A Transaction Cost Model of Tax-Motivated Income Shifting into Dot-Sized Tax Havens and an Empirical Examination of E-Commerce Effects

Abstract

ABSTRACT Our paper develops a new transaction cost model of tax-motivated income shifting. We analytically show that income shifted by U.S. multinational parent corporations into their tax haven subsidiaries differs from predictions based only on tax rate differences because of the transaction costs of shifting income into tax haven subsidiaries. Our model predicts that e-commerce facilitates greater income shifting by lowering the transaction costs of income-shifting operations, which theoretically supports our focus on actual income shifting instead of the traditional focus on effective tax rates alone. Empirically, we find that greater numbers of multinational corporations’ dot-sized tax havens significantly increase profits shifted out of their U.S. parent corporations and also show with a separate estimation that this amount is similar to amounts shifted into their tax haven subsidiaries, consistent with income shifting being a zero-sum strategy. This novel approach documents income shifting materially increasing with e-commerce activities that lower transaction costs. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: H26; L81; F38; M48.