Tax Competition and Transfer Pricing Disputes

In the U.S., transfer-pricing regulations, which are designed to limit multinationals' profit shift activities, have been tightened in recent years. The new regulations have been enacted in response to concerns that foreign companies are not contributing adequate tax revenues. Against this background, the paper examines the implications of competing governments who maximize tax revenues from multinational firms and use transfer-pricing regulations as strategic variables. The result is a non-cooperative equilibrium that implies a double taxation of corporate profits and a depressed level of international trade. Cooperation between governments could potentially increase both tax revenues and trade.