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

37 Pages Posted: 26 Apr 2012

See all articles by Dhammika Dharmapala

Dhammika Dharmapala

UC Berkeley School of Law; CESifo (Center for Economic Studies and Ifo Institute); European Corporate Governance Institute (ECGI)

Nadine Riedel

Oxford University CBT; University of Hohenheim

Multiple version iconThere are 3 versions of this paper

Date Written: April 25, 2012

Abstract

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 firms, earnings shocks

JEL Classification: H250

Suggested Citation

Dharmapala, Dhammika and Riedel, Nadine, Earnings Shocks and Tax-Motivated Income-Shifting: Evidence from European Multinationals (April 25, 2012). CESifo Working Paper Series No. 3791, Available at SSRN: https://ssrn.com/abstract=2045989 or http://dx.doi.org/10.2139/ssrn.2045989

Dhammika Dharmapala (Contact Author)

UC Berkeley School of Law ( email )

302 JSP
2240 Piedmont Ave
Berkeley, CA 94720
United States

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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Belgium

Nadine Riedel

Oxford University CBT ( email )

Park End Street
Oxford, Oxfordshire OX1 1HP
United Kingdom

University of Hohenheim ( email )

Stuttgart
Germany

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