مجاورت-تمرکز تجارت کردن با تغییر سود

We study a firm which serves two unequally-sized jurisdictions and must choose where to locate its first production plant, and whether to open a second plant to serve the other market through local sales rather than exports. An exporter pays taxes only to the region where it locates its single production plant. A double-plant multi-regional firm pays taxes in both regions, but may shift taxable profits across them, at a cost. We show that the standard trade-off between fixed and trade costs is modified, depending on both the average tax of, and the tax difference between, the two regions. We also find that increased market size asymmetry may make it more likely that the firm builds a second production plant. From a total-welfare viewpoint, it is always desirable to control the firm’s tax avoidance ability when the double-plant structure is given. However, the fact that the firm may react to corporate taxation by changing its production structure may be a reason not to curb profit-shifting activities.

Firms operating in multiple jurisdictions are the norm, rather than the exception, in modern economies. It is generally acknowledged that industries characterized by scale economies and imperfect competition are dominated by this kind of firms.1 Firms which own fiscal entities at different locations are capable of shifting profits from high-tax to low-tax jurisdictions. This has prompted several countries to introduce specific rules as to the way in which taxable profits are to be allocated across regions. The most well-known examples are the Formula Appointment systems implemented in Canada, the United States and Germany (Riedel and Runkel, 2007).2 The existence of profit shifting through various mechanisms, such as royalty payments, transfer price manipulation, debt-financing and dividend remittances, is widely documented (see Hines (1999), for a comprehensive survey of the empirical literature). While most of the empirical evidence relates to profit shifting across countries, there are by now a number of contributions showing that firms also manipulate taxable profits at the sub-national level. As stated by Mintz and Smart (2004), while the inter-regional tax differences are lower, hence decreasing the incentives to shift taxable profits, there is an offsetting effect, that of the likely lower costs to do so. These authors report an elasticity of taxable income with respect to tax rates of 4.9 for multi-jurisdictional firms in Canada, more than the double of that of the firms which cannot shift income across locations. Klassen and Shackelford (2000) also report evidence of profit shifting across Canadian provinces and US states. At the international level, horizontal Foreign Direct Investment (FDI) has become a major policy issue in the last decades, as multinational firms carry out growing proportions of international economic activity (according to the OECD, around 60% of international trade involves transactions between two related parts of multinationals).3 Both the OECD, 1995 and OECD, 1998 and the European Communities, 1992 and European Communities, 1998 have issued documents reacting to such a widespread phenomenon alleged of eroding corporate tax bases. From a theoretical viewpoint, the firm’s choice on how to serve the consumers in another jurisdiction has been treated in the literature by the so-called “proximity-concentration trade-off”.4 The trade-off states that serving distant markets through local production is a good option under high trade costs, whereas concentrating production in just one location and exporting to the other markets is the best option when fixed set-up costs (e.g. building the factory, buying machines, training workers, etc.) are high. One of the main contributions of our paper is to shed additional light on this issue by showing how taxes and profit shifting might affect this trade-off. In general, the relationship between transport and fixed production costs is fundamental to the regional organization of an economy, as the New Economic Geography (NEG) literature growing out of Krugman’s (1991) work has often highlighted.5 The primary focus of NEG is on how agglomeration of economic activities results from the interaction of increasing returns to scale, trade costs and factor price differences.6 The Home Market Effect (HME), one of the main NEG results, suggests that, in a two-region economy, the location with larger local demand will attract a more than proportionate share of firms in imperfectly competitive industries. Combining the proximity-concentration trade-off with the HME, a common theoretical prediction is that a multi-regional firm is more likely to arise when regional income is fairly similar. 7 Several empirical papers, including Devereux and Griffith, 1998 and Head and Mayer, 2002, find a robust positive relationship between market size and the likelihood to attract FDI. The empirical literature on strategic tax-setting shows that region size positively impacts tax rates.8 Moreover, there is extensive evidence that the corporate tax rate of the host region has a negative and significant impact on inward FDI (see, e.g., De Mooij and Ederveen (2003) for a synthesis of empirical studies based on EU data). If we put such empirical findings together, we are led to conclude that large regions are more likely to benefit from direct investments by foreign firms but also to set higher corporate tax rates which, in turn, should discourage foreign firms from investing there. The theoretical literature has analyzed the relationship between firm location and fiscal policies mostly using single-plant firms, the notable exceptions being Behrens and Picard, 2008 and Bucovetsky and Haufler, 2008. Behrens and Picard (2008) set up a symmetric two-region tax/subsidy competition model which builds on a NEG general equilibrium framework. They show that competition for mobile firms can be weakened when firms are allowed to establish an additional plant abroad, rather than simply relocate production across regions. Namely, when only double-plant firms exist in the economy, the tax base becomes immobile, and governments may tax away firms’ organizational rents. 9 Bucovetsky and Haufler (2008) model capital tax competition when firms can endogenously choose their organizational structure and governments can commit to long-run tax discrimination between multinational and domestic firms. While granting tax breaks to multinationals softens tax rate competition, it also provides incentives for firms to choose a multinational structure with the aim of enjoying tax savings. Interestingly, a small coordinated increase in the tax preferences in favor of mobile firms may relax tax rate competition, thereby increasing global welfare. A different line of research focuses on competition for firms and for taxable profits at the sub-national level. Pinto (2007) analyses strategic manipulation of Formula Appointment by regions facing a multi-regional firm (when the multi-regional structure of the firm is given). Mintz and Smart (2004) also put forward a theoretical model to motivate their empirical analysis on profit shifting across Canadian provinces. Riedel and Runkel (2007) model the co-existence between two regions that impose Formula Appointment as an accounting system on multi-regional firms and a third one under Separate Accounting. It should be noted, however, that most of the insights of these papers are valid for both multi-regional and multinational firms (and the same is true of papers whose primary focus is on multinationals). In this paper, we study the interaction between the proximity-concentration trade-off and fiscal motivations when the possibility of profit shifting is explicitly taken into account. Differently from Behrens and Picard (2008), we take into consideration asymmetric market size and profit shifting, and we model an optimal tax avoidance decision by a multi-regional firm, unlike Bucovetsky and Haufler (2008). In addition, while the focus of the latter is on the tax breaks versus fixed costs trade-off for the firm, we do consider both trade costs and tax savings stemming from serving the distant market locally. Our tax policies are, however, taken as exogenous for most of the analysis, while both Behrens and Picard, 2008 and Bucovetsky and Haufler, 2008 endogenize fiscal policy decisions. Our theoretical set-up is based on the literature about policy competition for multi-plant firms under imperfectly competitive markets, region-size asymmetries and trade costs.10 We model two regions of asymmetric market size who levy corporate taxes on the profits generated within their borders and allow the firm to partially deduct its investment (fixed) costs from the corporate tax base. A monopolist must decide on whether to serve the two markets locally, i.e., with two local production plants (a multi-regional structure) or to set a production plant in one market and serve the other one through exports (an exporter structure). 11 The trade-offs faced by the firm are twofold. On the (technological) cost side, building a second production plant entails a fixed set-up cost, while serving the distant market through exports involves positive trade costs. On the fiscal side, an exporter pays taxes on its overall profits just in the region where it produces, while a multi-regional firm pays taxes to different jurisdictions, which possibly levy unequal tax rates. Hence, becoming multi-regional allows the firm to shift taxable profits – at some cost – to the low-tax region. In spite of that, being an exporter from the low-tax region may represent an indirect way of minimizing tax liabilities on overall profits. In such a framework, we characterize and analyze how the firm’s location–organization choice depends on the tax rates set by the two regions, on market size asymmetry and on the ability to shift profits. We further show that granting more profit-shifting opportunities to the firm – i.e., by lowering the intensity of tax auditing – may be total-welfare improving. Finally, we briefly look at strategic tax setting. The remainder of the paper is organized as follows. Section 2 presents the model. Section 3 looks at the monopolist’s location–organization choice under asymmetric taxation and the possibility of profit shifting. In Section 4, we investigate the desirability of profit shifting from the total-welfare viewpoint. In Section 5, we discuss tax competition between the two regions in a special case. Section 6 concludes.

This paper augments the standard proximity-concentration trade-off set-up by introducing market size asymmetry and fiscal considerations. We show that taking into account taxes and profit shifting changes the proximity-concentration trade-off non-trivially, depending on both the average tax rate and the tax difference. Higher average taxes make it less likely that a firm operates as a multi-regional one. The impact of tax differentials depends on whether the second production plant is fiscally-advantageous, i.e., in the low-tax region, or fiscally-disadvantageous, i.e., in the high-tax region. When the first production plant is located in the high-tax region, we say that the second plant is fiscally-advantageous and larger tax differences induce the firm to prefer a double-plant structure. This can only happen when the big region is also the high-tax one and can illustrate a firm located in the (high-tax) European core regions considering whether to open a second plant in the (low-tax) periphery. On the contrary, when the firm locates its first plant in the low-tax region, larger tax differences can decrease the relative profitability of operating as a double-plant. Moreover, in contrast to a standard result of the literature, we find that increased market size asymmetry may make it more likely that the firm chooses a multi-regional structure. We also look at the impact of profit shifting on the firm’s location–organization decision. Not surprisingly, the gain to open the second production plant is always increasing in the ability to shift profits. We then use this fact to analyze the desirability from a total-welfare viewpoint of implementing a stricter tax auditing policy. When the double-plant structure is given, it is optimal to make profit shifting as expensive as possible in order to minimize the cost incurred by the firm for this activity. By contrast, the opposite may occur when the firm’s location–organization choice is endogenous. In this case, the two regions may raise total welfare by giving the firm more latitude to shift profits when the net profit-maximizing choice is the single-plant one and welfare maximization would require the firm to go double-plant. Finally, we undertake a preliminary analysis of tax competition in our setting in a case when the second production plant does not entail any fixed costs, so that it is always desirable, from a total-welfare viewpoint, to open the second production plant. Interestingly, while under exogenous taxes it may happen that the firm chooses the single-plant structure, strategic tax choice by the two regions leads to the optimal firm’s organization choice. We conclude with some remarks on possible extensions. Firstly, all our results hold with a non-linear market demand, as long as the ranking of before-tax profits between local sales and exports are kept. Moreover, the cost of profit shifting can be generalized to any convex function. The crucial feature is that it generates a gain from profit shifting which is increasing and convex in the tax difference. The most crucial step in terms of future research is to go further in the analysis of tax setting by the two regions. This exercise proves difficult due to the non-linearities induced by the profit shifting possibilities. Hopefully, this will shed further light on the welfare impact of such policies and on the effectiveness of some forms of tax harmonization and/or coordination between regions.