Multinational tax avoidance in developing countries.

Author:Johannesen, Niels

In recent years many global firms--including Starbucks, Google, and Amazon--have come under fire for avoiding paying faxes in one country by shifting their profits to a country with lower tax rates, Attention has been largely focused on companies avoiding tax in developed countries, but our new WIDER Working Paper documents a strong relationship between economic development and the prevalence of multinational tax avoidance: countries with low incomes and poor governance are more exposed to tax dodging. This is particularly worrying given the urgent revenue needs and already limited tax bases of developing countries.

Multinational tax avoidance costs hundreds of billions of dollars

Multinational Arms reduce their lax bills substantially by shifting profits from countries with high taxes to countries with low taxes. The various profit-shifting techniques are fairly well understood. Transfer mispricing, aggressive financial structures, and the strategic allocation of intangible assets, give multinational firms a large degree of flexibility to decide where their profits should be taxed.

Recent evidence suggests that the resulting loss of government revenue is likely to be counted in hundreds of billions of dollars every year.

More tax dodging in less developed countries

While almost all studies of multinational tax avoidance focus on developed countries, a rich dataset with financial information on 210,000 corporations in 102 countries allows us to take a global perspective.

We document that the profits reported by corporations depend systematically on their incentives to shift profits to foreign affiliates.

Concretely, if we consider two corporations in the same country with similar inputs of capital and labour, the one whose parent company faces the lower tax rate tends to report the lower profits. This pattern is clearly consistent with tax motivated profit-shifting: the lower the tax rate of the parent, the larger the tax saving from shifting profits by means of transfer pricing or otherwise.

Interestingly, the relation between reported profits and the incentives for profit-shifting varies systematically with the level of economic and institutional development. In countries with low incomes and poor governance, the sensitivity of corporate profits to profit-shifting incentives is much stronger.

Evidence of tax avoidance in the raw data

Figure 1 provides an illustration of aggressive profit-shifting in low-and middle-income countries. For...

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