Tax Law Asymmetries and Income Shifting: Evidence from Japanese Capital Keiretsu

In: The B.E. journal of economic analysis & policy, Volume 10, Issue 1

Abstract

Abstract
While the asymmetric treatment of positive and negative income creates clear tax incentives to shift income among a group of closely related corporations, attempts to document the impact of such behavior on economic outcomes are relatively sparse. We aim to provide evidence on tax-motivated transfers from a large dataset of Japanese corporate groups. Using company level data on 33,340 subsidiary time pairs from 1988, 1990, and 1992, we consider testable implications of income shifting in a theoretical model tailored to the Japanese institution of the early 1990s and empirically examine the spread of the profitability distribution, the attrition rate of loss-making subsidiaries, and the propensity to report zero profit. The findings suggest that income shifting was pervasive when Japan had not adopted a formal allowance for group-level tax. The result underscores the importance of accounting for the inter-relatedness of companies, in designing a corporate income tax.