The Effects of Multinationals’ Profit ShiftingActivities on Real Investments

This paper investigates whether the size of multinationals’ real investments ina high-tax country is affected by profit shifting activities. A simple theoretical analysisshows that tax rates abroad impact the cost of capital in the presence of profit shiftingactivities of multinational companies. As profit shifting opportunities constitute a competitiveadvantage, the respective size of investments should theoretically increase if profitscan be shifted to a lower taxing country. An empirical analysis, based on a panel of Germaninbound investments, confirms a positive tax response of real investments with a decreasingtax rate at the foreign direct investor’s home country. Hence, the results suggest thatthe size of foreign investments in a high-tax country is positively affected by lower foreigntaxation of shifted profits.