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voxeu.org/article/tax-bargaining

The OECD estimates that more than $100 billon is lost each year to tax avoidance by
MNEs. One way that firms do this is by using their size and mobility to bargain for tax
breaks. This column uses French data to identify the nature of such bargaining. It finds
that the scale of the projected tax payment accounts for 41% of the tax break, and a
credible threat to relocate accounts for the rest.

If big companies are outed as paying little or no corporate tax, the public outcry is loud
and angry. When, in 2014, the EU opened an investigation into Apple and its Irish
subsidiary, the public was shocked to find out that the Irish government had issued two
tax rulings to help the company save more than €13 billion in corporate tax. The OECD
estimates that between 4% and 10% of global corporate tax revenues, or between $100
billon and $240 billion, is lost each year due to tax avoidance.

News like this feeds the public opinion that multinational firms (MNEs) do not pay their
fair share in taxes. According to a survey by the Pew Research Center (2017), more than
50% of Americans believe that large or multinational companies ought to pay more tax.

In contrast to small and medium-sized firms that operate in one country only, MNEs are
able to reduce their tax burden in three ways:

1. Profit-shifting. Foreign affiliates enable MNEs to shift profits abroad, out of high-
tax jurisdictions.
2. A credible threat to relocate. The operation of foreign subsidiaries signals a
higher degree of footlooseness than comparable domestic-only operating firms.
This gives MNEs better bargaining opportunities than domestic firms when they
negotiate with national government.
3. Size mattering. The larger economic size of MNEs relative to domestic firms
increases that bargaining power.

All three aspects could lead to much smaller tax rates on corporate profits for MNEs than
for comparable domestic firms.

Bargaining to reduce tax

To illustrate the difference in tax rates between MNEs and firms without foreign
affiliates, Figure 1 shows the average effective tax rate (ETR), for firm types in France
between 2007 and 2012. The ETR is actual tax payments relative to pre-tax profits.
Domestic firms are separated into single-entity (parent-only) and multi-entity (parent-
plus-affiliates).

Figure 1 Average effective tax rate per firm type in France, 2007 to 2012

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Source: Orbis database.

The figure suggests that between 2007 and 2012, on average, MNE tax rates in France
were 3.5 percentage points lower than those of multi-entity domestic firms and 4.2
percentage points lower than those of single-entity domestic firms, for the three reasons
mentioned above.

Well-known profit-shifting channels such as transfer pricing, debt-shifting, or patent-

shifting with approximated royalty payments have been identified and addressed by the
coordinated actions of international organisations. We focus on a different channel,
related to points 2 and 3 above, namely, bargaining between local tax authorities and
firms. Firms are able to negotiate deductions with local tax authorities that would reduce
their tax burden. Advanced tax rulings are an important tool in this bargaining process.
They allow firms to contact tax authorities and discuss deductions if they were to make
an investment, and the tax authority issues a binding advanced ruling for the company
as part of the bargaining process. Nearly all European countries and the US use these
advanced tax rulings.

Some countries consider individualised tax breaks and special deductions to be valuable
instrument of industrial policy (Economist 2018). But these bargaining opportunities, and
the tailor-made tax breaks they imply, undermine the coordinated actions of the EU, the
OECD, and the G20 towards establishing a fair system of taxation within and across
countries.

The Irish Apple case is a well-documented example. In 1991 and 2007, the Irish Revenue
Commission issued two rulings that allowed the use of two branches of the same firm to
deal with Irish double taxation. This ultimately allowed Apple to shield €100 billion in

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profits from other tax authorities. Other US multinationals such as Google and Pfizer
were not able to use these rulings.

The size of the bargaining effect

In a recent paper, we argue that bargaining between firms and local tax authorities is an
important factor in explaining the lower ETRs of MNEs (Egger et al. 2018). MNEs are
favoured in two ways:

The sum is still large. MNEs are, on average, bigger and more profitable than
domestic firms. This makes them more valuable for tax authorities and, as in the
case with Apple in Ireland, tax authorities are willing to cut better deals with bigger
firms. Although the effective tax rate the firm faces is lower, the absolute overall
benefit to the country (including revenues from the affected tax bases, such as
personal income tax revenues of the firm’s workers) are still large and positive for
the tax authorities. Clearly, the tax difference between MNEs and domestic firms
flowing from this argument has nothing to do with foreign affiliates per se but only
with the size of MNEs.
MNEs are more mobile. Hence, threats that they will relocate their activities
abroad and away from high taxes are more credible. This greater threat potential
relative to domestic firms – even ones of comparable size – may also force tax
authorities to make greater concessions. This threat is obviously only relevant for
MNEs and cannot be exploited by comparable domestic firms.

Empirically, it is hard to disentangle profit-shifting from bargaining as contributors to the

tax gap between MNEs and domestic firms. We control for profit-shifting to
quantitatively isolate the bargaining aspect of the tax gap, and to disentangle the effect
of firm size from the effect of firm footlooseness. We find that MNEs in France have an
effective corporate tax rate that is more than 6 percentage points lower than
comparable domestic firms after profit-shifting.

Specifically, the size effect leads to a downward-sloping ETR schedule, meaning that
corporate profits for firms with larger pre-tax profits have lower effective tax rates.
Figure 2 shows the estimated ETR schedules for French MNEs (the red line) and French
domestic firms (blue line).

Figure 2 Estimated effective tax rates based on an unweighted regression

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Source: Orbis
database and
authors' own
calculations.

Obviously,
corporate
profit taxes in
France
decline with
the size of
overall
profits. This is
the case for
both MNEs
and domestic
firms,
pointing to a
regressive
size effect
that is
independent
of the firm
type. It is
bigger for
MNEs
because they
are, on average, larger than domestic firms.

The vertical distance between the two ETR schedules for MNEs and domestic firms
indicates the tax savings due to the greater mobility of MNEs, given identical pre-tax
profits to domestic firms. Both domestic firms and MNEs appear to bargain lower
corporate tax rates with the French authorities when they are larger (have higher pre-tax
profits), but MNEs are comparably more successful than domestic firms in doing so due
to a more credible threat to relocate.

On average, the bargaining-related size effect of MNEs in France accounts for 41% of the
overall 6 percentage point tax gap, while the rest was due to their more credible
footlooseness. We show that the better bargaining position leads to annual tax savings
of, on average, €20,000. Given that France has around 3.5 million firms, and about 0.5%
of them are multinationals (Egger et al. 2018), this means it loses more than €360 million
each year due to the bargaining power of these 17,500 French and foreign-owned
MNEs.1

References
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Egger, P H, N M Strecker, and B Zoller-Rydzek (2018), “Estimating Bargaining-related Tax
Advantages of Multinational Firms”, CEPR Discussion Paper 13143.

Egger, P H, R Riezmann, and B Zoller-Rydzek (2018), “Multi-Unit Firms and Their Scope
and Location Decision”, mimeo.

Pew Research Center (2017), "Summer 2017 Political Landscape Re-Interview Survey –
Final Topline", 15-21 August.

The Economist (2018), “African governments let too many taxpayers off the hook”, 18
August.

Endnotes

[1] This back-of-the-envelope calculation is based on the empirical findings in Egger et al.
(2018). It does not consider non-linear effects and disregards the biggest MNEs in France.

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