Corporate Tax Reforms and Tax-Motivated Profit Shifting: Evidence from the EU

Abstract

This paper examines whether the profit-shifting trend in Europe during 2003–2013 can be explained by tax policy changes. Consistent with prior literature, we find that affiliates’ profits are sensitive to tax rate changes. However, we document that tax base–broadening reforms have mitigated the incentives for both inward and outward profit shifting. In particular, we find that anti-avoidance rules prevent multinational companies from shifting profits out of their foreign affiliates, whereas other tax base–broadening rules, such as restrictions on the deductibility of tax losses or on group tax relief, reduce the incentives for multinational companies to shift profits into foreign affiliates. Furthermore, we find evidence of a downward trend in profit shifting across European countries, especially when the tax enforcement is stricter. Overall, these results suggest that broader tax bases and stricter tax enforcement have successfully curbed this particular tax strategy.

Keywords: tax policy, profit shifting, tax avoidance, tax enforcement, multinational firms

JEL Classification: F23, H25, H26, M41