Bilicka Presents Organizational Capacity And Profit Shifting Today At UCLA

Katarzyna Anna Bilicka (Utah State; Google Scholar) presents Organizational Capacity and Profit Shifting (with Daniela Scur (Cornell; Google Scholar)) at UCLA today as part of its Colloquium on Tax Policy and Public Finance hosted by Kirk Stark and Jason Oh: 

Good organizational capacity drives productivity and potential taxable profits, but may also enable multinationals (MNEs) to more efficiently re allocate profits across tax jurisdictions, lowering actual taxable profits. We show that MNE subsidiaries with better organizational capacity report significantly lower profits and have a higher incidence of bunching around zero reported profitability in high-tax countries. This pattern is not present in low-tax countries. Further, responsiveness to corporate tax rate changes in terms of profit reporting is driven by firms with good organizational capacity. We show our results are consistent with profit-shifting behavior and rule out key alternative channels. JEL codes: M11, M02, H26, H32.

Conclusion
We show that the previously established link between organizational capacity and profitability has an important caveat: for multinationals, it only holds in low-tax countries. We document new patterns of reported profitability across countries taking into account heterogeneity in the quality of management of MNE subsidiaries, and propose that these patterns can be best attributed to profit shifting activities for those MNEs that can be classified as aggressive tax avoiders. We find that practices related to tractable and predictable production and MNE-aligned incentives are most likely to enable such actions. We rule out alternative explanations such as “real” performance differences, differential take-up of local tax incentives, the quality of information environment, or individual manager quality.

Our results have important implications for how we understand the relationship between management and firm performance, as well as how heterogeneity in firm management quality can mediate the effectiveness of tax policy. First, while better subsidiary management may increase firm productivity and “real” profitability, it also seems to reduce reported profitability in high-tax countries. Lower reported profits can lead to lower corporate tax revenues, having potentially important welfare implications. Second, the landscape of firm organizational capacity may significantly impact the effectiveness of national tax cuts, as we find the firms that respond to such cuts tend to be those that are well-managed. Further, total factor productivity estimations require accurate reporting of inputs such as materials and capital. If multinationals are systematically mis-reporting such inputs as a result of profit shifting activities this could have important implications for productivity estimates of this group of firms across jurisdictions with different tax rates. Finally, the results presented in this paper are likely to be lower bound estimates of how large the effect of management is for profit shifting, since profits reported by firms are generally different between tax returns and accounting statements (Bilicka; 2019). Further exploration of the “real” impacts of profit shifting and the local-level determinants of implementation capacity are fruitful areas of further research.