Presentations – Ron Davies

1. Presentations – Ron Davies

2. Common Consolidated Corporate Tax Base: Closing Doors and Opening Windows on Transfer Pricing Ronald B. Davies (UCD)

3. Transfer Pricing • Firms use prices to allocate revenues and profits across borders • Separate Accounting • Generally negotiated between the firm and the tax authority • Conflict between firm’s tax avoidance and gov’t revenue collection

4. CCCTB • High tax locations are concerned that transfer pricing is hurting revenues • CCCTB suggested as a way to reduce this • Eichner and Runkel (2008, Scandinavian) • Switch from Separate Accounting to Formula Apportionment

5. Formula Apportionment • Profits allocated via a formula • Payroll • Sales • Investment • Only need to allocate income to jurisdictions hosting a permanent establishment • Often said to eliminate transfer pricing

6. Formula Apportionment • Where is the weight given to factor i

7. Intensive Margins • Keeping locations constant, as firms seek to manipulate factors in the formula, this creates new distortions • Hines (2010, EER), Riedel (2010, ITAX), Mintz and Smart (2004, JPubE), Nielsen, Raimondos-Møller, and Schjelderup (2010, EER)

8. Relative Activity Shifting • Shift shares of activity to change formula shares • Shift labour, capital, and sales towards low-tax locations • Changes real activity

9. Technology Choice • Technology can affect: • The ability to shift intensive activity across locations • Capital intensity

10. Extensive Margins • Firms can also choose to shut down foreign affiliates in high tax locations • No permanent establishment, no tax liability • Relocation vs. Outsourcing • Outsourcing vs. Offshoring

11. Three key questions • Was transfer pricing an option? • Do you need to carry out activity in the high-tax jurisdiction? • Location specificity: On- or off-shore • Do you need to internalize the activity? • Proprietary asset: In- or out-source • FDI is offshore insourcing

13. So which industries will make extensive changes? • “Fuzzy” transfer prices • Location specific; Outsourcable • Non-location specific; Not outsourcable • Those that were on the margin between FDI and not to begin with

14. Fuzzy transfer prices • Rauch Classification • Homogeneous goods traded on an organized exchange • Commodities; raw materials • Reference priced (i.e. Benchmark prices) • Chemicals; other specialized but relatively homogenous inputs • Differentiated goods • Electronic components; services

15. Location specificity • Is the activity horizontal or vertical? • Horizontal: consumer seeking • How tradable is it? • Retail, construction is non-tradable • Autos, electronics, banking are tradable • Vertical: input seeking • How widely available is the input? • Low-skill, low-cost labour easily found • Textiles, basic assembly • High-skill, task-specific labour hard to find • Pharmaceuticals, software programming

16. Outsourcable • Nunn Classification • Contract intensity of an industry • Matches institutional quality with trade levels • Contract unintensive – easily outsourced • Contract intensive - internalize

17. Contract intensity

18. So which industries will have extensive changes? • Relocation • Electronics • Engine manufacturing • Banking • Outsource • Specialized metals • Chemicals • Take this with a grain of salt

19. Implications for Growth • Shifting real activity has relative growth implications • Can be intensive or extensive shifting • Slows growth in high-tax jurisdictions relative to low-tax countries • Changing technologies has shared growth implications • Can be switch in capital intensity or outsourcing

20. Outsourcing and growth • Falk and Wolfmayr (2008) study 14 industries across OECD countries for 90s and 00s • Service outsourcing seems to increase growth • Materials outsourcing, especially to low-wage countries, lowers growth

21. Additional Price Motives • Tax management is only part of the internal price decision • Tariffs (Davies, 2012) • Management Incentives • These can run counter to the tax minimization transfer price • CCCTB can result in greater price manipulation

22. Separate Accounting • Profit • Cost used by Eichner & Runkel (2011, JPubE), Riedel & Runkel (2007, JPubE)

23. SA – Impact of downstream tariff • Tariff rises, output falls: • But, more reason to avoid it: • If , then q falls and less misrepresentation. • If , then ambiguous. • Tariff up, more shifting; output falls, less shifting • Real activity falls

24. SA – Impact of downstream tax • As , move profits upstream, • Tends to reduce costs, output rises, q moves away from • If , same direction, q rises • If not, ambiguous.

25. SA – Impact of upstream tax • As , move profits downstream, • Tends to increase costs, output falls, q moves towards • If , same direction, q falls • If not, ambiguous.

26. FA vs. SA – Transfer price

27. Revenue changes • CCCTB changes costs and therefore output • Total economic activity can rise or fall • A country’s tax base changes • Formula • Size of total activity • Net effect is ambiguous

28. FA vs. SA – Revenues, low markup

29. FA vs. SA – Revenues, high markup

30. Conclusion • CCCTB removes the incentive to use internal prices to minimize tax avoidance • It introduces new distortions • Intensive and Extensive • Location of activity • Technology choices • These shift real economic activity • No clear-cut expectation of the net welfare, revenue, or economic implications

31. Thank you