Transfer Prices and Import and Export Price Indexes : Theory and Practice

The main purpose of this paper is to suggest a theoretical foundation for determining what is the appropriate price that a statistical agency, such as the U.S. Bureau of Labor Statistics, should seek from domestic establishments that engage in international transactions with affiliated establishments abroad. The price of transactions between related parties, called a transfer price, is an internal price. In a world where there are taxes on international transactions or where the rates of business income taxation differ across countries, a multinational enterprise (MNE) has financial incentives to choose strategically a transfer price that maximizes global after-tax profits. This strategically chosen transfer price will generally differ from an economic transfer price (based on opportunity costs) that would be suitable for a statistical agency to use in an import or export price index. How, then, should the statistical agency determine the appropriate transfer price for collection? Should the agency use the transfer price that the related party reports to the national customs authority? Or should it be the transfer price that the MNE reports for corporate income tax purposes? If the conceptually perfect transfer price cannot be collected for practical reasons, what are the practical alternatives for the price collector and can they be ordered in terms of their desirability? These are the questions addressed in this paper. We look at quot;practicalquot; approximations to the theoretical transfer price in the context of a single commodity traded internationally between related establishments. We then develop practical alternatives that a statistical agency could use for collecting transfer prices and order them in terms of their desirability. Our recommended strategy for the collection of transfer prices is somewhat radical, given that we recommend that the MNE's listed transfer price only be used as a last resort. Even in this situation, both time and financial constraints may change the ranking of the acceptable methods or make the MNE's stated transfer price the only practical alternative