The Effect of Profit Shifting on the Corporate Tax Base in the United States and Beyond

Abstract

This paper estimates the effect of profit shifting on corporate tax base erosion for the United States. Using Bureau of Economic Analysis survey data on U.S. multinational corporations over the period 1983 to 2012, the analysis estimates the sensitivity of foreign incomes to tax burdens for major foreign direct investment destinations. Controlling for a host of other variables as well as country fixed effects, I find that taxable income is very sensitive to corporate tax rates. Estimates of tax sensitivity are used together with data on reported foreign income to calculate how much “extra” income is booked in low-tax countries due to profit shifting; I then estimate what the tax base would be in the United States without profit shifting. I find that profit shifting is likely costing the U.S. government between $77 and $111 billion in corporate tax revenue by 2012, and these revenue losses have increased substantially in recent years. These findings are consistent with the stylized facts about large quantities of income booked in tax havens. I also undertake a speculative extension of this analysis to other countries, finding that corporate tax base erosion is likely a large problem in countries that do not have low tax rates. The paper concludes with a discussion of suggested reforms.

Keywords: international taxation, corporate taxation, transfer pricing, BEPS, corporate tax base erosion, profit shifting, income shifting

JEL Classification: H25, H87, H26