draining development.pdf - Khazar University

Tax Evasion and Tax Avoidance: The Role of International Profit Sharing 121base will be 20 percent of this investment because interest is deductiblefrom the tax base.Second, one should note that this type of analysis is purely descriptiveand does not investigate the factors driving profit shifting. Thus, existingtax gap estimates do not help to explain why multinational firms mayhave an incentive to transfer profits out of developing economies. Taxationmay not be the main factor that causes income shifting out of thedeveloping world. Other factors such as the threat of expropriation orconfiscation of private property, economic and political uncertainty, fiscaldeficits, financial repression, or devaluation may be the real drivingforces, as pointed out by, for example, de Boyrie, Pak, and Zdanowicz(2005). The implementation of effective policy measures against profitshifting from developing countries requires knowledge about the mainmotivations and incentives behind this type of activity and is thus animportant topic for future research.As mentioned above, there is a growing literature that investigates therole played by taxation as a factor driving income shifting. Unfortunately,most of this work focuses on OECD countries, rather than developingcountries.Grubert and Mutti (1991) analyze profit shifting among U.S. multinationalfirms and use a data set that includes developed and developingcountries. They show that firms systematically report higher taxableprofits in countries with lower tax rates. In their analysis, firms in countrieswith a tax rate of 40 percent would report an average ratio of pretaxprofit and sales of 9.3 percent, whereas firms in countries with a tax rateof 20 percent would report a profit and sales ratio of almost 15.8 percent.This suggests that some profit shifting that is motivated by taxation doesoccur.Azémar (2008) investigates how the effectiveness of law enforcementaffects profit shifting. Interacting a summary measure of law enforcementquality and tax profit ratios of firms in her regressions, she findsthat a low quality in law enforcement accompanies a high sensitivity intax payments to corporate tax rates. Her interpretation of this observationis that countries with ineffective law enforcement face greater difficultiesin efficiently implementing anti–tax avoidance measures such asthin capitalization rules or transfer pricing corrections. This suggests