No. 80: Do personal income taxes affect corporate tax–motivated profit shifting?

Abstract

This paper examines the role of personal income taxes in multinationals’ corporate tax–induced profit shifting. As required by corporate tax rules in most countries, firms need economic substance in low–corporate tax countries to justify profit shifting to these countries. Because higher personal income taxes increase the cost of labor and thus the cost of providing economic substance, we argue that personal income taxes can mute corporate tax–induced profit shifting. Using data on personal and corporate income taxes from 26 European countries, we find that personal income taxes substantially mute profit shifting to low–corporate tax countries. This effect is stronger if the parent country has strict economic substance requirements to curb tax avoidance. Our results show important interactions between personal and corporate income taxes that shape multinationals’ profit-shifting decisions.