Strategic Taxation of the Multinational Enterprise: Profit-Shifting and Globally-Joint Inputs

This paper models strategic taxation policy of home and host governments when a multinational enterprise sets transfer prices on globally-joint inputs such as research and development. Tax credit and deduction allowances, as well as no taxation of foreign-earned profits, result in identical optimal transfer price solutions and national income effects in both countries. An equilibrium home tax solution is to tax foreign-earned profits at a higher rate than domestically earned profits. The multinational responds by shifting profits abroad through transfer pricing mechanisms.