Abstract: We develop a framework to study the macroeconomic implications of taxing multinational enterprises (MNEs) that shift profits to subsidiaries in low-tax jurisdictions by transferring ownership of non-rival intangible capital. We first prove analytically that profit shifting increases intangible investment, leading to higher profits and output at the MNE level. We then calibrate our model so that it reproduces salient country-level facts about production, trade, FDI, and, most importantly, profit shifting. We use our calibrated model to evaluate the consequences of two proposals by the OECD and G20 governments to reduce profit shifting by MNEs: allocating the rights to tax some of an MNE's profits to the countries in which it sells its products; and a 15% minimum global corporate income tax. We show that these policies would reduce profit shifting by more than two-thirds, but would also reduce intangible investment and output in high-tax regions. This highlights a key tension for policymakers: profit shifting erodes high-tax countries' tax bases, but also boosts economic activity, and thus policies that reduce profit shifting have harmful macroeconomic side effects.
Keywords: Multinational enterprise; transfer pricing; profit shifting; base erosion; intangible capital; corporate tax
JEL Classification: E6; F23; H25; H27