Why is There Corporate Taxation in a Small Open Economy? The Role of Transfer Pricing and Income Shifting

35 Pages Posted: 10 Jun 2000 Last revised: 1 Oct 2009

See all articles by Roger H. Gordon

Roger H. Gordon

University of California, San Diego (UCSD) - Department of Economics; Harvard University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Jeffrey K. MacKie-Mason

UC Berkeley; University of Michigan

Date Written: March 1994

Abstract

Several recent papers argue that corporate income taxes should not be used by small, open economies. With capital mobility, the burden of the tax falls on fixed factors (e.g., labor), and the tax system is more efficient if labor is taxed directly. However, corporate taxes not only exist but rates are roughly comparable with the top personal tax rates. Past models also forecast that multinationals should not invest in countries with low corporate tax rates, since the surtax they owe when profits are repatriated puts them at a competitive disadvantage. Yet such foreign direct investment is substantial. We suggest that the resolution of these puzzles may be found in the role of income shifting, both domestic (between the personal and corporate tax bases) and cross-border (through transfer pricing). Countries need cash-flow corporate taxes as a backstop to labor taxes to discourage individuals from converting their labor income into otherwise untaxed corporate income. We explore how these taxes can best be modified to deal as well with cross-border shifting.

Suggested Citation

Gordon, Roger H. and MacKie-Mason, Jeffrey K., Why is There Corporate Taxation in a Small Open Economy? The Role of Transfer Pricing and Income Shifting (March 1994). NBER Working Paper No. w4690. Available at SSRN: https://ssrn.com/abstract=226971

Roger H. Gordon (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
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Harvard University - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Jeffrey K. MacKie-Mason

UC Berkeley ( email )

102 South Hall
Berkeley, CA 94720-4600
United States

HOME PAGE: http://jeff-mason.com

University of Michigan ( email )

Ann Arbor, MI 48109-1092
United States

HOME PAGE: http://http:/jeff-mason.com/

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