable transactions of IPs between unrelated parties, determining the arm’s
length price for company’s intangible transactions is usually very difficult, leaving room for
tax-induced manipulation of transfer prices (see e.g. Grubert, 2003; Desai et al, 2006).

Empirical evidence concurs that the location of valuable IP is systematically distorted toward
low-tax locations, by documenting a negative association between the level of corporate tax
rate and the probability of patent application and the subsidiary’s level of IPs in one country.
Specifically, using a panel data set of multinational affiliates within the EU–25 between 1995
and 2005, Dischinger and Riedel (2011) find that a decrease in the average tax difference to
all other affiliates by one percentage point raises the subsidiary’s level of IP by 1.6 percent.
Using data on corporate patent holdings of European MNCs, Karkinsky and Riedel (2012)
find that a one percent point increase in the corporate tax rate reduces the probability of
patent applications by around 3.5-3.8 percent. Tax-responses of IP locations are found to be
heterogeneous across European countries (for instance, due to differences in market size or
enforcement)9, with the amount of patents held most sensitive to tax in Luxembourg (with an
estimated tax semi-elasticity of 3.9) and least sensitive in Germany (with an estimated tax
semi-elasticity of 0.5) (Griffith et al, 2014). Empirical evidence using data on European and
US patent and trademark applications during 1996-2012 also suggests that there is substantial

8
Relocation of such intangibles commonly take place before they are fully developed (and the value is fully
known to the tax authority) to avoid capital gains tax on the initial transfer.
9
Theoretically, smaller countries may be expected to have relatively high own tax elasticities, as a change in
their tax rate will not affect the market rate of return, making the cost of capital more responsive to tax changes.
 9

difference in the tax-responses of IP locations between types of IP (Dudar and Voget, 2016),
where the estimated tax semi-elasticity of trademarks is -6.2 and is significantly larger than
that of patents (with an average tax semi-elasticity of -1.9), as generation of the latter is likely
to be tied with some real R&D activities.

3. International Debt Shifting

A third way for an MNC to reduce its tax bill is through intracompany loans. Cross-country
differences in rates of CIT create opportunities for lending from low-tax countries to
affiliates in high-tax countries or by locating external borrowing in high-tax countries. This
debt shifting reduces the group’s tax bill without affecting the overall debt exposure of the
group (and hence its bankruptcy risk).

Empirical studies confirm the presence of debt shifting, by showing that host-country taxes
or international tax differentials have a positive and significant effect on internal debt of
German MNCs (Weichenrieder, 1996; Ramb and Weichenrieder, 2005; Overesch and
Wamser, 2006; Mintz and Weichenrieder, 2010; Schindler et al., 2013; and Buettner and
Wamser, 2013), on intrafirm interest and debt ratio of U.S. MNCs (Grubert, 1998, Altshuler
and Grubert 2003; Desai et al, 2007), and on internal leverage of MNCs in Europe (Huizinga
et al, 2009). Synthesizing this literature in a meta analysis, De Mooij (2011) finds that the tax
elasticity of intra-company debt is 0.5, which based on an average ratio of intra-company
debt-to-assets of 0.24 in the meta sample, corresponds to a tax impact on the internal debt-
asset ratio of 0.12. Debt shifting is found to be more pervasive in developing countries, with
the effect of taxes twice as large as in developed economies (Fuest et al, 2011).

4. Tax Treaty Shopping

Considerable variation in the WHT rates in more than 3000 bilateral DTTs creates
opportunities of treaty shopping. This enables MNCs to link different DTTs and divert cross-
border payments through the country with the lowest WHT rate.

Empirical evidence for treaty shopping is first documented by Weichrieder and Mintz (2008),
who show that higher bilateral WHTs to (from) Germany increase the probability that
outward (inward) FDI is diverted via a third country. The link between lower WHT rates and
re-routing of FDI is further supported in Weyzig (2013), who shows that the reduced WHT
rate on dividend payments in Dutch tax treaties is the key driver of FDI diversion through
Dutch Special Purpose Entities. Revenue losses associated with treaty shopping can be
substantial for source countries. Beer and Loeprick (2018) find that treaty-shopping has
reduced CIT revenues in Sub Saharan Africa by around 15 percent among countries having
signed a treaty with an investment hub. Balabushko et al. (2017) show that reduced WHTs
under the Ukraine-Cyprus DTT imply revenue losses of around US $77 million for Ukraine
in 2015, or one percent of CIT revenue.
 10

5. Tax Deferral

As worldwide taxation imposes residence tax only upon repatriation of the profit, MNCs can
avoid repatriation taxes by retaining foreign earnings abroad. The tax deferral channel is
different from the others in that with an unchanging tax rate, deferral affects only the present
value of taxes paid instead of the total revenue. Moreover, theory predicts that, tax deferral
may or may not be a relevant avoidance strategy. Analogous to the “new view” of dividend
taxation, Hartman (1985) argues that dividend taxes are unavoidable costs for mature foreign
subsidiaries, i.e. at some point in time they must be paid. Hence, if the subsidiary’s choice is
to distribute dividends now or later and taxation remains constant, the tax rate should play no
role. However, effects are expected if tax rates are anticipated to change. Several empirical
papers find support for tax deferral, by showing that US MNCs increase their dividend
payout in response to lower taxes on repatriation (Hines and Hubbard, 1990; Altshuler and
Newlon,1993; Grubert,1998; Altshuler and Grubert, 2003). Recent studies, exploiting UK’s
and Japan’s adoption of a territorial system in 2009 in a quasi-experimental setting, provide
similar evidence that exemption of foreign earnings boosted dividend repatriation in the UK
(Egger et al, 2015) as well as in Japan (Hasegawa and Kiyota, 2017).

6. Corporate Inversions and HQ Location

MNCs in worldwide countries can also avoid repatriation taxes by changing the residence of
the corporation or, stated differently, by “inverting” roles in the corporate group.10 Corporate
inversion by US parents are generally associated with substantial tax savings (Desai and
Hines, 2002). Using a dataset of 60 US MNCs that restructured between 1983 and 2015,
CBO (2017) finds that the average saving in each company’s global corporate taxes is around
US $45 million in the year after the inversion.

More broadly, corporate inversions are a special case of cross-border mergers and
acquisitions (M&As) that are influenced by tax considerations. Using data on 278 cross-
border M&As between 1997 and 2007, the taxation of foreign passive income in CFC
legislations and worldwide taxation of foreign active income are found to be major drivers
for cross-border M&As (Voget, 2007; Huizinga and Voget, 2009).

C. How Effective are Anti-Avoidance Regulations?

During the last few decades, countries have adopted various anti-avoidance regulations to
mitigate tax avoidance by MNCs. These include, for example, the adoption of transfer
pricing regulations, thin capitalization rules, controlled foreign corporations (CFC) rules or a
general anti-avoidance rule (GAAR). These efforts have received considerable attention in
light of the G20-OECD initiative on BEPS. For instance, countries participating under what
is now called the inclusive framework on BEPS, commit to four minimum standards (e.g. on
treaty abuse) and adhere to the common approaches to adopt anti-avoidance legislation. The

10
Corporate inversions can take the form of a merger with a foreign entity, which then results in the former
domestic parent becoming a subsidiary of the new foreign parent (even though the shareholders of the original
domestic company may retain more than 50 percent of the shares in the new corporation).
 11

European Union has also adopted an anti-tax-avoidance directive that requires its member
states to implement a common set of rules to address tax avoidance. This section reviews the
studies that analyze the effectiveness of anti-avoidance rules.

Transfer Pricing Regulations offer guidance in the implementation of the arm’s length
principle. They often specify the methods that can be used to calculate transfer prices,
determine documentation requirements, include various specific requirements in its
application needed to support the transfer prices used, and set penalties if mispricing is
detected or adequate documentation is not provided. Their effectiveness in curbing
international tax avoidance is supported in two concurrent studies, which show that
introduction and tightening of transfer pricing rules can diminish the tax sensitivity of
corporate profits by 50 percent (Riedel et al, 2015), though with much weaker effects for
firms with many intangible assets or complex group structures (Beer and Loeprick, 2015). A
later study shows that stricter regulations reduce reported profits of MNCs, possibly due to
the combination of lower profit inflows into countries that are intermediate hubs for profit
shifting and higher compliance costs of MNCs (Saunders-Scott, 2013).11

Thin Capitalization Rules deny interest deductibility above a certain threshold of either net
interest payment (as a ratio of income) or net debt (as a ratio to equity). The precise
conditions under these rules vary between countries and over time. Empirical evidence
suggests that, on average, well-designed thin capitalization rules are effective in reducing
debt shifting by multinationals, using data for MNCs in Germany (Overesch and Wamser,
2010; Buettner et al, 2012) and the U.S. (Blouin et al, 2014).

CFC Rules stipulate that foreign subsidiaries’ income are subject to domestic taxation
without deferral if certain conditions are met. CFC rules thus expand domestic taxation rights
of territorial systems and limit the impact of deferral under worldwide systems. Initial studies
have exploited the German MiDi dataset and find that CFC legislation reduces passive assets
by 77-82 percent for subsidiaries where the legislation was binding, i.e. for whom the
statutory tax rate in their host country falls below the safe-haven tax rate (Ruf and
Weichenrieder, 2012). A recent study confirms this finding, by contrasting the financial
earnings of subsidiaries in 200 countries just above and below the tax rate threshold; it
reports a 20 percent difference in the level of reported profit due to binding CFCs (Clifford,
2017).

III. A NEW CONSENSUS ON TAX-MOTIVATED PROFIT SHIFTING

The research reviewed in the previous session examines channels of international tax
avoidance separately. In contrast, following a simple conceptual framework developed by
Hines and Rice (1994), and extended by Huizinga and Leaven (2008), a wide body of
empirical work has examined the overall extent of tax-motivated profit reallocation by
estimating the following regression:

11
Another explanation could be that stricter transfer pricing rules increase the effective marginal tax rate, and
therefore dampen MNC investment (De Mooij and Liu, 2018).
 12

log ̅ , (1)

where is a measure of reported profit before taxation in country i, ̅ is a tax rate

differential, X is a vector of control variables, and is an idiosyncratic error term. The tax
rate differential measures the difference in statutory CIT rate between location and the
average CIT rate among other affiliates of the same company group. The tax coefficient ( )
captures the responsiveness of reported profits to the tax rate differential, and is expected to
be negative in the presence of profit shifting. The vector of controls, X, typically includes real
variables, such as capital and labor inputs, to avoid confounding effects of tax on profit
shifting and real production.

The typical study estimates equation (1) by using firm-level data. However, some studies use
more aggregate data to infer a relationship between taxable profits and tax rate differential.
Micro studies on profit shifting only capture avoidance behavior that affects the observed
profits of a MNC. While transfer mispricing, international debt shifting, and strategic
location of IPs directly effects reported profitability, other avoidance channels are not
necessarily captured in studies using variants of equation (1). For instance, avoidance of PE
status implies that there is no profit reported in the first place, suggesting that micro studies
that exploit firm-level data would neglect this channel.12 Alternatively, avoidance of dividend
taxes on repatriation would change after- but not before-tax profits, and would not be
captured in either macro or micro studies. Macro studies may capture a wider range of profit
shifting channels related to statutory CIT rate differential. Yet, by exploiting variation in the
statutory CIT rates, all studies neglect avoidance of other corporate taxes, including those on
interest, royalty and service fees, or on capital gains tax (treaty shopping and offshore
indirect transfer of assets).

Empirical estimates of the semi-elasticity vary widely. Part of this dispersion is structural, as
costs of profit shifting are likely to differ across MNCs of different operating scale or
industry structure, and across countries with varying enforcement and administrative
capacity. Given these differences, we expect variability in the estimates from different
studies even with the same regression specification. Part of the dispersion in the estimated
semi-elasticity, however, is study-specific. For example, early studies often use cross-
sectional data at the country level, and rarely control for real determinants of economic
profitability. More recent studies use micro-level panel data and control for a wide range of
non-tax determinants of profits at both the macro and firm level.

This section uses meta regressions to synthesize existing empirical evidence on profit
shifting, and to disentangle the drivers behind reported estimates. Specifically, we first
construct a comprehensive dataset that includes 402 estimated semi-elasticities of reported
profit with respect to a tax measure, associated standard errors, and a range of specification-
and study-specific variables. We then use a meta regression to uncover the “consensus

12
Avoidance of PE would be captured though, in macro-studies that use national accounts.

(continued…)
 13

estimate”, which represents the most likely value of the true semi-elasticity based on all
evidence currently available.13

A. Data and Descriptive Statistics

We identify relevant studies in a comprehensive search of the EconLit database, economic

journals, and working paper platforms, such as SSRN, using the keywords “income shifting”,
“profit shifting” and “tax avoidance”.14 We include studies that use a profit measure as the
dependent variable and that either directly produce tax semi-elasticities or allow for their
imputation. Our baseline sample has 402 semi-elasticities from 37 papers:15 the earliest study
Hines and Rice (1994) uses cross-sectional data in 1982; the latest Dowd et al., (2017) uses
micro-level panel data up to the year 2012.

Table 1. Estimated Semi-Elasticity of Pre-Tax Profits

Number of
Sample Mean Weighted Mean Median Observations underlying
studies
(1) (2) (3) (4) (5) (6)
Baseline 1.59 0.79 1.05 402 37
No conditional
estimates 1.54 0.79 1.01 294 35
Heckemeyer and
Overesch (2017)
sample 1.47 0.79 1.00 208 26
Peer-reviewed,
micro-data sample 1.38 0.72 0.99 269 22
Notes: This table reports the summary statistics of the semi-elasticity estimates in four different samples in
column (1). Weighted mean is computed as the average of semi-elasticity estimates weighted by the inverse
squared standard error.

Table 1 summarizes features of the semi-elasticities in four subsamples of the main dataset
(column 1, differences described below). Column 2 shows the mean semi-elasticities. The
average semi-elasticities of 1.58 in the baseline sample suggests that reported profit
decreases by 1.59 percent in response to a one percentage point increase in the statutory tax
rate. Simple averages, however, ignore imprecisions in the primary estimates. Following HO,
column 3 summarizes the weighted averages of estimated semi-elasticities by weighting each
estimate with its inverse squared standard error, and shows a much smaller average response
of 0.79 for the baseline sample.

13
Throughout this section, we report the absolute value of this semi-elasticity (i.e. as a positive value, even
though this reflects a negative effect of reported profit to the tax rate).
14
Our search took place in February 2018 and focused on both accounting and economic studies. The meta-
analysis fully follows the Journal’s reporting guidelines as summarized in Stanley et al (2013).

15
See Appendix 1 for detailed descriptions of the baseline sample.

(continued…)
 14

Baseline sample. Our baseline sample expands the HO sample in two important ways. First,
it includes more studies of profit shifting. Second, it includes more estimates from the same
studies included in HO.16 Several papers investigate how profit shifting varies with some
other explanatory variables ( , such as the presence of mandatory documentation
requirements or the intangible intensity of the firm, typically in regressions of the form:

log ̅ ̅ . (2)

To avoid loss of information, we compute average conditional semi-elasticities as

, evaluated at the mean value of z. The associated standard errors are computed using the
delta method.

Sample without conditional estimates. When dropping conditional elasticities from the
baseline sample, we lose around one quarter of observations. The mean estimate is 1.54 and
slightly smaller to the average in the baseline sample, while the weighted average and
median are almost identical.
HO (2017) sample resembles the data used in their study, with similar mean and median
values of the estimated semi-elasticity.17 Minor differences occur because we use estimates
based on updated or published versions of the primary studies.

Peer-reviewed micro-data sample includes 269 semi-elasticity estimates from 22 peer-

reviewed papers that exploit micro-level data. The mean, weighted-average and median
semi-elasticity estimate in this sample is 1.38, 0.72, and 0.99, respectively.

Figure 1 illustrates semi-elasticities of the baseline sample by the average sample year of the
underlying study. On average, reported estimates (solid line) have decreased over time. This
may reflect a reduced tax response over time. Alternatively, the declining trend may also
reflect the more extensive use of granular data (i.e. firm-level panel instead of country-level
cross-sectional data) or improved empirical strategies. We further explore the impact of these
characteristics on the consensus estimate in the meta-analysis.

16
One exception is that we do not include 12 estimates presented by Loretz and Mokkas (2015), which by
regressing after-tax profitability on domestic tax rate introduces mechanical negative correlation between the
two variables.
17
HO found an arithmetic mean and median of 1.52 and 1.02, respectively, in a set of 203 observations from 27
studies. Our sample include all the studies from the HO (2017) except Loretz and Mokkas (2015).
 15

Figure 1. Semi-Elasticity Estimates over Time

Notes: the crosses show estimated semi-elasticities using macro-data; the squares show estimated semi-
elasticities using micro-data. The solid line is an aggregate time trend; the dotted lines differentiate between
micro- and macro-based estimates.

B. Synthesis of Primary Estimates: Meta-Regression

Benchmark Specification. Measured semi-elasticities differ due to structural differences in

the underlying sample and differences in the estimation strategy. To disentangle these, we
estimate a meta-regression of the form:

′ , (3)

where is the semi-elasticity reported in study , the vector comprises a set of

dummy variables that take the value of one if estimate in study i deviates from the
benchmark specification, and is an error term. The intercept thus captures the true
semi-elasticity while the coefficients on indicate deviations from this consensus estimate
due to study- and estimate-specific attributes. Specifically, includes four groups of study
or estimation characteristics:

Estimation techniques and data features: Despite more use of micro-datasets in recent
studies, researchers continue to exploit macro data due to its broader coverage in time and
geography. Time-series of aggregate data help revealing long-run tax elasticities, as it often
takes time for MNCs to restructure their transaction or financing arrangement in response to
tax changes. Aggregate data also have obvious drawbacks: profit shifting incentives at the
affiliate level are unobservable, factor inputs cannot be matched with reported profitability,
and unobservable factors at the firm-level cannot be controlled.18

18
Another drawback of the BEA dataset, a major information source for macro studies, is that reported earnings
include dividend income. This raises concerns about double counting (Clausing, 2016)
 16

Our preferred specification uses micro-data and controls for firm- and country-specific fixed
effects. The indicator Aggregate Data takes the value of one for studies using country-level
data; the indicators No Firm FE and No Country FE, take the value of one if the study does
not control for unobservable characteristics that differ across firms or countries, respectively.

Dependent variable characteristics: The distribution of firm profitability is heavily skewed

and may not fit with a linear regressions model. Previous work addresses this issue in two
ways: (1) dropping observations with negative profits and using the natural logarithm of
profits as a dependent variable, or (2) using a profitability ratio, such as return on sales or
return on assets, as the dependent variable. However, limiting the sample to firms with
positive profitability might induce bias as loss making entities are potentially among the most
aggressive tax planners (see e.g. Johannessen et al, 2017).19 While using a profitability ratio
may alleviate this bias, it may capture real responses to the tax rate in the denominator,
confounding tax-minimization responses with real ones.

Against this background, our preferred specification uses the logarithm of reported profit
before taxation as dependent variable. The dummy variable Ratio takes the value of one for
studies using profitability ratios instead of the logarithm. The expected effect of this indicator
is ambiguous as it depends on the denominator’s response to tax differentials. The dummy
variable EBIT takes the value of one for studies using before financing profit as the
dependent variable. As before-financing profits excludes tax avoidance through internal
borrowing, we expect the coefficient of EBIT to be negative.

Tax variable characteristics: From a theoretical perspective, the tax rate variable should
capture the net tax savings associated with a relocation of one dollar across the corporate
group. Micro-level data often allows computing statutory tax rate differentials that are likely
good approximations to this theoretical concept. Absent detailed ownership information,
researchers typically use the host country’s statutory tax rate. Several studies, particularly
from the US, use backward looking average effective tax rates. These rates are outcomes of
past profit shifting behavior and raise reverse causality concerns.

Absent special tax regimes and tax holidays, statutory corporate tax rates are precisely the
rates applying to the marginal unit of profits and thus capture the true incentive for profit
shifting (Devereux, 2007). Our preferred specification uses a statutory tax rate differential.
The dummy SingleRate takes the value of one for studies using a single tax rate. The
indicator Effective takes the value of one for studies relying on effective tax rates instead of
statutory corporate tax rates. We expect the indicator SingleRate to have a negative sign due
to attenuation bias. Given the reverse causality between reported profit and effective tax rates
(that is, low levels of reported profits after shifting imply a low effective tax rate, generating
a spurious positive correlation between the two variables), we expect a positive sign on the
indicator Effective.

19
On the other hand, tax law asymmetries (such as loss-offset) imply that loss making entities are subject to a
different tax treatment and tax avoidance incentives might differ as a result (Dhamapala, 2014).
 17

Controlling for real activity and leverage. Part of the variation in reported profits are due
to changes in economic profits, which depend on the scale of real activities. Excluding
controls for real activies, the estimated tax elasticity is the elasticity of total taxable income
that encompasses both real and reporting responses.

Our benchmark study controls for real production inputs, but not for debt, as internal
financing decisions are one channel of profit shifting. Accordingly, the indicator NoReal
takes the value of one for studies that do not control for either assets, the number of
employees, or payroll, and is expected to have a positive sign. The indicator Debt takes the
value of one for studies that hold financing decisions constant (by including leverage
decisions as an explanatory variable). We expect the coefficient on Debt to be negative as it
excludes an important channel of profit shifting through debt shifting.

Other sample characteristics. We include the average sample year of the underlying study
(Z-MIDYEAR) to investigate whether the observable extent of profit shifting has changed over
time.20 The expected sign of this variable is ambiguous: while growing importance of
intangible assets and increasingly sophisticated tax planning strategies may indicate a larger
tax sensitivity of the global tax base, strengthened anti-avoidance measures may add to the
costs of profit shifting to the MNC.

C. Efficient Estimation

Researchers typically account for the varying precision of primary estimates by estimating
meta-regressions with Weighted Least Squares (WLS). By using the inverse of the reported
standard error as a weight, this estimation strategy gives more weight to more accurately
measured observations and should thus increase estimation efficiency over OLS.

The efficiency gains of WLS depend on the correct specification of the error structure.
Notably, WLS rules out correlation of primary estimates at the study level, which seems to
be a restrictive assumption in our context. For instance, studies focusing on intangible
intensive firms likely find larger semi-elasticities than studies focusing on publicly-owned
manufacturing firms. Such differences would imply correlation of estimates at the study-level
and render WLS a less efficient estimation strategy.

We allow for correlation of primary estimates at the study-level to increase the efficiency of
our estimates. More specifically, we assume that the unobservable error component of semi-
elasticity j in study i is given by,

, (4)

where is study-specific and is estimate-specific. The study- and estimate-specific error

components are independently distributed with mean zero and variances and .This
formulation allows sample characteristics, such as the underlying industry-composition or

20
The Z-MIDYEAR variable is standardized, reflecting deviation from the average sample year of all studies in
the baseline sample.
 18

strength of country-specific anti-abuse measures, to drive the tax sensitivity of reported

profits.

We implement the estimations in a two-stage approach. In the first stage, we use OLS on
study-specific average values of all dependent and independent variables21 to obtain the
residuals 1/ ∑ , where is the number of point-estimates provided in study
i. Note that primary studies derive estimates conditional on study-specific characteristics.
Reported standard errors thus directly provide information on the estimate-specific
component σ , . We infer the second component using

∑ ∑ ∑ σ (5)

Where V is the number of control variables included in the regression. In the second step, we
combine these estimates to construct the covariance matrix for a feasible generalized least
squares (GLS) estimation.

A critical advantage of the GLS is that the weight given to any observation depends on the
total number of estimates in a study: each observation tends to receive less weight if the
underlying study provides many estimates; it receives more weight if the underlying study
provides only a few estimates. This makes intuitive sense with intra-study correlation, as the
first estimate of an additional study adds more new information to the true semi-elasticity
than the 45th estimate of the same study. In contrast, WLS weighs observations solely based
on the reported standard error, neglecting the underlying information source.

Figure 2 contrasts WLS (left panel) and GLS (right panel) estimates of the unconditional
mean (red vertical line) in the baseline sample. Small vertical black lines depict point
estimates; grey clouds around these point estimates illustrate associated 95 percent
confidence bands. In the left panel, we use the standard errors which are reported in primary
studies to illustrate these confidence bands, thus ignoring correlation at the study level. Many
confidence intervals do not encompass the mean value in the left panel, suggesting that
reported semi-elasticities and associated standard errors are from different distribution.22 In
contrast, the right panel presents confidence bands that account for variation at the study-
level, and show considerable more overlap.23

21
Typically referred to as “between” estimation in a panel data context.
22
Otherwise we would expect that around 95 percent of these confidence bands do cover the red line.

23
In other words, we use equation (5) to estimate in the right panel, where the clouds cover roughly 2 times
in each direction. In contrast, we simply set 0 in the left panel.
 19

Figure 2. Unconditional Semi-Elasticity Estimates

Notes: the short vertical black lines denote study means, the (overlapping) clouds indicate associated
confidence bands. The long red vertical lines denote the unconditional mean of all semi-elasticity estimates in
our sample using WLS (left panel) and GLS (right panel) estimation.

The simple graphical evidence suggests that a two-component error structure is more
suitable to describe the unconditional mean in the baseline sample. Similarly, we do find
that an important share of the observed variation is at the study level in all conditional
estimations of the mean (see regression results in the next section). Accordingly, we use
GLS in all estimations to improve estimation precision over previous work.

D. Main Findings

Table 2 summarizes our regression results based on Equation (3) using the baseline sample.
The dependent variable is the reported semi-elasticity of pre-tax profits, winsorized at top
and bottom one percentile to remove the influence of outliers.24 We account for
heteroscedasticity and intra-study correlation by presenting fully robust GLS standard errors
(see e.g. Arellano, 2003 and Wooldridge, 2010). Moreover, we correct for the small number

24
We check the sensitivity of our results to winsorization in Table 3, and show that it has hardly any impact on
the consensus semi-elasticity estimate.

(continued…)
 20

of clusters by inflating residuals25 and reporting p-values based on t-distributions with G-1
degrees of freedom, where G is the number of the included studies (see Cameron, Gelbach,
and Miller, 2006).

Column 1 of Table 2 examines the joint impact of estimation techniques and data sources on
measured semi-elasticities. The average semi-elasticity estimate is 0.72, when using micro
data and including firm fixed effects. The coefficient on the indicator No Firm FE is positive
and significant at the one percent level, suggesting that the assumption of no correlation
between unobservable components at the firm-level and the dependent variable might be
violated in these models. Omitting country fixed effects increases the estimated semi-
elasticity by an average of 0.46.

Among studies using aggregate data, estimated semi-elasticities are significantly larger and
more sensitive to the inclusion of country-specific fixed effects. The coefficient on the
Aggregate Data indicator of 1.11, which is significant at the 5 percent level, suggests that the
data sources differ beyond the ability to control for unobservable factors at the firm level.
With a magnitude of 2.29 (=0.72+0.46+1.11), the implied semi-elasticity for macro-studies is
much larger than the effect identified in micro-studies. Two explanations seem possible. On
the one hand, macro-data potentially captures long-run responses and more channels. On the
other hand, the larger effect may reflect bias, as aggregate data does not allow to match
production factors with profitability measures at the firm level and precludes computation of
relevant tax differentials. Country-specific fixed effects play a similar role for aggregate data
as do firm-specific fixed effects for micro-data. We acknowledge this difference by
interacting the No Country FE indicator with the Aggregate Data indicator. Our findings
suggest that estimated semi-elasticities increase by 0.76 (=0.46+0.3) if macro-based studies
do not control for country-specific fixed effects; this effect is significantly larger than the
increase for micro-based studies.

.
25
We use the factor .
 21

Table 2. Baseline Results

EXPLANATORY VARIABLE: (1) (2) (3) (4)
CONSTANT 0.724*** 1.205*** 1.017*** 0.974***
[0.127] [0.244] [0.286] [0.128]
NO FIRM FE 0.121*** ‐0.159 ‐0.096 ‐0.211***
[0.039] [0.157] [0.146] [0.070]
NO COUNTRY FE 0.456*** 0.468*** 0.359*** 0.472***
[0.036] [0.025] [0.125] [0.020]
AGGREGATE DATA 1.110** 1.674** 1.445** 1.082**
[0.515] [0.637] [0.632] [0.513]
AGGREGATE DATA * NO COUNTRY
FE 0.302*** 0.296*** 0.448*** 0.354***
[0.045] [0.044] [0.147] [0.043]
SINGLE RATE ‐0.22 ‐0.23
[0.187] [0.211]
EFFECTIVE ‐0.536 ‐0.548
[0.671] [0.677]
RATIO ‐0.341** ‐0.344** ‐0.374***
[0.152] [0.142] [0.069]
EBIT ‐0.044 ‐0.045
[0.067] [0.067]
NO REAL CONTROLS 0.469*** 0.454***
[0.104] [0.116]
DEBT 0.02
[0.113]
NO MARKET 0.349
[0.319]
NO TIME FE 0.116
[0.114]
Z‐MIDYEAR 0.035*** 0.033*** 0.036*** 0.036***
[0.008] [0.008] [0.009] [0.008]
GROUP VARIANCE/TOTAL
VARIANCE 0.34 0.362 0.412 0.367
OBSERVATIONS 402 402 402 402
Notes: ***, **, and * depict significance at the 1%, 5%, and 10% level, respectively. Fully robust standard
errors in square brackets.

Column 2 of Table 2 adds dependent and tax variable characteristics, reporting an average
semi-elasticity of 1.2. The firm fixed effect indicator is no longer significant, suggesting the
additional controls subsume variations in the firm-level unobserved heterogeneity. The
coefficient on Single Rate is -0.22 but not significant at conventional statistical levels.
Similarly, the coefficient on the Effective indicator is negative and statistically insignificant.
Studies using profitability ratios report significantly smaller semi-elasticities (-0.34) than
studies using the logarithm of reported profit. Surprisingly, we do not find systematic
differences between studies using EBIT and studies using profit before taxation as a
dependent variable. Debt-shifting thus plays, on average, a minor role in our baseline sample.
 22

We examine the importance of real production controls, leverage and other covariates in
column 3. The coefficient on the indicator No Real Control is close to 0.5 and significant at
the one percent, indicating an omitted variable bias in studies that neglect real responses to
taxation. In contrast, debt ratios, macro-controls, and time fixed effects do not seem to matter
systematically in our baseline sample.

Following HO, we drop insignificant explanatory variables in column 4 to increase the

estimation precision. The estimated constant of 0.98 is our preferred consensus semi-
elasticity estimate. Studies yield smaller effects if they employ a profit ratio (instead of
logarithm) or use a simple statutory tax rate (instead of a differential); they yield larger
estimates if they do not control for unobservable country-specific effects, real activity, or use
aggregate data.

Throughout all columns the coefficient for the Z-Midyear variable is around 0.03 and
significant at the one percent level, suggesting that the consensus semi-elasticity estimate
increases with the sample year. For example, the consensus semi-elasticity is estimated to be
0.60 in 1990 and 1.5 in 2015. The positive coefficient of the sample year also suggests that
the declining trend in the primary elasticity estimates in Figure 1 is driven by important
characteristics of the primary studies other than time per se.

Robustness checks
Table 3 checks the robustness of our findings by re-estimating specification in Table 2
Column 3 with alternative samples. Column 1 examines the effect of outliers by using
reported observations without winsorizing. Column 2 drops the top and bottom 5 percent of
primary estimates. The results change slightly: with average values of 1.03 and 1 for the
consensus estimate, respectively.

Column 3 excludes studies that are not published in peer-reviewed journals, and reports a
slightly larger consensus estimate of 1.25. While most indicator variables have the expected
signs, two differences emerge: first, the omission of country-specific fixed effects now
impacts negatively on measured semi-elasticities. Second, we find a negative and significant
coefficient on the indicator EBIT. Profit before interest and taxation decreases, on average,
by 0.86 (=1.25-0.39) percent in response to a one percentage point increase in the local
statutory tax rate. The two estimates on the semi-elasticity of profits, before and after
financial income, allow gauging the importance of debt shifting relative to other channels of
profit shifting. Assuming that interest payment account for 9 percent of pre-tax profit,26 if
MNCs neglect financial channels to shift profit, the measured semi-elasticity of profit after
interest payments should be 9 percent larger than the semi-elasticity of profit before interest
payments.27 We would thus expect to find a semi-elasticity of 0.94 when using profit after
interest payments. However, the measured semi-elasticity for profit after interest is 1.25,
indicating that MNCs also use financial channels to manipulate profit. Comparing these

26
For instance, the average ratio of pre-tax EBIT to profit, based on consolidated financial statements for the
largest 1,000 non-financial companies (measured by total assets) in ORBIS is 1.09 in 2011.
27
Note that d[f(t)(1+r)]/dt=(1+r)f’(t), where r is the constant interest rate.
 23

effects implies that financial tax avoidance strategies account for roughly one quarter
(=(1.25-0.94)/1.25) of the total profit shifting response.
Table 3. Robustness Checks
DEPENDENT VARIABLE: SEMI‐ELASTICITY OF REPORTED PROFIT (NO WINSORIZING)
EXPLANATORY VARIABLE: (1) (2) (3) (4)
CONSTANT 1.026*** 0.995*** 1.250*** 1.012***
[0.292] [0.282] [0.256] [0.288]
NO FIRM FE ‐0.102 ‐0.103 0.595 0.273
[0.146] [0.143] [0.486] [0.630]
NO COUNTRY FE 0.361*** 0.360*** ‐0.906 * 0.298
[0.124] [0.124] [0.479] [0.684]
AGGREGATE DATA 1.458** 1.461** 1.237 * 0.931
[0.638] [0.611] [0.699] [0.758]
SINGLE RATE ‐0.231 ‐0.229 0.051 ‐0.434
[0.214] [0.212] [0.198] [0.353]
EFFECTIVE ‐0.549 ‐0.558 ‐0.569 0.657***
[0.679] [0.678] [0.694] [0.163]
RATIO ‐0.350** ‐0.322** ‐1.161** ‐0.093
[0.145] [0.139] [0.453] [0.469]
EBIT ‐0.047 0.007 ‐0.387 * ‐0.282***
[0.068] [0.020] [0.206] [0.102]
NO REAL CONTROL 0.475*** 0.426*** 0.810*** 0.734***
[0.108] [0.084] [0.160] [0.145]
DEBT 0.022 0.032 ‐0.081 ‐0.248**
[0.114] [0.124] [0.154] [0.114]
NO MARKET 0.348 0.356 1.034*** ‐0.105
[0.322] [0.317] [0.353] [0.078]
NO TIME FE 0.115 0.116 ‐0.169 ‐0.037
[0.114] [0.114] [0.160] [0.224]
AGGREGATE DATA * NO COUNTRY
FE 0.447*** 0.440*** 1.060** NA
[0.146] [0.145] [0.478] NA
Z‐MIDYEAR 0.036*** 0.036*** 0.029*** 0.069**
[0.009] [0.009] [0.003] [0.031]
GROUP VARIANCE/TOTAL
VARIANCE 0.336 0.801 0.291 0.704
OBSERVATIONS 402 380 328 208
Notes: ***, **, and * depict significance at the 1%, 5%, and 10% level, respectively. Fully robust standard
errors in square brackets.

Publication Bias
In principle, estimated semi-elasticities and reported standard errors should be independently
distributed. However, researchers, editors, and referees tend to prefer significant statistical
results over insignificant results and previous work has indicated that selective reporting and
publication of empirical findings is ubiquitous in the economics literature (see e.g. Card and
 24

Krueger, 1995; Ashenfelter, 1999; Doucouliagos and Stanely, 2013). Empirical work on
profit shifting is likely no exception.

Theoretical considerations imply that profit shifting induces a negative correlation between
reported profit and the tax differential. However, data sources often have insufficient detail
and local statutory tax rates change infrequently. As a result, the identified effect is
sometimes imprecisely measured and random errors might even lead to estimated semi-
elasticities which are positive. If researchers do not report such estimates, our meta-
regression suffers from sample selection and the mean estimate will be upward biased.
Besides selective reporting, researchers potentially re-estimate the same regression with
slight perturbations (p-hacking) to provide statistically significant results. While this practice
does not necessarily introduce bias in reported semi-elasticities, it does induce a correlation
between standard errors and coefficient estimates, which impacts estimations using reported
standard errors as weights.

Figure 3 presents two pieces of graphical evidence to explore the potential of publication bias
in our sample. The left panel presents a funnel plot, where the inverse of reported standard
errors is plotted against the reported semi-elasticity. Observations located at the top of the
graph are accurately measured and should thus approximate the true mean. In contrast,
observations at the bottom of the graph are imprecisely measured and on average expected to
deviate to a larger degree from the mean. The plot clearly conveys asymmetry in the
distribution of reported estimates, suggesting that the probability of ending up in our sample
decreases substantially if the semi-elasticity carries the wrong sign. The right panel presents
the density of t-values in our sample, where the vertical line depicts the critical value of 1.96.
The spike right next to this line is consistent with p-hacking.

Figure 3. Graphical Evidence for Publication Bias

 25

Notes: Left panel plots semi-elasticities against standard errors. Points above the line in the left panel are significant at
the 5% level. Right panel plots the density of associated t-values (semi-elasticity/standard error). The vertical line in
the right panel depicts a t-value of 1.96.

Table 4 column 1 examines the presence of publication bias by estimating the baseline
specification, adding the reported standard error as an additional explanatory variable.28 The
positive effect of the standard errors on reported semi-elasticities is significant at the one
percent level and consistent with publication bias. The implied publication bias is not related
to the average sample year (column 2) or whether an estimate was taken from a published
study or from an unpublished study (column 3).

Table 4. Evidence on Publication Bias

Dependent variable: semi-elasticity estimates (no winsorizing)
(1) (2) (3)
Constant 0.520** 0.509** 0.548**
[0.219] [0.239] [0.240]
SE 1.986*** 2.033*** 1.901***
[0.385] [0.432] [0.404]
SE*zMidyear 0.044
[0.050]
SE*WP 1.011
[0.696]
Controls Yes Yes Yes
Group Variance/ Total
variance 0.31 0.317 0.321
Observations 402 402 402
Notes: ***, **, and * depict significance at the 1%, 5%, and 10% level, respectively. Fully robust standard
errors in square brackets.

E. Simulation of Revenue Effects

This section illustrates the revenue impact of profit shifting using the consensus estimate.29
Specifically, drawing on the theoretical model of Huizinga and Laeven (2008), which we
elaborate in Appendix 3, the observed tax base in country i ( ) is the sum of true profits ( )
and shifted income :

, , , 1, … (6)

Shifted income can be either positive or negative and is a function of the unobservable vector
of true earnings before profit shifting ( ), where different elements of refer to true
earnings in different countries that the MNC operates, the semi-elasticity of reported earnings

28
For brevity, we omit the estimated coefficients on other control variables.
29
These calculations should be interpreted with caution, since they are based on a highly stylized model and do
not account for heterogeneity across countries and firms. Thus, it is meant only as an illustration of what the
average semi-elasticity obtained in the previous subsection means in terms of the allocation of tax bases and,
consequently, corporate tax revenue.
 26

( , negative) and the vector of tax rates in countries where the MNC operates
(based on profit maximization set out in equation A. 1 in Appendix 3):

∑
1
∑
1

For a given semi-elasticity, vector of tax rates, and observed tax bases, the true tax base
vector , , can be imputed from Equation (6) with the expression for above.

For the calculations, we obtain corporate tax rates for 2015 in 81 countries from the KPMG
database. We obtain corporate tax bases of these countries by dividing corporate tax revenues
for 2015, obtained from the IMF’s government finance statistics, by statutory tax rates.30 We
then calculate for each country the tax base without profit shifting, the amount of profits
shifted in or out of the country, and the associated revenue effect. In the calculations, we
impute the semi-elasticity to be 1.5 for the year 2015, using the preferred semi-elasticity of
0.98 (Table 2, column 4) and the Z-Midyear coefficient of 0.036.

Table 5 summarizes the simulation results for four country groups: the US, the 15 largest
countries in the sample, the 15 countries with the lowest corporate tax rates, and the average
among all 81 countries. Column (1) of Table 5 suggests that reported corporate tax revenue
in the US is roughly US$ 360 billion in 2015. The combined federal and state tax rate of 40
percent implies an underlying reported tax base of US$ 900 billion. The high statutory
corporate tax rate relative to the rest of the world implies a net outward profit shifting from
the US of US$ 198 billion, implying a true tax base of roughly US $1,095 billion. Hence,
profit shifting activities eroded the US tax base by about 17 percent, or 0.4 percent of US
GDP.31 This number is comparable to the 14.4 percent reported by Zucman (2014), but
somewhat smaller than Clausing (2016) who estimates a revenue loss between 19 and 30
percent of corporate tax revenue, and Torslov et al (2018) who estimate it at 40 percent of tax
revenue from MNCs.

Table 5. Estimated Revenue Losses

Country US Big 15 Low-tax 15 Global
(1) (2) (3) (4)
CIT revenue (in billion. US$) 363 1,563 49 1,888
CIT rate (federal + state, %) 40 31 15 30

30
Note that this approach introduces two counterbalancing inaccuracies: first, by using total corporate revenues
rather than the share of revenues from MNCs, we may overestimate the relevant tax base. Second, by ignoring
the effect of accelerated depreciation, tax losses, and other provisions in determining the actual tax liability of
corporations the statutory tax rate can be much higher than the effective average tax rate. By dividing total
revenue by statutory rates, we thus underestimate the relevant tax base.

31
Following the US Tax Cuts and Jobs Act (TCJA), global profit shifting patterns are likely to change
substantially (see, e.g. Beer et al 2018).
 27

Reported CIT base 907 4,983 318 6,213

True CIT base 1,095 5,0784 263 6,213
Corporate income shifted 198 102 -55 0
Revenue loss (in % of CIT revenue) 17.2 4.1 -19.8 2.6
Revenue loss (in % of GDP) 0.42 0.11 -0.43 0.07
Note: we calculate the variables as follows: CIT revenue is ∑ , reported CIT base is ∑ , pre-shifting
∑
CIT base is ∑ , Income shifted is ∑ , tax revenue losses is ∑
and revenues.

Columns 2 and 3 present the average effect for the largest 15 economies (Big 15), including
the US, and the 15 countries with the lowest statutory tax rate (Low-tax 15). Compared to the
US, the revenue consequences of profit shifting are much smaller for Big 15: corporate tax
revenue declines in these countries by an average 4 percent, or by 0.11 percent of GDP. The
reason is that several large countries have CIT rates below the world average. As a result, the
15 countries with the lowest statutory CIT rate gain from inward profit shifting, with
corporate tax revenues increasing by almost 20 percent, or by 0.43 percent of their GDP.

Column 4 further shows the global net revenue effect of profit shifting, i.e. the balance of the
gains in some countries and the losses in other countries. While the total of shifted income is
equal to zero (by definition, as cross-border profit shifting does not change the total income
of a MNC), the shifting from high-tax to low-tax countries reduces the total of corporate tax
revenue by 2.6 percent of corporate tax revenues, or 0.07 percent of global GDP. These
numbers are somewhat smaller than those reported by Crivelli et al. (2017), OECD (2015),
and UNCTAD (2015).

Figure 4 presents country-specific results for a selection of simulated variables. The graph
shows that seven large economies actually gain from profit shifting because their rate is
lower than those prevailing elsewhere.

sFigure 4. Country-Specific Estimates of Fiscal Impact

 28

Notes: Figure 4 illustrates simulation results, depicting tax rates (left panel), changes in the tax base due to
profit shifting (middle panel), and revenue losses due to profit shifting (right panel). Negative base and
revenue losses are gains.

IV. DISCUSSIONS AND CONCLUSION

The existing literature on international tax avoidance has significantly advanced over recent
years, but there remain several blind spots and puzzles that future research should address.

First, we reviewed granular evidence on tax-motivated behavioral responses of MNCs in

areas such as transfer mispricing, strategic location of intangibles, intra-company debt
shifting, treaty shopping, corporate inversion, and tax deferral. However, there is much less
evidence on some of the other channels of profit shifting. For example, MNCs can structure
their businesses to artificially avoid the creation of permanent establishments, thus escaping
source country taxation at the outset. Alternatively, they can exploit mismatches in national
tax rules, when different countries classify the same entity, transaction, or financial
instrument differently.32 Another pressing issue for especially developing countries relates to
the taxation of offshore indirect transfers of assets, where MNCs avoid taxes on significant
capital gains in source countries (see, e.g. Wei (2015) and IMF (2018)). Understandably, the
lack of systematic analysis on these alternative channels of profit shifting is due to both their
highly technical and complex nature and the lack of suitable data. More and deeper analysis
in this area is needed to advance our understanding on the anatomy of international tax
avoidance.

Second, there is little evidence on the interaction between alternative modes of profit
shifting. Empirical work tends to focus on specific channels in isolation, so it is difficult to
infer information about substitution between alternative channels. A notable exception is
Saunders-Scott (2016), who provides insight into whether transfer mispricing and debt
shifting are substitutes or complements. The study examines changes in the reported EBIT
following a tightening of thin-capitalization rules for multinational affiliates, using the
ORBIS database. The findings suggest that MNCs use transfer mispricing and intra-company
debt shifting as substitutes (see also Nicolay et.al. (2017)). More research is needed in this
direction in order to shed light on how successful targeted anti-abuse rules are in restricting
the overall extent of international tax avoidance by MNCs.

Third, there is limited insight into the systematic variation in tax avoidance across countries,
sectors, firms and time. Indeed, the relative costs of various shifting methods are likely to
differ in all these dimensions. Therefore, conclusions of certain studies are hard to generalize
to all MNCs or all countries. Recently, some studies have started to focus on specific sectors
or extended the scope to developing countries. For example, using tax records of US MNCs,
Dowd et al (2017) find significant non-linear effect of tax differential that points to more

32
A notable exception is Hardeck and Wittenstein (2017), which use the Luxembourg Leaks database and show
that hybrid arrangements by MNCs are related to substantial and continuous reduction in the effective tax rate
of MNCs. The empirical evidence provide support for the considerable tax benefits of hybrid arrangements
outline in theoretical research by Johannesen (2014).

(continued…)
 29

shifting into tax havens. Findings by Johannessen, Torslov, and Wier (2017), which uses data
from multinational affiliates in 142 countries, including 25,000 corporations in 94 developing
countries (from ORBIS), suggest that less developed countries are more exposed to cross-
border profit shifting.33 The literature is too scattered, however, to draw firm conclusions on
important sources of heterogeneity.

Fourth, there is little attention in the literature on the interaction between profit shifting and
the reallocation of real activities by MNCs. Existing research has focused largely on
quantifying either the scale of profit shifting or the impact of taxes on the location of FDI.
Yet, profit shifting may interact with investment and thus have complex and unexpected
welfare implications, with important policy implications. For instance, some have argued that
profit shifting can mitigate distortions from existing tax systems on real capital (Hong and
Smart, 2010; Desai, Foley and Hines, 2006). Anti-avoidance measures might then reduce
welfare to the extent that they magnify distortions in real capital allocation.

Only a handful of recent studies analyze the spillover effect of anti-avoidance rules on
investment. For example, De Mooij and Liu (2018) exploit introductions and tightening of
transfer pricing regulation in countries as a quasi-natural experiment and find that transfer
pricing regulation has a negative and significant effect on MNC investment in fixed assets.
Buettner et al. (2017) provide evidence that thin-capitalization rules have a negative effect on
MNC investment financed by debt. Egger and Wamser (2015) explore whether limitations to
foreign income exemptions affect investment using a regression continuity design. They find
that the German CFC rule decreased foreign subsidiaries’ real investments. The scarce
evidence thus suggests that unilateral tightening of profit shifting through anti-avoidance
rules may have negative effects on MNC investment. More evidence is needed, however, to
inform the debate on effective policy design, including through international coordination.

There are also several puzzles in the literature that remain partially unresolved. One is the
‘large aggregate effects’ versus “small micro effects’. In particular, our meta regressions
suggest that firm-responses reflected in aggregated data are substantially larger than in micro
data, thereby controlling for several study attributes that may confound the estimated semi-
elasticities in primary studies. Our interpretation of this difference is between short-term and
long-term responses, e.g. due to adjustment costs and optimization frictions (i.e. fixed costs
of tax planning). Indeed, micro-studies typically exploit variation across time from which the
contemporaneous effect is obtained while macro-studies exploit cross-sectional variation that
yield an estimate of the long-run effect. Moreover, macro studies may cover a wider array of
shifting channels than micro studies. Whether this is indeed the case should be explored more
deeply.

Another puzzle is our finding regarding debt shifting. The literature directly exploring the
extent of debt shifting finds a robust significant impact of corporate tax differences on

33
On the extensive margin, Johannessen, Torslov, and Wier (2017) reports that the tax rate faced by a foreign
affiliate has a significant positive effect on the likelihood that the affiliate reports zero profits. On the intensive
margin, the tax semi‐elasticity of reported profits is found to be around 1 in low/middle‐income countries, but
less than 0.2 in high‐income countries.
 30

intracompany debt. One would expect that this would be reflected in studies on the total size
of profit shifting by showing a systematic difference between studies using profit indicators
that include and exclude interest costs. While our meta regressions confirm this difference,
deeper analysis is needed to explain this, which might include methodological issues such as
omitted variable bias or attenuation bias.
 31

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 40

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 41

Appendix 1. Descriptive Overview of Included Studies

Study Total Conditional Mean Median Min Max

estimates estimates
Azemar (2010) 3 2 2.54 1.02 0.99 5.62
Barrios and d'Andria (2016) 8 0 0.49 0.37 0.23 0.95
Becker and Riedel (2012) 3 0 0.76 0.73 0.71 0.84
Beer and Loeprick (2015) 19 18 0.85 0.90 0.39 1.28
Beer and Loeprick (2017) 31 31 1.77 1.69 0.61 2.91
Beuselinck et. al (2016) 25 7 3.60 1.60 -3.25 12.54
Blouin et. al (2012) 1 0 0.54 0.54 0.54 0.54
Castillo and Lopez (2016) 1 0 2.08 2.08 2.08 2.08
Clausing (2009) 5 0 3.76 3.65 1.05 5.52
Clausing (2016) 8 0 2.92 2.84 1.85 4.61
Collins et al (1998) 1 1 0.32 0.32 0.32 0.32
Crivelli et al. (2016) 20 1 2.02 1.33 0.17 5.59
De Simone (2015) 9 9 0.83 0.91 0.25 1.29
De Simone et. al (2014) 2 0 1.00 1.00 0.66 1.34
Dharmapala and Riedel (2013) 1 0 1.13 1.13 1.13 1.13
Dischinger (2010) 16 4 1.60 1.54 0.72 3.32
Dischinger and Riedel (2011) 4 0 3.20 3.18 2.14 4.29
Dischinger et al. (2014) 28 4 0.91 0.68 -0.51 1.82
Dowd et al. (2017) 10 4 0.81 0.84 -0.03 1.44
Grubert (2003) 5 4 0.75 0.85 0.33 1.05
Grubert (2012) 18 6 1.31 1.20 0.63 2.31
Hines and Rice (1994) 6 0 5.16 3.31 2.25 12.99
Huizinga and Laeven (2008) 27 1 1.25 0.98 0.49 3.71
Johannessen et al. (2017) 8 0 0.69 0.75 0.12 1.31
Klassen and Laplante (2012a) 9 9 0.60 0.44 0.17 1.19
Klassen and Laplante (2012b) 8 8 0.91 0.88 0.69 1.28
Loretz and Mokkas (2015) 12 0 -0.07 -0.11 -0.79 0.80
Maffini and Mokkas (2011) 22 0 1.21 1.03 0.23 4.87
Markle (2016) 12 3 0.95 0.92 0.34 1.71
McDonald (2008) 20 14 1.26 1.36 0.73 1.65
Merz and Overesch (2017) 13 12 2.05 2.18 0.23 3.00
Mills and Newberry (2004) 4 0 1.94 1.03 -1.16 6.86
Riedel et al. (2015) 14 14 0.71 0.59 0.29 1.79
Rousslang (1997) 12 0 4.74 5.00 3.63 5.63
Saunder-Scott (2016) 2 0 0.87 0.87 0.66 1.08
Schwarz (2009) 9 0 1.78 2.03 -1.33 3.62
Weichenrieder (2009) 6 4 0.94 0.91 0.79 1.25
 42

Appendix 2. Comparison to Heckmeyer and Overesch (2017)

Table 3 column 4 restricts the sample to estimates that were included in HO, and reports a
consensus estimate of around 1. The measured sensitivity to international tax differentials
exceeds HO’s estimate by 25 percent, which could be due to (i) a different estimation
strategy, (ii) a different baseline sample, or (iii) the inclusion of different control variables.
We examine each one in turn in Table A.1, by using the HO assumptions and then addressing
each of these possibilities in turn. For (ii) and (iii), however, we also show GLS estimates.

Columns 1 and 2 of Table A.1 examine the importance of different estimation strategies, by
using the same sample and specification in HO (2017). Column 1 reports a consensus
estimate of 0.797 using WLS, which is very similar to the value of 0.786 found by HO.34
Column 2 reports the GLS consensus estimate, which increases to 0.997. The difference in
estimates is not surprising, given that around 60 percent of the residual variation in primary
estimates is due to differences between studies.

Table A.1. Comparison to HO

Dependent variable: semi-elasticity of reported profit (no winsorizing)
Differences in: Estimation Strategy Sample Controls
WLS GLS WLS GLS WLS GLS
(1) (2) (3) (4) (5) (6)
Constant 0.797*** 0.997*** 0.499*** 0.816*** 0.759*** 0.963***
[0.116] [0.248] [0.119] [0.161] [0.118] [0.294]
EBIT 0.061 -0.263** 0.117 -0.012 0.115 -0.267**
[0.132] [0.116] [0.079] [0.058] [0.166] [0.100]
Debt -0.346 -0.302** -0.343* -0.031 -0.348 -0.259**
[0.402] [0.126] [0.190] [0.195] [0.386] [0.115]
After Tax 0.488 0.312 0.792*** 0.186 0.516 0.405
[0.492] [0.258] [0.193] [0.248] [0.709] [0.359]
zMidyear 0.014 0.055* 0.020*** 0.034*** 0.02 0.060*
[0.029] [0.033] [0.007] [0.008] [0.027] [0.033]
Aggregate Data -0.055 1.459* 0.31 1.430*** 0.037 1.300*
[0.473] [0.749] [0.479] [0.518] [0.708] [0.724]
Single Rate -0.049 -0.414 0.266** -0.204 -0.054 -0.396
[0.150] [0.356] [0.101] [0.146] [0.160] [0.366]
No Time -0.117 -0.136 -0.014 0.02 -0.049 -0.08
[0.433] [0.253] [0.106] [0.089] [0.411] [0.237]
No Firm 0.091 0.583 0.301* 0.083 0.083 0.617
[0.238] [0.702] [0.163] [0.091] [0.214] [0.723]
No Country FE 0.119 0.244 -0.156 0.500*** 0.042 0.091
[0.340] [0.671] [0.206] [0.119] [0.428] [0.706]
Ratio 0.022 -0.096
[0.366] [0.457]

34
The coefficient estimates on the indicators are not directly comparable, as we defined our baseline differently.
However, none of the coefficient estimates is statistically significant at conventional levels.
 43

No Real Control 0.263 0.715***

[0.325] [0.127]
Group
variance/Total
variance 0 0.649 0 0.368 0 0.714
Observations 208 208 402 402 208 208
Notes: ***, **, and * depict significance at the 1%, 5%, and 10% level, respectively. Fully robust standard
errors in square brackets.

Columns 3 and 4 check the effect of using different samples. Column 3 estimates HO’s
preferred specification with WLS in our broader sample, and finds a much smaller consensus
estimate of 0.499. Column 4 reports the GLS results under the same specification and
sample, which increases the consensus estimate to roughly 0.816. Interestingly, the
coefficient for the Z-midyear variable also becomes significant at the one percent level when
using the larger sample, suggesting the increasing trend of the consensus semi-elasticity
estimate is only captured in the broader sample that include more studies and primary
estimates. The insight is important for the policy debate on profit shifting and for the
calibration of economic models that account for tax avoidance.

Finally, columns 5 and 6 examine the importance of specification bias. In our baseline
regressions, we control for characteristics of primary studies that explain measured effects in
our sample, which were not included in HO. Column 5 adds the indicators Ratio and No Real
Control in HO’s preferred specification and uses the HO sample. The estimated constant
remains very close to the HO estimate and the indicator variables do not explain variation in
primary estimates. Column 6 repeats estimation with GLS. While the coefficient on Ratio
remains insignificant, the indicator No Real Control now systematically explains differences
in primary estimates. The consensus estimate is, with a value of 0.96, slightly smaller than
the GLS estimate presented in column 2 of Table 2 when neglecting these indicators.

In sum, the differences in estimation strategy, sample and control variables cause differences
between our findings and HO. The broader sample and the additional control for study-
specific characteristics reduce estimated semi-elasticities, while the use of GLS seems to
raise them. A major difference between these estimation methods is that reported standard
errors are more important in determining the weights used in the WLS approach.
Accordingly, a positive correlation between standard errors and estimated semi-elasticities
would explain why WLS yields smaller average semi-elasticities than GLS.
 44

Appendix 3. Estimating Tax-Motivated Profit Shifting: Theoretical Underpinnings

We use a simple model based on Huizinga and Laeven (2008) to set out the effect of taxes on
cross-border profit shifting. A representative MNC operates in n countries, with the parent
residing in country p. The corporate tax base in country i is reported profit πi, which is the
sum of true earnings (Bi) and shifted income (Si). The latter can be positive or negative and is
set to minimize the global tax obligation of the MNC group. Profit shifting is costly,
however. When marginal concealment costs increase proportionally with the ratio of shifted
to true profit, total shifting costs in country i are given by with γ the factor of
proportionality. The MNC relocates reported profit to maximize its worldwide after-tax
income, subject to the constraint that profit shifting does not generate additional income
∑ 0. The corresponding Lagrangian is

γ
1 , (A.1)
2

where is the shadow value of profit shifting, and is the statutory corporate tax rate in
country i. The first order condition with respect to requires that:
1 0, , (A.2)

so that the marginal tax benefits of income reallocation equals the marginal concealment
cost. Using the requirement that the sum of shifted income equals zero, we obtain the optimal
profit shifting into country i:

∑
, (A.3)
∑

or more generally,

, (A.4)

Where s, B, and are vectors in i=1…n, is the vector of relevant tax rates for the MNC
group outside country i, W is a weighting matrix, and the parameter , defined as 1/ , is
negative. The weights in W are determined by the true earnings B.

As an alternative, Crivelli et al. (2016) assume that the cost of profit shifting is unrelated to
the true profit reported in a particular country, to accommodate circumstances that significant
profit are shifted into a tax haven without substantial earnings. We explore the implications
of this alternative assumption by specifying the cost of shifting as by , i.e.
independent of true earnings. The vector of optimal shifting is now given by:

, (A.4’)
 45

where is the un-weighted average tax rate.

The relationships in (A.4) and (A.4’) summarize three simple and intuitive results. First, the
direction of profit shifting depends on relative statutory tax rates, i.e. the difference between
a host country’s statutory tax rate and a weighted or unweighted average of corporate tax
rates in all countries where the MNC operates. When a host country’s tax rate is above
average ( 0 or 0 , profit shifting reduces the domestic tax base
0 . Second, the magnitude of shifted income can be proportional to true earnings B or
independent of it, depending on the nature of the concealment costs. Third, the tax sensitivity
of reported profit is inversely related to the shifting cost parameter γ, i.e. increasing
concealments costs dampen the amount of profit reallocation.

Note that, while cross-border profit shifting does not change the total income of a MNC (
∑ 0 , it does lead to losses in the total tax revenue globally: ( ∑ 0 . In our
analysis below, we will assess this revenue loss.

Much of the empirical work on profit shifting centers around identification of . The
theoretical model provides guidance in this respect. Substituting the optimal amount of
income shifting in the definition of reported profit, , and taking a log-linear
approximation gives:

log , (A.5)

whereby would be replaced by if (4’) were used. Eq. (5) shows that the semi-elasticity
of reported profit with respect to international tax differentials is directly related to
unobservable concealment costs. Once is known, eq. (5) provides an estimate of the
average base change of an affiliate. This is proportional to the revenue effect from profit
shifting for a single country.

The shifting cost parameter plays a key role in determining the tax elasticity (since ≡
). It could vary across MNCs of different operating scale or industry structure, as well as
between countries, reflecting the country-specific enforcement environment and the tax
administrative capacity. Conceivably, for every bilateral combination of countries i and j
there is a different shifting cost parameter γ . At the group level, is likely to be lower for
MNCs with more affiliates in countries with lax enforcement or weaker administrative
capacity. Moreover, is likely to be lower for MNCs operating in certain industries for
which the arm’s length principle is less applicable. The heterogeneity of expected tax
responses among different types of MNCs suggest that different empirical studies are likely
to report different elasticity estimates. Most empirical studies estimate an average elasticity
of all MNCs in the sample. Variation in the elasticity estimates across studies will thus reflect
structural differences of the MNCs or countries included in the sample.

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