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Profit shifting and corruption Katarzyna Bilicka1,2 · André Seidel3

© Springer Science+Business Media, LLC, part of Springer Nature 2020

Abstract This paper introduces heterogeneous profit shifting costs induced by corrupt tax officials to the analysis of profit shifting of multinationals. Using a theoretically derived corruption weighted tax differential, we show that corruption increases profit shifting of European firms. We use our estimates to calculate the implied tax revenue elasticities for European countries and find that countries with otherwise similar tax rates face lower tax revenue elasticities when they are more corrupt. This means that corruption negatively affects the revenue gains that countries could have from increasing their tax rates. Keywords  Corruption · Profit shifting · Tax revenue elasticities JEL  H25 · H26 · D73

1 Introduction The issues of tax evasion and tax avoidance have gained more attention in the political and economic debates since the revelations from Panama Papers and Paradise Papers. Since then, the OECD has extensively pushed to increase the country memberships in the Base Erosion and Profit Shifting (BEPS) initiative beyond the OECD

Electronic supplementary material  The online version of this article (https​://doi.org/10.1007/s1079​ 7-020-09596​-4) contains supplementary material, which is available to authorized users. * Katarzyna Bilicka [email protected] André Seidel [email protected] 1

Jon M Hunstman School of Business, Utah State University, 3500 Old Main Hill, Logan, UT 34322, USA

2

Oxford University Centre for Business Taxation, Oxford, UK

3

Department of Economics, University of Bergen, P.O. 7802, 5020 Bergen, Norway



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K. Bilicka, A. Seidel

borders.1 As a result, many Eastern European countries have started to implement the first stages of the BEPS action plan. However, weaker institutions are likely to be a large obstacle in the expansion of the BEPS initiative beyond the OECD borders. Different international organizations have repeatedly stated that corruption in tax administration2 and the practice of revolving tax officials3 are serious threats to the ability of countries to enforce the collection of tax liabilities of multinational firms. Coupled with evidence that even large multinational companies are involved in straightforward corruption practices,4 this raises a question of whether corruption in the tax administration may affect profit shifting decisions on multinational companies. In this paper, we build a theoretical model in which a large multinational firm weights the costs of shifting profits against the benefits. The benefits include low tax rates. In the costs function, we introduce corruption in the tax administration. In our model, governments have regulations to help them fight tax avoidance, i.e., to monitor the legal transfer of profits between countries. A firm that is involved in profit shifting devotes some time to comply with the country-level regulations. In our model, these efforts a