Corporate Tax Systems, Multinational Enterprises and Economic Integration

This paper addresses the outcome of international tax competition in the presence of multinationals that use transfer pricing for strategic purposes as well as to reduce their tax burden. We examine how economic integration affects tax levels, transfer pricing behaviour and national welfare. We show that the tax elasticity of the transfer price depends on the tax system and on the extent of economic integration. Under separate accounting the conventional wisdom that increased economic integration forces governments to reduce tax rates is supported by our findings. However, this is not true under formula apportionment, where increased integration reduces the tax elasticity to the transfer prices and indeed allows governments to levy higher tax rates.