The Tax Responsiveness of Investment under Increasing Opportunities for Income Shifting. An Analysis of the European Context

Abstract

Empirical literature suggests that the separate accounting system in Europe promotes cross-border profit shifting. A common tax system is under discussion, which would have the merit of making current tax avoidance strategies obsolete. In the present research, we assess the extent to which investment responsiveness to corporate taxation is inversely associated with cross-border profit shifting activities in order to shed light on whether lowering financial tax planning activities can be expected to cause additional tax distortions of foreign real investment. Using a firm-level dataset for the period 2001–2009, the results suggest that greater ability to shift profits out of highertax countries is associated with less investment response to the host country’s corporate taxation. Furthermore, investment sensitivity to taxation in the case of firms with greater incentives to relocate profits appears to be lower when compared to those companies with fewer incentives to do so.