draining development.pdf - Khazar University

Tax Evasion and Tax Avoidance: The Role of International Profit Sharing 117Third, the results are difficult to interpret because the counterfactualis not clear. Assume that, in one period, there is only one transaction inthe upper quartile price range and only one transaction in the lowerquartile price range. All other transactions are priced below the upperquartile price and above the lower quartile price. In this case, the counterfactual,which is a hypothetical situation without mispricing, shouldbe that the two mispriced transactions disappear or their prices areadjusted to within the inner quartile price range. But now assume that,in the next period, the two transactions identified as mispriced in thefirst period take place at corrected prices, which are between the upperand lower quartile prices identified for the preceding period; everythingelse remains the same. In this case, the quartile price ranges for the secondperiod would change, and transactions that were not identified asmispriced in the previous period are now identified as mispriced. Thisinconsistency occurs because there is no well-defined counterfactual.Fourth, the price filter method, by construction, identifies overpricedand underpriced transactions, so that it always identifies income shiftingin two directions: into and out of the country under consideration. Yet,many studies using the approach only report income shifting in onedirection and ignore income shifting in the other direction. For instance,Pak (2007) reports underpriced imports into the United States and overpricedU.S. exports, but overpriced imports and underpriced exports(both of which would shift income out of the United States) are neglected.A similar approach is used by Christian Aid (2009) and other studies.The restriction to one direction in income shifting leads to highlymisleading results if the findings are used to estimate the impact ofincome shifting on corporate income tax revenue collected by a particularcountry or group of countries such as in Christian Aid (2008, 2009).A meaningful estimate of the tax revenue effects would have to take intoaccount profit shifting in both directions. Consider the following simpleexample.Assume that there are three exporters of a good in country A. Firm 1exports the good at a price of 4; firm 2 exports the good at a price of 8;and firm 3 exports the good at a price of 12. The mispricing approachwould identify the transaction at a price of 4 as underpriced and thetransaction at a price of 12 as overpriced. Assume, further, that all firmshave costs of 4 in country A that are deductible from the profit tax base