Evidence for Profit Shifting with Tax-sensitive Capital Stocks

This paper contributes to the literature providing indirect evidence for profit shifting within multinational companies. In contrast to the previous studies, we take account of the tax responsiveness of the capital stock and analyze the effect of corporate taxes on both pre- and posttax profitability. Evidence from a system of equations using a large panel data set of European subsidiaries by and large supports the profit-shifting hypothesis. We find that a 10-percentage-point decrease in the tax rate increases posttax profitability by up to 0.6 percentage points, with a larger direct tax effect. Further, our results suggest that financial profits and losses are particularly responsive to taxes, which indicates that a large part of profit shifting takes place via debt shifting.