The downside of formula apportionment: evidence on factor demand distortion

This paper investigates the impact of corporate taxes on the input factor choice of multi-jurisdictional entities (MJEs) under a formula apportionment (FA) regime. Our testing ground is the German local business tax that applies FA regulations with income apportionment according to the relative payroll share. Using unique data on the population of German firms, we find that MJEs distort their employment and payroll costs in favor of low-tax locations. On average, a 1-percentage-pointincrease in the tax rate differential between an affiliate and foreign group members is found to lower the affiliate’s payroll to capital ratio by 1.9%.