This paper analyzes the effect on firm behavior and national tax revenues of a policy of allowing multinational firms to choose whether to be taxed under separate accounting rules (transfer prices) or an apportionment formula. Either method can be preferred by low-cost firms and by high-cost firms, and the preferred method can vary non-monotonically with firm cost characteristics. Separate accounting always generates more profitable output and conditional labor demand distortions while either method can generate a more profitable income-shifting distortion. With asymmetric countries, country preferences are only partially aligned with firm preferences due to the fact that countries and firms value tax base distortions differently. With partial alignment of firm and country preferences, choice can increase tax revenues in both countries.
formula apportionment separate accounting transfer prices