sign in sign up
<<
Home , Corporate tax, Financial Secrecy Index, Tax, Tax haven, Tax rate, Tax treaty

VOLUME 1 NO 1 | OKTOBER 2019 ISSN 2686-5718

DOES FINANCIAL SECRECY AFFECT PROFIT SHIFTING?

I Wayan Agus Eka Direktorat Jenderal Pajak. Email: [email protected]

ABSTRACT Global efforts to increase financial transparency have been made throughout the last decade. Nevertheless, profit shifting among Multinational Companies still become a crucial issue worldwide. This study investigated whether financial secrecy is one of the determinants of profit shifting that has been overlooked in previous profit shifting studies. Using multiple regression analysis, I concluded that financial secrecy negatively affects profit shifting, meaning an increased transparency will induce to shift profit out of the country since ending secrecy equals higher risk for the evaders. The finding implies two important recommendations: first, to continue the global efforts to promote financial information exchange for tax purposes and second, to strengthen domestic anti-profit shifting regulations. Keywords: financial secrecy, financial transparency, banking secrecy, profit shifting, exchange of informa- tion.

ABSTRAK Inisiatif global untuk meningkatkan transparansi telah dilakukan dalam satu dekade belakangan ini. Di sisi lain, pengalihan laba oleh perusahaan multinasional tetap menjadi isu penting. Penelitian ini menginvestigasi apakah kerahasiaan data keuangan merupakan salah satu variabel determinan dari pengalihan laba yang selama ini belum pernah diperhitungkan dalam penelitian-penelitian sebelumnya. Menggunakan analisis regresi berganda, penelitian ini menyimpulkan bahwa kerahasiaan data keuangan secara negatif memengaruhi pengalihan laba, yang berarti bahwa peningkatan transparansi memberikan insentif kepada Wajib Pajak untuk mengalihkan laba ke luar suatu negara karena peningkatan risiko yang dialami para Wajib Pajak. Penelitian ini menghasilkan dua rekomendasi: pertama, usaha untuk mewujudkan pertukaran informasi keuangan secara menyeluruh harus tetap dilanjutkan dan kedua, diperlukan penguatan peraturan untuk mencegah dan mengatasi pengalihan laba.

27 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

1. INTRODUCTION A better understanding of profit shifting cannot be separated from the study of tax Over the last decade, taxation has havens. One of its characteristics is finan- become a major issue for top political cial secrecy. Jansky and Prats (2015) leaders. They have started to realize the argued that there are two main reasons importance of raising to why tax havens play an important role in sustainable developments. profit shifting: (i) low or nil and (ii) Taxation has also become a mandatory secrecy provision (banking secrecy, lack of agenda in global economic forums in exchange of tax information, etc.). Johan- the midst of economic uncertainty and nesen and Zucman (2014) also found that wars. the end of Swiss secrecy through a Since tax revenue has become amendment with results the major revenue source after the in a roughly 11% decline in the Swiss declining of , every deposits held by French residents. OECD nation has an to protect its tax (1998) report emphasizes that defining tax base. It is not an easy job since 30% of haven is not only from a tax perspective, the international transactions involve but also stress on the lack of exchange of affiliated multinational information and transparency. (MNCs) that raise the concern of profit , offshore financial center shifting (United Nation, 2017). /O- and secrecy jurisdiction are usually used ECD countries then took an initiative to interchangeably to describe a country that curb the base erosion and profit shifting induces profit shifting. However, the known as BEPS Action Plan (OECD, unclear and disagreement on tax haven 2015). and offshore financial center definition There is no precise number of contributed to the weakness in analyses how much the tax revenue is lost to (Cobham, Jansky & Meinzer, 2015). The profit shifting. OECD estimated the last term, secrecy jurisdiction, was promot- revenue loss at 4%-10% of the corpo- ed by Murphy (2008). He defined the rate tax revenue or USD100-240billion secrecy jurisdiction as a jurisdiction which at 2014 levels (OECD, 2015a). Among all provides facilities that enable people or countries, non-OECD countries (which entities escape or undermine the , are commonly developing countries) rules and regulations of other jurisdictions bear more costs from profit shifting elsewhere, using secrecy as a prime tool than developed countries (Crivelli, de (Murphy, 2008). Mooij & Keen, 2015). Clausing (2016) In connection with profit shifting, estimated that profit shifting is costing there are relatively more studies that use roughly between $77billion to $111bil- tax haven and offshore financial center lion of 2012 US tax revenue. Further- terms than secrecy jurisdiction. Two nota- more, the most recent research from ble studies, Hines and Rice (1994) and Torslov, Wier, and Zucman (2018) Johannesen and Zucman (2014), study estimated that 40% of MNCs profits are how tax haven affect US firms’ foreign shifted to low-tax countries each year. activities.

28 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

By contrast, several other research 2. LITERATURE REVIEW explores the roles of offshore financial 2.1 Profit Shifting center (Picard & Pieretti, 2011; Foad & Lundberg, 2017; Chernykh & Mityakov, There are several definitions of profit shift- 2017). ing. OECD (2018) defines profit shifting as Empirical studies on profit shift- allocation of income and expenses ing mostly concentrated on how the between related corporations or branches profit shifting was affected by tax rate of the same legal entity (e.g., by using differential, commonly called as the ) in order to reduce the semi- of profit shifting. Hines overall tax liability of the group or corpo- and Rice (1994), the pioneers of this ration. Similar objective is expressed by study, estimated the semi-elasticity of Huizinga and Laeven (2008) where profit 2.3, meaning a reduction in the tax rate shifting should reduce MNC profits by one percentage point will increase reported in high-tax countries. the reported profit by 2.3%. Dozens of There are two main ways to shift similar studies then followed Hines and profit: transfer pricing and financing struc- Rice. In the latest study by Beer, de ture (Maffini & Mokkas, 2011; Buettner, Mooij and Liu (2018) who reviewed all of Overesch & Wamser, 2017). Another way these empirical studies, it was found involves treaty shopping and strategic that one percentage point reduction in location of intellectual (Beer et the tax rate increases the before tax al., 2018). profit by 1.5%. Transfer pricing is a neutral term. It In addition to the aforemen- is defined as a set by a tioned, empirical research studying the when selling to, buying from, or sharing connection between financial secrecy resource with a related person (Arnold & and profit shifting is still not well-devel- McIntyre, 2002). To minimize taxable oped in the literature. The study by profit, MNCs locating in high-tax country Akhtar, Akhtar, John and Wong (2017) will overstate the price and/or might be the closest one, as they inves- understate its price (Huizinga & tigated whether Laeven, 2008). Moreover, transfer pricing affects the probability of tax . is considered the dominant profit shifting This paper tries to fill the gap in the channel based on meta-database analysis literature by empirically studying the from 27 empirical studies (Heckemeyer & impact of the financial secrecy on profit Overesch, 2017). shifting. This paper also contributes to In the context of financing struc- the literature since it tries to extend the ture, reducing tax burden can be achieved determinants of profit shifting by by imposing high to affiliated including secrecy issue that was over- company located in high tax country looked in the previous research. (Huizinga & Laeven, 2008). The main reason is that interest is deductible mean- while are not deductible hence

29 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

financing is considered more fixed effect. Dharmapala and Riedel (2013) effective than financing (Arnold found that parents’ positive earning & McIntyre, 2002). shocks are associated with a significantly positive increase in pretax profits at 2.2 Determinant of Profit Shifting low-tax affiliates, relative to the effect on the pretax profits of high-tax affiliates. Most of the empirical research in profit In addition to the tax differential as shifting regards tax rate as the main one of the main important variables, the profit shifting determinant since the study about profit shifting cannot be sep- potential tax savings rely on the differ- arated from the existence of tax havens. In ence in the rate. Grubert principle, tax haven is a location with a and Mutti (1991) and Hines and Rice very low tax rate and other tax-favorable (1994) are considered the pioneers in characteristics to attract foreign direct empirical profit shifting study. Their investment (Dharmapala & Hines, 2009). papers used cross-sectional regression Dyreng and Lindsey (2009) studied how analysis for 1982 country-level data, tax haven affect tax burden of US multina- resulted in similar finding that tax nega- tionals. They found that tax burden of US tively affects reported profit; indicating firms with tax haven operation was 1.5 the existence of profit shifting. percentage point lower than other firms. Another well-cited profit shifting In relation to tax haven, several literature was written by Huizinga and other studies found that low-tax was not Laeven (2008) which extended Hines the only factor contributing to the exis- and Rice (1994) work. For the tax vari- tence of tax haven. Mara (2015) found that able, Huizinga and Laeven (2008) build tax havens are associated with countries a composite index consisting not only which GDPs are significantly made up of the tax rate difference, but also other services. Hansen and Kessler (2001) stud- incentives to shift the profit. Unlike ied the link between tax haven and geo- Hines and Rice (1994), Huizinga and graphical factors. They argued that small Laeven used micro level data (compa- countries have a possibility to become tax ny-level data) for the year 1999. The havens since the could sepa- finding, however, was relatively consis- rate between wealthy and poor tent with previous study in that an due to limitation of land. increase in (the tax rate Perhaps the most widely cited liter- difference) will significantly increase the ature on non-tax characteristics of tax profit shifting. haven is a study conducted by Dharmapa- Another study that uses compa- la and Hines (2009). They focus on study- ny-level data was carried out by Dhar- ing tax haven characteristics other than mapala and Riedel (2013). This paper the tax rate using the cross-sectional data did not only offer new way to measure for the year 2004. The study used the tax profit shifting, but also used firm level haven list defined by Hines and Rice panel data, enabling the author to con- (1994). For the explanatory variable, the trol firm-level characteristic and year paper used the country-level governance

30 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

index constructed by Kaufmann, Kraay, connection with tax haven. Dharmapala and Mastruzzi (2005). Other indepen- and Hines (2009) study the components dent variables include GDP per capita, that makes up a tax haven. As the depen- population, openness variable, and dent variable, they used the tax haven list other geographical variables. The paper defined by Hines and Rice (1994). For found that tax havens are small coun- independent variables, they used both tries with high-quality governance. The economic indicators such as the GDP per finding also explains why low-level gov- capita and geographical indicators such as ernance countries will never be a tax population and area. With regard to trans- haven. parency in this paper, Dharmapala and Hines (2009) used the governance index 2.3 Secrecy and Profit Shifting from Kaufmann et al. (2005). The gover- nance index is constructed from six differ- In addition to tax haven, literatures also ent elements: voice and , commonly used two similar terms: political stability, effective- offshore financial center and secrecy ness, regulatory quality, rule of , and jurisdiction. While tax haven determina- control of . Using cross-section- tion is closely connected with country al regression, the study shows that the with no or nominal tax (OECD, 1998), level of governance has a positive and offshore financial center is indicated by significant impact on the probability of provision of intermediation services for being a tax haven. larger neighboring countries (Rose & Akhtar et al. (2017) study whether Siegel, 2007). Secrecy jurisdiction, on governance level contributes to the likeli- the other hand, relates to the legislative hood of MNCs committing . provision of financial secrecy to those The use of the governance variable (both who are physically resident elsewhere micro and country level) in Akhtar et al. (Cobham, Jansky & Meinzer, 2015). Even (2017), to some extent, is similar to this though those terms provide different study that uses financial secrecy as a vari- emphases, they offer similar character- able of interest. In addition, Akhtar et al. istic: financial secrecy. The level of secre- (2017) investigate if the probability of con- cy in the financial institution of a partic- ducting tax evasion was caused by the ular jurisdiction is one of the main prop- level of governance. This purpose is erties of tax haven, offshore financial somewhat similar to this paper, which tries center as well as secrecy jurisdiction. to study the level of financial secrecy as Therefore, this paper will use financial one of the profit shifting determinants. secrecy as the main variable of interest. Low-level of financial secrecy Literature that discussed the means that the tax authority in that juris- direct connection between financial diction has a relatively higher access to secrecy and profit shifting is limited. financial data compared to those in Most of them examined financial jurisdictions with high-level financial secrecy (or governance index) in secrecy.

31 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

That is why I presume that MNCs locat- (, 2015). Conversely, ed in jurisdictions with low-level of low score means that the jurisdiction is financial secrecy have the incentive to more transparent and there is a higher shift their profit to other jurisdictions compliance in information exchange. with higher level of secrecy. The secrecy score is a qualitative measure looking at a jurisdiction’s laws 3. DATA AND METHODOLOGY and regulation, international treaties and so on. It was constructed based on 15 key financial secrecy indicators. Among these Empirical research in profit shifting usu- indicators, several important ones are ally uses the -based profit as related to , country-by-coun- the dependent variable. Hines and Rice try reporting, tax administration efficiency, (1994) used the pre-tax non-financial tax treaty, and automatic exchange of income meanwhile Huizinga and information (Tax Justice Network, 2015). Laeven (2008) used the earnings before Therefore, secrecy score should be able to interest and tax as the dependent vari- represent the level of transparency of a able. This paper, however, will use the particular jurisdiction. illicit financial outflows data provided by The control variables used in this Global Financial Integrity. The main analysis include, among others, the logs of reason is that the illicit financial outflows GDP per capita obtained from the World data was constructed primarily based Bank’s World Development Indicators on trade misinvoicing (Global Financial database. This variable is also used by Integrity, 2017). Therefore, I argue that Baumann, Buchwald, Friehe, Hottenrott the illicit financial outflows data is able and Weche (2016). This paper also con- to become a proxy for profit shifting trols countries governance institution since fraudulent misinvoicing is the represented by the Government Effective- main tool in transfer pricing abuse. ness Index provided by The Worldwide The main purpose of this paper Governance Indicators. The Government is to study empirically whether the level Effectiveness Index reflects the percep- of transparency induces profit shifting. tions of the quality of public services, the Transparency is the common character- quality of the civil service and the degree istic that can be found in three following of its independence from political pres- terms: tax haven, offshore financial sures, the quality of policy formulation and center, and secrecy jurisdiction. As an implementation, and the credibility of the indicator of transparency, I use secrecy government's commitment to such poli- score provided by Tax Justice Network. cies. The index takes values from -2.5 to Secrecy score ranges from 0 to 100. 2.5, in which higher value indicates better High score means that the jurisdiction effectiveness. lacks transparency, is unwilling to This paper also aims to provide engage in information exchange and is information about the semi-elasticity of less compliant with international tax rate to profit shifting. Therefore, I also norm to combat -laundering include tax rate as one of the control

32 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

variables. The tax rate data is provided Robustness Check by KPMG. I also include two country char- For robustness check I changed two vari- acteristic variables: development/high ables in the baseline specification. First, for income and tax haven status. I use the dependent variable I used the amount of binary variable representing developed illicit outflow from trade misinvoicing data (value as 1) and developing countries provided by Global Financial Integrity. This (value as 0). Countries categorized as variable measures the fraudulent manipu- high-income countries based on The lation of the price, quantity, or quality of a classification are considered good or service on an invoice allowing tax developed countries. From this binary evaders to shift profit across international variable, I would like to know whether borders (Global Financial Integrity, 2017). there is significant difference in profit Second, I replaced the government effec- shifting between those high-income tiveness to government quality index pro- and non-high-income countries. vided by The Worldwide Governance Indi- It is also interesting to know cators. The government quality index whether profit shifting is different reflects the perceptions of the ability of the between tax haven and non-tax haven government to formulate and implement countries. Therefore, I also include the sound policies and regulations that permit binary variable representing the tax and promote private sector develop- haven status. The list of tax haven coun- ments. tries is obtained from Dyreng and Lind- sey (2009). The robustness check specification is sum- marized by: The baseline econometric specification is summarized by:

Definitions of the variables as well as summary of the datal sources can be seen in the Appendix. The secrecy score variable (ss), as the main variable of interest, is based on report issued by Tax Justice Network in 2011, 2012 and 2014. However, the data for the report were based on the observations for the year before. Therefore, the year coverage in this paper is 3 years: 2010, 2012 and 2014.

33 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

Summary statistics is shown in Table 1 and the variables descriptions as well as the data source is provided in the Appendix. Table 1 Summary Statistics Source: Stata

Variable N Mean Std. Dev Min Q1 Median Q2 max

Illicit Financial Flows Outflow (Million of US$) 369 4,860.28 16,875.93 1.00 128.00 621.00 3,142.00 192,372.00

Trade Misinvoicing Outflow (Million of US$) 332 3,524.02 10,464.45 1.00 88.00 446.50 2,243.50 84,115.00

Secrecy Score 231 65.24 16.19 31.00 52.00 70.00 78.91 93.31

GDP per Capita (Current US$) 605 16,049.95 23,485.87 231.19 1,928.96 6,231.77 19,729.87 179,308.10

Government Effectiveness 593 -0.01 0.99 -2.45 -0.76 -0.11 0.74 2.24

Government Quality 593 -0.02 1.00 -2.53 -0.76 -0.12 0.66 2.23

Tax Rate (%) 495 17.38 12.91 0.00 0.00 20.00 28.00 55.00

Developed Country (=1) 654 0.37 0.48 0.00 0.00 0.00 1.00 1.00

Non Haven Country (=1) 654 0.79 0.41 0.00 1.00 1.00 1.00 1.00

4. RESULT AND DISCUSSION 4.1 Variable of Interest

Table 2 provides the regression results in three variations. The first column shows the most basic regression equation including only the secrecy score as the independent variable and the illicit financial outflow as the dependent variable. Column 2 is the main regression results adding all of the control variables. The last column basically runs the same thing as the second column with only the addition for an interaction variable between the development status and the tax haven status. Regression 1 shows that the transparency level has a negative significant impact on profit shifting. After controlling several variables, regression 2 basically shows similar result in which transparency level moved in opposite direction of the profit shifting (in 10% significance level). (1) (2) (3) VARIABLES liffo liffo liffo

ss -0.119*** -0.0326* -0.0461*** (0.0126) (0.0165) (0.0172) lgdppc 1.365*** 1.288*** (0.352) (0.348) goveff -0.191 -0.0901 (0.439) (0.458) taxrate 0.0660*** 0.0593*** (0.0212) (0.0223) Table 2 Regression Results high -1.077** -0.775 (0.519) (0.612) Source: Stata Output nonhaven 2.401*** 2.537*** (0.6) (0.634) high_nonhaven -1.332* (0.776) Constant 15.04*** -4.975 -3.317 (0.922) (3.276) (3.305)

Observations 89 76 76 R-squared 0.403 0.628 0.636 Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

34 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

Since higher secrecy score means that transparency level is one of the determi- the jurisdiction is less transparent, the nants of profit shifting. The result implies negative result implied that increasing that taxpayers located in a relatively trans- the secrecy level (become less transpar- parent country tend to shift their money/- ent) would reduce profit shifting. How- profit out of the country. This is because ever, it will be more useful to interpret they have less incentive to keep their the result in opposite way: increasing money/profit domestically since higher the transparency level (reducing the transparency in the host country means a secrecy score) will induce profit shifting. higher probability of the financial informa- In the aftermath of the 2008 tion to be exposed to tax authority. global financial crisis, G20 countries The negative regression result started the global initiative to increase should not be interpreted that jurisdiction transparency by forcing several jurisdic- should maintain secrecy to combat profit tions which were considered less trans- shifting because maintaining secrecy no parent to sign information exchange longer becomes an option amid global treaties under the threat of economic transparency movement. The result, how- sanction (Johannesen & Zucman, 2014). ever, should become an alert that multilat- The effort to increase transparency was eral cooperation in promoting transparen- then continued by promoting the cy is important. Since this paper found implementation of Common Reporting that ending secrecy in the host country Standard for Automatic Exchange of will increase profit shifting, it is important Information purposes. At the same to close the gap of incentive by imple- time, there is an increasing progress in menting transparency globally. When all the implementation of Coun- countries commit to end secrecy and start try-by-Country Reporting for Action 13 exchanging financial information, there of the BEPS. All of these ongoing proj- will be no more incentive for taxpayers to ects have the sole goal to increase shift their profit or money to other jurisdic- transparency level in combating tax tions. evasion. The regression result is interest- What about ? ing amid the global efforts to promote transparency, since it says that increas- The enactment of the Government Regu- ing the transparency level will induce lation in Lieu of Law Number 1 Year 2017 profit shifting. However, this might have (hereinafter refer to Law No. 1) marks the been caused by the use of data for the new era of transparency in Indonesia. The year 2010, 2012, and 2014, during which Law is important in two ways. First, it the global initiative in increasing trans- becomes the legal basis for Directorate parency was still in the beginning stage General of to access financial infor- and was implemented by only a handful mation for exchange of information pur- of jurisdictions. poses. On an alternative view, the result shows an important finding in that

35 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

Second, the law ends restriction in and PMK-107/PMK.03/2017 (CFC Rules). accessing financial information stipulat- These regulations, along with the previous ed in General Provision , Bank- regulations, become an integral part in ing Law, and Sharia Banking Law. combating profit shifting by providing In connection with the findings disincentive to evaders. in this paper, the increase in transparen- cy level since the enactment of the Law 4.2 Control Variables No. 1 provides a bigger incentive to shift money/profit out of Indonesia. Since a Table 2 shows that GDP per capita has a worldwide implementation of Automat- positive and significant impact on profit ic Exchange of Information is still in shifting. It says that 1% change in GDP per progress and several jurisdictions are capita will increase profit shifting by 1.3%. yet to ratify the commitment, it is The finding is consistent with Baumann et. important to mitigate the increasing risk al. (2016). Furthermore, the negative coef- of profit shifting resulted from the ficient of government effectiveness implies ending of Indonesian banking secrecy. that higher government’s quality is associ- Mitigating the profit shifting risk ated with lower profit shifting. Even is mainly about establishing disincentive though the coefficient is not significant, using anti-profit shifting regulations. this finding still signifies the importance of The impacts of these regulations are government effectiveness in combating well documented in empirical literature. profit shifting. Lohse and Riedel (2013) suggest that The paper also measures the transfer pricing rules significantly semi-elasticity of profit shifting. A percent- reduce shifting activities. More precisely, age point increase of the host country’s they found that implementation of tax rate will instigate profit shifting by transfer pricing documentation reduced 6.6%. Increasing the tax rate in host coun- profit shifting by 50% on average. try will provide the taxpayers an incentive Blouin, Huizinga, Laeven and Nico- to shift their profit out of the country to dome (2014) found that thin capitaliza- minimize their tax burdens. This finding is tion rule negatively affects both total consistent with previous findings, for leverage and internal leverage. In addi- example, by Hines and Rice (1994) who tion, Markle and Robinson (2012) con- found an elasticity of 2.3 and Huizinga and clude that CFC Rules reduce the use of Laeven (2008) who obtained an elasticity tax haven. of 1.3. Following the end of Indonesia For the country characteristic vari- banking secrecy and considering the ables, this paper found that higher occur- impact of the anti-profit shifting regula- rence of profit shifting was suffered by tion, the Indonesian government then non-high income or developing countries enacts Regulation and non-tax haven countries. In order to Number PMK-169/PMK.010/2015 (thin give more interpretation about country capitalization), PMK-213/PMK.03/2016 characteristic, I constructed an interaction (transfer pricing documentation) variable of the development and the tax

36 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

haven variables. The result can be seen in regression 3 where the interaction variable coefficient is negatively significant. This result means that the impact of the tax haven status on profit shifting depends on whether or not the country is categorized as a high income country. The impact of country status as non-tax haven on profit shifting will be greater in developing country than in developed country. Hence, the regression result for the country characteristic variables shows that profit shifting is larger in non-tax haven and low/middle income countries.

4.3 Robustness Check

Table 3 shows the regression results for robustness check. The table suggests that the coefficient of transparency still shows a negative and significant impact on profit shift- ing. The same consistent result was also found in the control variables (GDP per capita, tax rate and country characteristics). These consistent results suggest that our baseline specification is quite robust.

Table 3 Robustness Check Source: Stata Output

(1) (2) VARIABLES ltmo ltmo

ss -0.126*** -0.0425** (0.0151) (0.018) lgdppc 1.658*** (0.372) govqual -0.963** (0.459) taxrate 0.0774*** (0.0237) high -1.203** (0.581) nonhaven 2.146*** (0.666) Constant 15.08*** -7.157* (1.081) (3.705)

Observations 79 66 R-squared 0.414 0.667 Robust standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

37 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

5. CONCLUSIONS AND Regarding the control variables, this paper RECOMMENDATIONS finds several compelling findings. The measurement of semi-elasticity of profit The roles of financial secrecy on profit shifting resulting in 6.6 means that a shifting are not well documented in percentage-point increase in tax rate will literature. This paper, to my knowledge, increase profit shifting by 6.6%. As regards provides the first empirical result on the the country characteristics variable, it is impact of financial secrecy on profit evidenced that profit shifting is larger in shifting. This paper also uses the illicit non-tax haven and low/middle income financial outflows as a new proxy for countries. profit shifting instead of the accounting profit which was widely used in previous 6. REFERENCES literature. The result suggests that the [1] Akhtar, S., Akhtar, F., John, K., & Wong, S. secrecy negatively affects profit shifting. (2017). Multinationals’ Tax Evasion: A Financial This means that an effort to increase and Governance Perspective. Journal of transparency will induce the taxpayers . Retrieved from https://- doi.org/10.1016/j.jcorpfin.2017.11.009 to shift profit out of the country. As the [2] Arnold, B.J., & McIntyre, M.J. (2002). Interna- transparency in a host country tional Tax Primer. The Netherland: Kluwer Law improves, the risk of tax authority International. accessing financial information also [3] Baumann, F., Buchwald, A., Friehe, T., Hotten- heightens. Therefore, there is a higher rott, H., & Weche, J. (2016). Tax Enforcement and Corporate Profit Shifting. Applied incentive for taxpayers to shift their Economics Letters, 24(13), 902-905. money/profit out of the country. [4] Beer, S., de Mooij, R., & Liu, L. (2018). Interna- From the perspective of tax tional Corporate : A Review of authority, the result implies two import- The Channels, Effect Sizes, and Blind Spots ant recommendations. First, the tax (IMF Working Paper WP/18/168). DC: IMF. authorities should continue the global [5] Blouin, J., Huizinga, H., Laeven, L., & Nico- efforts to promote the exchange of dome, G. (2014). Thin Capitalization Rules and financial information for tax purposes, Multinational Firm Structure (IMF providing disincentive for tax evaders so Working Paper WP/14/12). Washington DC: that there will be no more place to hide IMF. [6] Buettner, T., Overesch, M., & Wamser, G. away their . Second, anticipating (2017). Anti Profit-Shifting Rules and Foreign that there will still be some jurisdictions Direct Investment. International Tax and Public which do not join the information Finance, 25(3), 553-580. exchange framework, anti-profit shifting [7] Chernykh, L., & Mityakov, S. (2017). Offshore domestic regulations should be estab- Schemes and Tax Evasion: The Role of . Journal of Financial Economics, 126(3), lished and strengthened. To summarize, 516-542. these recommendations basically build [8] Clausing, K.A. (2016). The Effect of Profit Shift- the disincentive for tax evaders. ing on The Corporate Tax Base in the and Beyond. National Tax Journal, 69(4), 905-934.

38 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

9] Cobham, A., Jansky, P., & Meinzer, M. [20] Huizinga, H., & Laeven, L. (2008). Internation- (2015). The : Shed- al Profit Shifting Within Multinationals: A ding New Light on the Geography of Multi-Country Perspective. Journal of Public Secrecy. Economic Geography, 91(3), Economics, 92, 1164-1182. 281-303. [21] Jansky, P., & Prats, A. (2015). International [10] Crivelli E., de Mooij, R., & Keen, M. (2015). Profit Shifting out of Developing Countries Base Erosion, Profit Shifting and Develop- and The Role of Tax Havens. Development ing Countries (IMF Working Paper Policy Review, 33(3), 271-292. WP/15/118). Washington DC: IMF. [22] Johannesen, N., & Zucman, G. (2014). The End [11] Dharmapala, D., & Hines, J.R. (2009). Which of Bank Secrecy? An Evaluation of the G20 Tax Countries Become Tax Havens?. Journal of Haven Crackdown. American Economic , 93, 1058-1068. Journal: , 6(1), 65-91. [12] Dharmapala, D., & Riedel, N. (2013). Earn- [23] Kaufmann, D., Kraay, A., & Mastruzzi, M. ing Shocks and Tax-Motivated Income (2005). Governance Matters IV: Governance Shifting: Evidence from European Multina- Indicators for 1996-2994 (World Bank Work- tionals. Journal of Public Economics, 97, ing Paper) 95-107. [24] Lohse, T., & Riedel, N. (2013). Do Transfer [13] Dyreng, S. D., & Lindsey, B. P. (2009). Using Pricing Laws Limit International Profit Shifting? Financial Accounting Data to Examine the Evidence from European Multinationals Effect of Foreign Operations Located in Tax (CESifo Working Paper No. 4404). Havens and Other Countries on U.S. Multi- [25] Maffini, G., & Mokkas, S. (2011). Profit Shifting national Firms' Tax Rates. Journal of and Measured Productivity of Multinational , 47(5), 1283-1316. Firms. Oxford Bulletin of Economics and [14] Foad, H., & Lundberg, C. (2017). The Deter- Statistics, 73, 0305-9049. minants of Portfolio Investment in Offshore [26] Mara, E.R. (2015). Determinants of Tax Havens. Financial Centers. International Review of Procedia Economics and Finance, 32, Financial Analysis, 54, 76-86. 1638-1646. [15] Global Financial Integrity. (2017). Illicit [27] Markle, K., & Robinson, L. (2012). Tax Haven Financial Flows to and from Developing Use Across International Tax Regimes. Mimeo, Countries. Retrieved from University of Waterloo and Dartmouth https://www.gfintegrity.org/wp-con- College. tent/uploads/2017/05/G- [28] Murphy, R. (2008). Finding the Secrecy World: FI-IFF-Report-2017_final.pdf Rethinking the Language of “offshore”. [16] Grubert, H., & Mutti, J. (1991). Taxes, Tariffs London: Tax Research LLP. Retrieved October and Transfer Pricing in Multinational 17, 2018 from http://www.taxre- Corporate Decision Making. The Review of search.org.uk/Documents/Finding.pdf Economics and Statistics, 73(2), 285-293. [28] OECD. (1998). Harmful Tax : An [17] Hansen, N.A, & Kessler, A.S. (2001). The Emerging Global Issue. Paris: OECD. Political Geography of Tax H(e)avens and [29] OECD. (2015). 2015 Final Reports, OECD/G20 Tax Hells. American Economic Review, Base Erosion and Profit Shifting Project. Paris: 91(4), 1103-1115. OECD Publishing. [18] Heckemeyer, J.H., & Overesch, M. (2017). [30] OECD. (2015a). Measuring and Monitoring Multinationals’ Profit Response to Tax BEPS, Action 11-Final Report. Paris: OECD Differentials: Effect Size and Shifting Chan- Publishing. nels. Canadian Journal of Economics, 50(4), [31] OECD. (2018). Glossary of Tax Term. Available 965-994. at http://www.oecd.org/ctp/glossaryoftax- [19] Hines Jr., J.R., & Rice, E.M. (1994). Fiscal terms.htm#P Paradise: Foreign Tax Havens and Ameri- [32] Picard, P.M., & Pieretti, P. (2011). Bank Secrecy, can . Quarterly Journal of Illicit Money and Offshore Financial Centers. Economics, 109, 149-82. Journal of Public Economics, 95, 942-955.

39 I Wayan Agus Eka / Does Financial Secrecy Affect Profit Shifting? (2019) 27-40

[33] Rose, A.K., & Spiegel, M.M. (2007). [35] Torslov, T.R., Wier, L.S., & Zucman, G. (2018). Offshore Financial Centres: Parasite or The Missing Profits of Nations (NBER Working Symbionts?. The Economic Journal, 117, Paper 24701). Cambridge: National Bureau of 1310-1335. Economic Research. [34] Tax Justice Network. (2015). Financial Secre- [36] United Nation. (2017). Practical Manual on cy Index 2015: Methodology. Retrieved Transfer Pricing for Developing Countries. from New York: United Nations. https://www.financialsecrecyindex.com/Ar- chive2015/Notes%20and%20Reports/FSI- Methodology.pdf

7. APPENDIX

Variable Definition

Symbol Variable Source

liffo Illicit Financial Outflow Global Financial Integrity: https://www.gfintegrity.org/wp- (natural log) content/uploads/2017/04/IFF_2017-04_WebTables.xlsx ltmo Trade Misinvoicing Outflow (natural log) ss Secrecy Score Tax Justice Network:

https://www.financialsecrecyindex.com/Archive2015/Notes%20and%20Reports/FSI -Rankings-2015.xlsx https://www.financialsecrecyindex.com/Archive2013/Notes%20and%20Reports/FSI -Rankings-2013.xlsx https://www.financialsecrecyindex.com/Archive2011/FSI-2011/FSI-Rankings- 2011.xls lgdppc GDP per capita World Bank: http://databank.worldbank.org/data/download/WDI_excel.zip (natural log) goveff Government The Worldwide Governance Indicators: Effectiveness http://info.worldbank.org/governance/wgi/wgidataset.xlsx govqual Government Quality

taxrate Statutory Tax Rate KPMG

high Developed/High World Bank: http://databank.worldbank.org/data/download/site-content/CLASS.xls Income Country (=1) nonhaven Non-Tax Haven Hines and Rice (1994) Country (=1)

40