How do taxes affect the location of debt and profit?

Differences in corporation tax rates between countries clearly create incentives for multinational companies to move taxable income to lower-taxed countries. But the economic significance of this is not well documented. This project attempts to quantify these effects using unconsolidated accounting data for a large number of companies for many countries. It investigates how the use of debt, and how rates of profit, depend on differences in tax rates and other factors.

A theoretical model predicts that if profit shifting is important, then post-tax profitability will be lower when the tax rate is higher. The prediction for pre-tax profitability is ambiguous, but if profit shifting is not too costly the same should also be true of pre-tax profit. We attempt to identify the effects of the host country tax rate on the pre- and post-tax profitability of foreign subsidiaries of French, German and British multinationals. Preliminary results suggest that a higher tax rate has a significantly negative effect on both the pre-tax and post-tax rates of profit.

Stephen Bond, Michael Devereux and Socrates Mokkas