The Optimal Design of Transfer Pricing Rules: A Non-Cooperative Analysis

The literature on the regulation of multinationals' transfer prices has not considered the possibility that governments choose their transfer pricing rules in a non-cooperative fashion. The present paper fills this gap and shows that a non-cooperative equilibrium is characterized by above-optimal levels of effective taxation in comparison with a cooperative solution. We also derive conditions under which harmonization of transfer pricing rules lead to a Pareto improvement, and show that harmonization according to the 'arm's length' principle is not Pareto improving relative to the non-cooperative outcome.