Transfer Pricing and Enforcement Policy in Oligopolistic Markets

In this paper we set up a symmetric two-country model with trade costs and international ownership to study the transfer pricing decisions by two multinationals operating in markets with Cournot competition. We let governments choose both the corporate profit tax rate and the level of enforcement of the arm's length principle and we examine how enforcement policies affect the tax competition game. Furthermore, we analyze in what direction economic integration, in terms of a reduction in trade costs and/or a larger international ownership of multinationals, influences the symmetric equilibrium level of the two policy instruments. We show that increased economic integration may lead to equilibrium tax rates, and that, as governments increase the level of enforcement, equilibrium tax rates as well. Moreover, we find that, when the two MNEs are not fully owned by domestic residents, trade liberalization the equilibrium enforcement policy, while increased international ownership the level of enforcement