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Earnings Shocks and Tax-Motivated Income-Shifting: Evidence from European Multinationals

36 Pages Posted: 25 Jun 2010 Last revised: 14 May 2012

Dhammika Dharmapala

University of Chicago Law School

Nadine Riedel

Oxford University CBT; University of Hohenheim

Multiple version iconThere are 3 versions of this paper

Date Written: April 2012


This paper presents a new approach to estimating the existence and magnitude of tax-motivated income shifting within multinational corporations. Existing studies of income shifting use changes in corporate tax rates as a source of identification. In contrast, this paper exploits exogenous earnings shocks at the parent firm and investigates how these shocks propagate across low-tax and high-tax multinational subsidiaries. This approach is implemented using a large panel of European multinational affiliates over the period 1995-2005. The central result is that parents’ positive earnings shocks are associated with a significantly positive increase in pretax profits at low-tax affiliates, relative to the effect on the pretax profits of high-tax affiliates. The result is robust to controlling for various other differences between low-tax and high-tax affiliates and for country-pair-year fixed effects. Additional tests suggest that the estimated effect is attributable primarily to the strategic use of debt across affiliates. The magnitude of income shifting estimated using this approach is substantial, but somewhat smaller than that found in the previous literature.

Keywords: International Taxation, Income-Shifting, Multinational Corporations

JEL Classification: H25, F23, K34

Suggested Citation

Dharmapala, Dhammika and Riedel, Nadine, Earnings Shocks and Tax-Motivated Income-Shifting: Evidence from European Multinationals (April 2012). 5th Annual Conference on Empirical Legal Studies Paper; Illinois Program in Law, Behavior and Social Science Paper No. LBSS11-09. Available at SSRN: or

Dhammika Dharmapala (Contact Author)

University of Chicago Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States

Nadine Riedel

Oxford University CBT ( email )

Park End Street
Oxford, Oxfordshire OX1 1HP
United Kingdom

University of Hohenheim ( email )


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