DPRIETI Discussion Paper Series 22-E-063

Antidumping on Tax-induced Dumping

MUKUNOKI, Hiroshi
Gakushuin University

OKOSHI, Hirofumi
Okayama University

The Research Institute of Economy, Trade and Industry

https://www.rieti.go.jp/en/

RIETI Discussion Paper Series 22-E-063
July 2022

Antidumping on Tax-induced Dumping *Hiroshi MUKUNOKI
Gakushuin University
Hirofumi OKOSHI
Okayama University
Abstract
This study theoretically investigates the effects of antidumping protection on tax-induced
dumping. When the goods are exported from a high-tax to a low-tax country, the exporters have an
incentive to set a lower internal price to their distribution affiliates in the destination country. By doing
so, they are able to avoid high taxes and also gain a stronger position in the product market. The
politically-motivated importing country can implement antidumping protection to protect domestic
firms. It is shown that a more stringent regulation on transfer pricing can trigger the antidumping
protection, which benefits the exporting country due to larger tax revenues and larger consumer
surplus. It also improves the world welfare. However, when the antidumping protection is
implemented, a further tightening of the transfer-price regulations may worsen the exporting country’s
welfare and the world welfare. These results suggest an important link between tax policies and trade
policies.
Keywords: Transfer pricing; Anti-dumping; Trade liberalization
JEL classification: F13; F15; F23; H26; L11

The RIETI Discussion Paper Series aims at widely disseminating research results in the form of professional
papers, with the goal of stimulating lively discussion. The views expressed in the papers are solely those of
the author(s), and neither represent those of the organization(s) to which the author(s) belong(s) nor the
Research Institute of Economy, Trade and Industry.

This study is conducted as a part of the Project “Economic Policy Issues in the Global Economy” undertaken at the
Research Institute of Economy, Trade and Industry (RIETI). We thank Jota Ishikawa, Hayato Kato, Eiichi Tomiura,
Makoto Yano and participants of 79th annual meeting of JSIE. Hiroshi Mukunoki acknowledges financial support
from JSPS KAKENHI Grant Numbers JP20K01659. Hirofumi Okoshi acknowledges financial support from JSPS
KAKENHI Grant number JP22K13390.
*

1

Introduction

For the last few decades, tax-avoidance behaviors of multinational enterprises (MNEs) havebeen one of the central policy discussions in the world economy. An important tax avoidancechannel is the manipulation of prices on intra-firm trade, which is known as transfer pricing.1 For example, Cristea and Nguyen (2016) concluded that Danish MNEs decrease theirunit value of their exports to low tax countries by at least 5.7%. To prevent the tax-avoidance
behaviors, the members of Organization for Economic Cooperation and Development (OECD)
have launched the base erosion and profit shifting (BEPS) project and the arm’s length principle (ALP) to tighten the regulations on profit shifting from high- to low-tax countries.2
As intra-firm trade is the basis for transfer pricing, trade policies that affect intra-firmtrade should affect MNEs’ tax avoidance.3 Among others, this paper focuses on the importing
countries’ anti-dumping (AD) measures. AD measures are one of the most frequently usedtrade policies in recent decades. From January 1995 to June 2021, 6,422 AD initiations and4,225 AD measures were reported in the World Trade Organization (WTO).4 Blonigen andPrusa (2016) also showed an increase in the number of countries adopting AD laws. AD
measures allow importing countries to impose an AD duty on imports when foreign exporters“dump” their goods, which causes material injury to the domestic firms producing the same
goods. In the context of international trade, an exporter’s pricing is deemed dumping if thefree-on-board (FOB) export price is lower than the normal value. The normal value is usually
the corresponding price of the good in the exporters’ home market. Specifically, let r H andr F be the price charged by a firm in the home and foreign country, respectively. Then, thedamping margin is defined as d = r H − (r F − τ ), where τ is a per-unit trade cost. If the
dumping margin is positive and the dumping decreases the domestic firms’ profits in theimporting country, the domestic firms can file a petition for AD measures to the government.
1 Recent empirical studies, such as Swenson (2001), Clausing (2003), Bernard et al. (2006), Cristea and Nguyen(2016), and Davies et al. (2018), observed that MNEs manipulate their transfer prices for tax-avoidance purposes.
2 Abusive transfer pricing is one of the central issues on global taxation. To prevent MNEs’ tax avoidance
behaviours, OECD launched 15 actions in the BEPS project. Three of fifteen projects, action 8-10, focus on transfer
pricing. Among them, actions 9 and 10 deal with risks regarding transfer pricing. This study connects the risksof transfer pricing to trade policies.
3 According to UNCTAD (2016), approximately one third of the exports were intrafirm trade. Moreover, using
the U.S. data, Bernard et al. (2010) and Lanz and Miroudot (2011) also showed that about 46% of imports in 2000
and 50% of imports in 2009 were transacted by related firms. According to OECD’s estimation, about 4% to 10%of the world’s tax revenue is lost due to MNEs’ tax-avoidance behaviors. The annual revenue loss is estimatedat 100-240 US dollars. See http://www.oecd.org/ctp/oecd-presents-outputs-of-oecd-g20-beps-projectfor-discussion-at-g20-finance-ministers-meeting.htm.
4 See https://www.wto.org/english/tratop_e/adp_e/adp_e.htm.

1

Although there are many reasons to set a lower price in a foreign country compared to thedomestic country, such as a third-price discrimination to take advantages of the difference inthe market-sizes, price-elasticities, and predatory pricing to kick out foreign rival firms, the
MNE’s transfer pricing to avoid a high-tax in the home country is one reason to set an export
price lower than the corresponding domestic price. The effect of AD measures on a so-called“tax-induced dumping” has been overlooked in the literature.
In reality, the intra-firm prices are sometimes subject to importing countries’ AD investigations. Suppose that a producer exports its product to its distribution affiliates by charging
an intra-firm export price. Then, the distribution affiliate sells the product to (unaffiliated)consumers with a sales price that is different from the export price. In the AD laws of the
U.S., if the first sale to an unaffiliated person is made by an affiliated seller in the U.S., the“constructed” export price is used to calculate the dumping margin. The constructed export
price is calculated by deducting the amount of expenses and profits of the affiliated seller in
the U.S. from the sales price. Therefore, the dumping margin is calculated based on the intrafirm price, rather than the sales price to consumers.5 The European Union also calculates theexport price to the affiliated importer by the same method. Bown and Sykes (2008) reported
some issues concerning transfer pricing and the calculation of dumping margin. Moreover,
Al-Eryani et al. (1990) also concluded that legal considerations including AD influenced U.S.
MNEs’ transfer pricing decision.
Against this backdrop, this paper investigates the importing country’s incentive to implement AD measures on a tax-induced dumping. Although there are AD cases targetingthe dumping calculated by exporting firms’ wholesale prices, no studies investigate the relationship between firms’ transfer pricing and the importing country’s AD protection. In
particular, this study analyzes how a more stringent enforcement of the ALP changes theimporting country’s AD policy. A tighter enforcement of the ALP change exporting firms’
settings of their wholesale prices and, thereby, changes the dumping margin and incentives
to apply AD measures. As AD measures are used as a policy to protect domestic industries,changes in transfer pricing regulation can generate unexpected losses to exporters if it induces
AD measures.
Despite the practical importance, AD measures and the regulation on transfer pricing have
5 See
the
websiteoftheInternational
https://enforcement.trade.gov/regs/uraa/saa-ad.html

2

Trade

Administration

of

the

U.S.:

been treated separately by different institutes; international trade and customs authorities
treat AD issues while tax authorities treat transfer pricing issues. The World Customs Organization sets the guideline to foster mutual cooperation between customs and tax authorities
to improve efficiency and financial gains in collecting duties and taxes (WCO, 2018).6 Given
the lack of academic insights in the link between AD policy and tax policy, the results of thisstudy provide valuable information on how these two policies interact.

1.1

Preview of the model and results

We construct an international oligopoly model with a single MNE competing with a local firmin a high-tax home and low-tax foreign country. The MNE produces its goods in the homecountry and ships them to distribution affiliates in the home and foreign countries by charging wholesale prices. Then, the distribution affiliates whose decision rights are delegated by
the MNE sell the goods to maximize their own profits.
Without AD protection, if a gap between the corporate taxes is large and a stringencyof the ALP is weak, the MNE sets a FOB export price lower than its corresponding domestic
price in the home country. This dumping is caused by the tax difference because the dumping
margin cannot be positive without it. With AD protection, this price discrimination leads toan imposition of AD duty. As a result, the AD protection forces the MNE to set a uniform
wholesale price between the two countries. The MNE’s wholesale price decreases in the homecountry and its export price (i.e., transfer price) increases.
As AD protection increases the MNE’s transfer price, it benefits the local firm in the importing country at the expense of consumers and tax revenues. Because the latter effect always
dominates the former, AD protection always worsens the social welfare of the importing country. Hence, the importing country implements AD protection only if the policy maker places
a lower weight on the social welfare relative to the profit of the local producer. Specifically,
given that the dumping margin is positive, the importing country applies AD protection if thepolicy maker is politically motivated and its weight on social welfare is below the thresholdlevel.7
Given this, we investigate how a tightening of transfer pricing regulation affects the im6 WCO (2018) stated that “...the WCO is working with the OECD and World Bank Group to encourage Customs
and tax administrations to establish bilateral lines of communication in order to exchange knowledge, skills anddata, where possible, which will help ensure that each authority has the broadest picture of an business, its
compliance record and can make informed decisions on the collect revenue liability.”
7 Nelson (2006) surveyed the literature about the political economy of AD protection.

3

porting country’s AD protection. We find that a stricter enforcement of the ALP can trigger
the importing country’s AD protection. Seemingly, regulating transfer pricing prevents AD
protection because it raises the transfer price and narrows the dumping margin. However, asmaller dumping margin actually encourages the policy maker to invoke an AD law because
the welfare cost of implementing AD protection becomes smaller and this effect dominates
the decrease in the profit gain of the local firm. As AD protection further increases the transfer
price, it works as an additional tool to prevent the MNE’s transfer pricing. If the stringency of
the ALP is sufficiently large, the importing country does not apply the AD protection because
the dumping margin becomes negative with a highly stringent ALP.
The AD protection induced by a tighter regulation on transfer pricing benefits the exporting country despite the profit loss of the MNE, because the inflows of the MNE’s tax baseincrease the tax revenues. Additionally, the MNE’s lower wholesale price in the home country intensifies the product market competition and decreases the consumer price, benefiting
consumers. Given that the AD protection is implemented, a further tightening of the transfer
price regulation may worsen the welfare of the exporting country because it increases theprice in the home country. The same property is applied to world welfare. This worldwide
welfare gain stems from the fact that AD protection results in efficient production patterns
because the price adjustments of the MNE increase the supplies of the MNE in the exporting
country that has a larger effective market size than the foreign country due to the absence oftrade costs.
In contrast, a tighter regulation on transfer price worsens the welfare of the importing
country. Although an increase in the transfer price benefits the local firm, the loss of tax
revenues along and consumer’s loss are larger. Furthermore, it triggers AD protection, andits welfare becomes even lower. This AD protection caused by a stricter transfer pricing
regulation can be avoided by facilitating trade liberalization in the importing country. As
trade costs decline, it is less likely that a tighter regulation triggers AD protection. Thisis because trade liberalization increases the dumping margin and, thereby, discourages thepolicy maker in the importing country to initiate AD protection.

1.2

Related literatureThis study relates to the literature on transfer pricing. Since Copithorne (1971) and Horst(1971), many researchers have analyzed to MNEs’ tax avoidance strategies with a focus on the4

impact of regulation on transfer price manipulation, such as the ALP. 8 Gresik and Osmundsen (2008) analyzed how vertically separated MNE decides transfer pricing under different
tests of the ALP and Choi et al. (2020) explored the impact on tax competition. Other studies
analyzed the impact of the ALP on tacit collusion (Choe and Matsushima, 2013), the buying or
making decision of the MNE (Bauer and Langenmayr, 2013), and location decision (Kato andOkoshi, 2019). Although the ALP does not allow MNEs to discriminate prices for related andunrelated firms, AD protection restricts MNEs to discriminate prices in domestic and foreigncountries. Thus, by focusing on AD measures, this paper studies the interaction between two
anti-price-discrimination policies.
Few studies deal with the connection between trade policies and international tax policies.
Exceptions are Choi et al. (2018), Mukunoki and Okoshi (2021a) and Mukunoki and Okoshi(2021b). Choi et al. (2018) examined optimal tariff on goods of an MNE’s intra-firm transaction
to mitigate profit shifting. Mukunoki and Okoshi (2021a) and Mukunoki and Okoshi (2021b)
investigated an impact of a free trade agreement (FTA) on an MNE’s profit shifting strategies
and showed that an MNE has an incentive to manipulate transfer price to meet rules of origins
and grant tariff-free access within the FTA. As the focus of this study is on AD measures, it
provides additional insights on the link between the two policies.
We also contribute to the literature of AD. There have been a lot of studies considering
the effects of AD.9 Some of these focused on the governments’ incentives to use AD laws.
Anderson et al. (1995) analyzed AD protections of two countries in an international oligopoly
model and found that the welfare-maximizing governments have no incentives to implement
AD laws, while politically-motivated governments that maximizes the domestic firm’s profit
invoke them. Although AD protection aims to protect the domestic producers, it results in thereciprocal AD and lowers the domestic prices and improves the social welfare of all countries
at the cost of the producers. Miyagiwa et al. (2016) insisted that the country size matters in
the AD wars between countries, and larger countries are more likely to implement AD protection against smaller countries. Mukunoki (2021) investigated whether trade liberalization
promotes or prevents AD and found that it depends on the reasons for dumping. However,these studies have not considered how tax policies are related to AD policies.
8 Another example of anti-profit-shifting policy is to introduce formula apportionment instead of separate

accounting. See for example, Nielsen et al. (2003), Kind et al. (2005) and Gresik (2010). Additionally, following
Janskỳ and Palanskỳ (2019), an internal debt is another important channel to shift profits and countries adopt thincapitalization rules. On the policy, see Haufler and Runkel (2012) and Mardan (2017) for instance.
9 See Blonigen and Prusa (2016) for the survey of the literature.

5

The rest of the paper is organized as follows. Section 2 represents the model and derives the equilibrium with and without AD protection. Section 3 investigates the decisionsof implementing AD protection by the politically motivated policy maker in the importing
country. Moreover, it explores how the stringency of the regulations on transfer pricing affects
the importing country’s AD protection and its welfare impacts. Section 4 considers the effectof trade liberalization and how it affects the importing country’s decisions on AD protection.
Section 5 summarizes the findings of this study.

2

Model

There are two countries, a high-tax home country (country H) and a low-tax foreign country(country F). Two local firms, firm H and firm F, produce homogeneous final goods in country
H and country F, respectively.
For these two firms, the marginal costs of producing final goods are identical and given
by c. These firms only supply to their respective domestic markets. In addition to these two
firms, another firm of country H (firm M) produces the same good in country H with a lower
marginal cost, c M (≤ c). Firm M is an MNE that supplies the good in both countries via its
distribution affiliates located in country H (firm M H ) and in country F (firm MF ). Firm M
sells the good to firm Mi by setting its intra-firm, wholesale price at ri . To distinguish the twowholesale prices, we refer to r H as internal price and r F as transfer price. In exporting the good
to firm MF , firm M incurs the trade cost, τ. The profits of the MNE’s distribution affiliate andthe local firm in i are given by:

π Mi = ( pi − ri ) x Mi ,andπi = ( pi − c ) xi ,(1)

respectively.
The inverse demand function in i ∈ { H, F } is given by:

pi = a − ( x Mi + xi ),(2)

where x Mi and xi are the supplies of the MNE and those of the local firm in country i,
respectively.10 The countries are symmetric except for the following two aspects. First, the10 The inverse demand function is derived from the utility of the representative consumer in country i, U =i

6MNE produces the good in country H because of the location advantages in that country,
such as a large pool of skilled labor.11 Second, country H imposes a higher corporate-tax rate
than country F, t H ≥ t F .12
By manipulating price for the intra-firm trade (i.e., transfer price), the MNE can shift its
profits from the high-tax to the low-tax country. As country F imposes a lower corporate tax,
the MNE has an incentive to lower its transfer price to shift profits from country H to country
F. However, if such transfer price manipulation is detected by the tax authorities in a hightax country, the MNE is penalized. To avoid a potential sanction, the MNE incurs some costs
to justify its pricing, for instance by hiring lawyers and consultants. Following the standard
literature of transfer pricing, we assume the MNE incurs the following concealment costs:

C (r F ) =δ (r F − c M − τ )2
.
2

(3)

The quadratic-form function reflects two important aspects. First, as the transfer price deviates more from the marginal cost of exports, the concealment cost becomes larger.13 This isbecause the tax authorities audit transfer pricing based on the ALP and it finds the deviationfrom the marginal cost more easily as the gap between r F and c M + τ increases. Second, δcaptures the stringency of the ALP. The MNE’s post-tax, total profit is given by:Π M = (1 − t H )[(r H − c M ) x MH + (r F − c M − τ ) x MF + π MH ] + (1 − t F )π MF − C (r F ).

(4)

In addition to avoiding the high-tax, the MNE has a strategic motivation to lower its
transfer price. Given that the MNE delegates its decision rights to their distribution affiliates(i.e., firms M H and MF ), these affiliates regard these wholesale prices as the costs. Then,the MNE sets low r H and r F to motivate these distributors to act more aggressively in theirrespective product markets and shifts the profits from the rival firms. Because both taxavoidance and strategic motivations lower r F , they do not conflict with each other. Therefore,( x + x )2a( xi + x Mi ) − i 2 Mi + yi , where yi is the consumption of a numeraire good.
11 More specifically, the industry needs skilled workers for conducting R&D intensive tasks. These skilledworkers are abundant in high-tax industrialized countries, such as Japan and the U.S. These countries were
frequently targeted by AD measures.
12 In our analysis, we focus on the case where local firms and the MNE’s distribution branches remain in thehimarket, in which the tax difference is not so large, such that t H − t F < ∆T ≡(1− t H )4a − c −2( c − c M )a−cholds.

13 The headquarters of the MNE incurs this concealment cost and it is deducted from the profits.

this cost is not subject to a corporate tax. Juranek et al. (2018) also employs the same assumption.

7

Therefore,Figure 1: Model
the MNE chooses the decentralization of decision rights, rather than centralization.14
Figure 1 summarizes the structure of the model. We solve the following three-stage game.
In the first stage, the government in country F decides whether to initiate AD protection. In
the second stage, given the government’s decision in the first stage, the MNE sets the internal
and transfer prices to maximize its post-tax profits. In the third stage, the firms engage in
Cournot competition. The rest of the section derives equilibrium without and with AD laws.

2.1

Equilibrium

Let us start with the equilibrium of the stage 3 subgame. In stage 3, firms M H and MF andthe local firms maximize their own profits. By maximizing eq. (1) with respect to x Mi and xi ,the optimal supplies of each firm become functions of ri :xbMi (ri ) =a − 2ri + c
3andxbi (ri ) =a − 2c + ri
.
3

(5)

A lower internal or transfer price of the MNE increases the equilibrium supplies of the MNE.
b M (r H , r F ).
b Mi (ri ), πb i (ri ), and Π
By substituting (5) in (1), we have the equilibrium profits as π
The equilibrium welfare of country F is given by:2b F (r F ) = { xbF (r F ) + xbMF (r F )} + (1 − t F ) πb F (r F ) + t F { πb F (r F ) + π
b MF (r F )},
W
2

(6)

14 As Nielsen et al. (2008) shows, the motivations are in conflict with each other when the MNE ships its goods
from a low-tax country to a high-tax country. In this case, the MNE may prefer centralization to decentralization.

8

where the first term is the consumer surplus, the second term is the post-tax profit of firmF, and the last term is tax revenues collected from firms F and MF . Although firm F pays
the corporate tax, its tax payment is cancelled out by its tax revenue. As we will see below,
AD protection leads to price undertaking and an AD duty is not imposed in equilibrium.
Therefore, we omit the revenues from AD duty from the welfare. Similarly, the equilibrium
welfare of country H is given by:2b H (r H , r F ) = { xbH (r H ) + xbMH (r H )} + (1 − t F ) πb M (r H , r F ).
b H (r H ) + t H { πb H (r H ) + π
b MH (r H )}Π
W
2(7)
The welfare of country H contains the post-tax profits of the MNE.
The equilibrium of stage 2 subgames depends on whether country F implements AD
protection or not, which is subsequently analyzed in the following subsections.

2.1.1

No AD protection

Starting with the benchmark case without AD protection, in the second stage, the MNE setsr H and r F to maximize the post-tax profits. By solving the first order conditions, the optimal
internal and transfer prices are:a + c − 2c M,
4
a + c − 2c M − 2τ 3(t H − t F )( a + c − 2c M − 2τ )r FN = c M + τ −−4
2{3(1 − t H ) − 2(1 − t F )}9δ(1 + 3t H − 4t F )( a + c − 2c M − 2τ ).
+4{3(1 − t H ) − 2(1 − t F )}[9δ + 4{3(1 − t H ) − 2(1 − t F )}]N
rH= cM −(8)(9)

The second term of these prices captures the decrease in the wholesale prices due to thestrategic motive. The third term of r FN captures the decrease in the wholesale prices due tothe tax-avoidance motive. 15 Although these two motives enable the MNE to lower its transfer
price, the existence of concealment costs prevents it from doing so, which is captured by the∂r N

fourth term. Since ∂δF > 0 and limδ→∞ r FN → c M + τ, r FN < c M + τ holds at any δ.
As explained in the introduction, the dumping margin is defined as the gap between thedomestic price in the exporting country and the FOB price of exports, d = r H − (r F − τ ). By
15 The assumption of t

H − t F < ∆T ensures that the second-order conditions of the profit maximization always

hold.

9

(8) and (9), the dumping margin is calculated as:
8{3(t H − t F )( a + c − 2c M − τ ) − (1 − t F )τ } − 9( a + c − 2c M )δN
. (10)
dN = rH− r FN − τ =4[9δ + 4{3(1 − t H ) − 2(1 − t F )}]The dumping margin increase in the tax gap, t H − t F , and decrease in the trade cost, τ,and the stringency of the restrictions on transfer pricing, δ. A larger tax gap enhances the
tax-avoidance transfer-pricing motive, and a lower trade cost enhances the strategic motive oftransfer pricing because it expands the profit opportunity in the market of country F. We canconfirm that:d N > 0 ⇐⇒ δ < δd ≡8{3(t H − t F )( a + c − 2c M − τ ) − (1 − t F )τ }.
9( a + c − 2c M )(11)

Therefore, the dumping margin is positive only if δ is smaller than the threshold level, δd .
(1− t )

Note that we have δd < 0 when t H = t F and δd > 0 only when t H − t F > 3(a+c−2cF −τ ) τ.
M

Unless the corporate-tax rate of country H is sufficiently higher than that of country F, theMNE does not “dump” its product. Without the tax gap, the profit opportunity is larger incountry H. Therefore, the gains from setting a lower wholesale price due to the strategic
motive are larger in country H than in country F. As a result, the MNE sets b
r H < (brF − τ)without a tax gap. Only if the tax gap is sufficiently large and the tax-avoidance motive
for lowering r FN dominates the strategic motive, the equilibrium dumping margin becomes
positive. In this sense, the dumping detected in this model is a “tax-induced dumping.”
Thus, we have the following proposition.
Proposition 1. Without AD protection, the MNE’s dumping margin is positive if the importing country’s corporate tax is lower than the exporting country’s corporate tax, the tax gap islarge, and the trade cost and the stringency of the regulations on transfer price are small.
By substituting these equilibrium internal and transfer prices in (4) and (5), we have theN , x N , π N , π N , andequilibrium profits of the supplies of the MNE and the local firm as x Mi
i
Mi
i

ΠN
M . By substituting these prices in (6) and (7), the corresponding welfare of each country
becomes WFN and WHN .

10

2.1.2

AD protection

Given that d N > 0 holds, this subsection shows AD protection changes the MNE’s internal
and transfer pricing. Under AD protection, country F imposes the AD duty that is equal to the
dumping margin. However, the MNE has an option to avoid the AD duty by manipulating
the prices. Namely, if the MNE sets its wholesale prices such that the dumping margin iseliminated after an AD investigation, the AD duty is not imposed. This price commitment isknow as “price undertaking.” The MNE’s post-tax profit with the AD duty that is contingentof the dumping margin, d = r H − (r F − τ ), isΠ0M = (1 − t H )[(r H − c M ) x MH + (r F − c M − τ − d) x MF + π MH ] + (1 − t F )π MF − C (r F ). (12)It is optimal for the MNE to set r H and r F such that d = 0 holds, yielding the following
equilibrium wholesale prices:
AD
N
rH
= rH
− θd N ,where θ ≡andAD
r FAD = r H+ τ = r FN + (1 − θ )d N ,(13)9δ+4{3(1−t H )−2(1−t F )}(θ ∈ (0, 1)) is the extent of price adjustments in country H
9δ+8{2(1−t H )−(1−t F )}given d N . Appendix A.1 explains why the MNE facing AD protection prefers to eliminate thedumping margin.
N and increasing
Thus, the MNE eliminates the dumping margin by decreasing r H from r H

r F from r FN . The degree of the price adjustments is proportional to the dumping margin underno AD protection, d N . The increase in r F reduces the effectiveness of transfer pricing and the
MNE’s profits shifted from the high-tax country (country H) to the low-tax country (country
F). It also makes firm MF less aggressive in country F’s market, though it makes firm M H
more aggressive in country H’s market. Therefore, AD protection has a role to discourages
the MNE’s tax avoidance and weakens the MNE’s strong position in the product market incountry F.

3Decisions on AD protection

We have analyzed the condition under which the MNE’s pricing generates a positive dumping
margin and how AD protection eliminates the price gap between the countries. This section
analyzes government F’s decision to implement AD protection in stage 1.
11

Since a lower export price of the MNE hurts firm F, ∆π F = π FAD − π FN > 0 holds and firm
F always prefers AD protection. In contrast, the AD protection increases the price in country
F and worsens the consumer surplus. Moreover, the tax revenues decrease because firm MF
earns less profits in country F. We can confirm that these losses in consumer surplus and tax
revenues always dominate the profit gains of firm F, implying that ∆WF = WFAD − WFN < 0.
Therefore, a welfare-maximizing government never implements AD protection. Hence,a political-economy consideration in implementing AD protection should be introduced.
Specifically, the objective function of government F in implementing AD protection is givenby:
GF = γWF + (1 − γ)(1 − t F )π F ,(14)where γ ∈ [0, 1] is a political weight of the government in country F on the social welfare.
The government maximizes social welfare when γ = 1, and it places more weight on the
post-tax profit of the local firm as γ approaches zero. The “government surplus” under no
AD protection and under AD protection are given by GFN = γWFN + (1 − γ)(1 − t F )π FN and
GFAD = γWFAD + (1 − γ)(1 − t F )π FAD , respectively. Thus, given that the dumping marginunder no AD case is positive (i.e., δ < δd ), the government in country F implements AD
protection ifb≡∆GF ≡ GFAD − GFN ≥ 0 ⇐⇒ γ ≤ γ(1 − t F )∆π F(1 − t F )∆π F − ∆WF(15)b < 1. Thus, an AD protection needs a sufficiently low
holds. Since ∆WF < 0 always holds, γ
weight of government F on the welfare.
Proposition 2. Given that the dumping margin under no AD protection is positive, d N > 0,
the importing country implements AD protection if the government’s weight on social welfare
b , where γ
b is the cut-off level.
is sufficiently low to satisfy γ ≤ γ

3.1Regulations on transfer pricing and AD protection

How does an incentive to implement AD protection associate with regulations on transfer
pricing? As explained above, δ captures the stringency of the ALP. We can confirm that∂bγ∂δ > 0 holds (see Appendix A.2 for the detailed calculation).

As δ becomes larger, the tax-

avoidance motive becomes lower and the MNE’s transfer price becomes higher. As a result,the dumping margin becomes smaller and the extent of the welfare loss of AD protection,|∆WF |, becomes smaller. Although the smaller dumping margin also decreases the profit
12Figure 2: The stringency of the ALP and AD protection
gains from AD protection, ∆π F , the former effect dominates the latter and a more stringentb takes the minimum value
regulation on transfer pricing makes AD protection more likely. γ
denoted by γ at δ = 0 and the maximum value (γ) at δ = δd . If γ > γ, the dumping marginis negative and AD protection can never occur.
b is presented in Figure 2. For instance, suppose that the
The relationship between δ and γb and the government
combination of δ and γ is initially at the point A1 . At this point, γ > γ
F does not implement AD protection. Starting from A1 , if the enforcement of the ALP isb holds and the government F implements
tightened and δ is increased from A1 to A2 , γ < γAD protection. Thus, a stricter rule on transfer pricing can trigger the AD protection of the
low-tax country. However, a further increase in δ to the point A3 prevents AD protection
because the dumping margin is negative.
The following proposition summarizes the effects of a stronger enforcement of the ALP
on the incentive to implement AD protection.
Proposition 3. Given that the dumping margin under no AD protection is positive, a strongerb.
enforcement of the ALP increases γ
The proposition implies that a stronger enforcement of ALP makes AD protection more
likely as it increases the threshold level of the government weight on social welfare, underwhich country F implements AD protection.

13

Figure 3: Welfare effects of stricter ALP

3.2

Welfare effects

We have investigated the effects of an increase in δ on the decisions of implementing AD
protection. Here, we analyze how changes in the enforceability of the ALP affect the social
welfare of the countries. The welfare of country H is given by (7) and the world welfare is
W = WH + WF .
By transforming (15), we can define a thresholds δγ (depicted as the left-vertical line ineach figure), above which the government F implements AD production given d N > 0. As
δd is the threshold level above which the dumping margin is negative, the range δ ∈ [δγ , δd ]represents the case with AD protection. The dumping margin becomes negative and country
F cannot implement AD protection when no dumping is realized when δ > δd holds.
Figure 3 illustrates a numerical example of the welfare effects of a stricter regulation ontransfer pricing.16 The figure on the left represents the welfare change in country H andthe figure on the right shows the changes in the world welfare. At δ = 0, the equilibrium
regime becomes no AD protection. Then, an increase in δ increases the welfare of country H
because it increases r FN and country H earns a higher tax revenues without affecting consumer
surplus and the local firm’s profit in country H. If an increase in δ reaches δγ , country F
implements AD protection and discretely increases WH . This is because the AD protection
increases the transfer price (r F ) and shifts a part of the tax revenue from country F to country
16 The parameters are set at a = 1, c

1
1
1
3
3
1
M = 16 , c = 8 , τ = 3 , γ = 4 , t H = 10 , and t F = 10 .

14

H. Additionally, because the AD protection decreases the internal price (r H ), it increases theconsumer surplus in country H. Although a lower r H intensifies the competition between
firm H and the MNE and decreases the joint profits of these firms, the consumers’ gains
always dominates the firms’ losses.
From δ = δγ , a further increase in δ can either increase or decrease the welfare of country
H. On one hand, a larger δ under AD protection increases r FAD and recovers more tax revenues
AD because it decreases the dumping
from country F. On the other hand, it also increases r Hmargin under no AD protection and, thereby, diminishes the degree of price adjustments,
AD hurts the consumers in country H. The former effect improvesθd N .17 The increase in r H

WH , while the latter effect worsens it. In the numerical examples of Figure 3, a larger δ
decreases WH , implying that, once country F applies AD protection, a further enforcement of
the ALP may hurt the high-tax country.
However, once δ becomes higher than δd , country F can no longer implement AD protection because the dumping margin is negative, in which case, an increase in δ only raisesr F and it always improves country H’s welfare. The results suggests that a small increase inδ that triggers the foreign country’s AD protection helps prevent tax avoidance. A further
increase in δ, however, decreases the country H’s welfare unless δ is high enough to eliminate
the positive dumping margin.
Moreover, we can also confirm that AD protection improves the world welfare. Although
the welfare of country F decreases with AD protection, the loss is dominated by the positive
welfare gains in country H. Intuitively, the MNE’s price adjustments due to the AD protection
increases the equilibrium supply and lowers the price in country H, while it decreases the
supply and raises the price in country F. Because of the trade costs, the effective market
size of country F is smaller than that of country H. Accordingly, the consumers’ gains incountry H dominate that in country F. In addition, as the MNE has a cost advantage over the
local firms, its increase in the market share in country H improves the overall efficiency of
production. Conversely, the overall efficiency in country H becomes worse but its magnitude
is lower because the effective market size is lower in country F. As in WH , an increase in δ
under AD protection can worsen the world welfare, while always improving it under no AD
protection.
17 Specifically, we have ∂ ( θd N ) = −18 (1−t H )( a+c−τ −2c M )+2(t H −t F )( a+c−2τ −2c M ) < 0.
∂δ
[9δ+8{2(1−t H )−(1−t F )}]2

15

4

Trade liberalization

It is also interesting to explore how trade liberalization in terms of a reduction in trade costsγaffects country F’s incentive to implement AD protection. We can confirm that ∂b∂τ > 0 holds.

By (10), the dumping margin decreases in trade costs, τ. This is because a higher τ reduces
the effective market size of country H, thereby weakening the tax-avoidance and strategic
motives to lower the MNE’s transfer price.
Proposition 4. Given that the dumping margin under no AD protection is positive, tradeb.
liberalization decreases γ
We can reformulate the condition as,
d N > 0 ⇐⇒ τ < τd ≡3{8(t H − t F ) − 3δ}( a + c − 2c M ).
8{1 − t F + 3(t H − t F )}The negative relationship between trade costs and the dumping margin differs with therelated literature, such as Mukunoki (2021). In the literature, exporting firms directly sell
their products to foreign countries. Therefore, these firms set lower export prices in response
to higher trade costs to absorb a part of the tariff burden to mitigate the negative profit effectfrom higher consumer prices. The imperfect pass-through of trade costs on consumer prices
generates the positive relationship between τ and d in the studies.
By contrast, the exporter’s dumping in our model is tax-induced, and the prices the exporter charges in the home and foreign countries are wholesale prices paid by the MNE’sdistribution affiliates. As τ becomes larger, the cost of the foreign affiliate becomes larger
and its sales become smaller. Then, the MNE has a less incentive to lower its transfer pricebecause a higher cost of the foreign affiliate weakens the profit gains from avoiding the hightax and motivating the foreign affiliate.
Figure 4 depicts the equilibrium outcomes in the (τ, γ) locus. Similar to the change inδ, a higher τ makes the AD protection more likely. For instance, a decrease in τ from B1
to B2 transforms an initially negative dumping margin into a positive dumping margin, andit changes the equilibrium outcome from no AD protection to AD protection. A further
decrease in τ from B2 to B3 makes the equilibrium outcome revert to no AD protection. Thisis because lower trade costs raise the dumping margin, thereby increasing the welfare cost of
AD protection in country F.
16

Figure 4: Trade liberalization and AD protection

5

Conclusion

Increases in intra-firm trade and MNEs’ manipulations of transfer prices has been an important issue in the world economy. Meanwhile, countries frequently apply AD measures toprotect the domestic firms. Although the prices of intra-firm trade are sometimes subject to
AD investigations, no theoretical studies have considered the effects of AD protection targeting the dumping caused by MNEs’ manipulations of transfer prices. A difference in corporate
taxes gives MNEs incentives to set low transfer prices than the corresponding domestic prices,
thereby becoming a reason for their dumping. Therefore, AD protection can prevent MNEs’
tax avoidance by limiting the tax-induced dumping.
This study has investigated the connection between tax policies and AD policies in aninternational oligopoly model. The results suggest that a tighter enforcement of regulations
on transfer pricing can trigger AD protection of the importing country, because a smaller
dumping margin reduces the welfare cost of AD protection and encourages the importing
country to implement AD protection. The AD protection serves as a tool to prevent the
MNE’s tax avoidance, which complements tighter regulations on transfer pricing.
This induced AD protection improves the welfare of the exporting country because of
the larger tax revenue collected and the MNE’s price adjustments benefit consumers in the17

exporting country. This also improves the world welfare because the price adjustments of
the MNE realize a more efficient allocation of the goods between countries. When AD protection is in effect, a further increase in the stringency of the regulations on transfer pricing
may worsen the exporting country’s welfare and world welfare. If the stringency of the regulations becomes a large enough, the dumping margin becomes negative and an increase in
the stringency improves the exporting country’s welfare as well as the world welfare. These
results suggest that, if countries face difficulty to crackdown on MNEs’ tax avoidance, AD
protection in low-tax countries can be an effective tool to recover the tax revenues in high-tax
countries. This effect has not been explored in the literature.
Although this study highlights the link between trade policy and tax avoidance activities
of MNEs, there is room for further research. First, we have assumed that the AD protection
leads to the MNE’s price adjustments to avoid AD duty. However, the MNE may choose
an advance pricing agreement on transfer pricing with tax authorities in advance. Second,as both AD protection and MNEs’ tax avoidance have been intensively observed in R&D
intensive industries, it is interesting to consider how tax policies and AD policies affect firms’
R&D activities. Third, we need empirical supports on the impact of AD protection on transfer
pricing.

18

Appendix
A.1 The MNE’s pricing under AD protection
In our model, we have supposed that the MNE facing AD protection sets a uniform price to
avoid AD duty. The MNE may still discriminate prices to avoid high taxes and take advantage
of strategic effects, even though AD duty is imposed.
However, we can confirm that this alternative action is not optimal for the MNE. By
substituting d = r H − r F + τ into (12), the profits of the MNE with AD duty can be rewrittenas:Π0M = (1 − t H ){( p H − c M ) x MH + (r F − c M ) x MF } + (1 − t F )( p F − r H − 2τ ) x MF .
Because we can confirm that

∂Π0M
∂r F

> 0 holds, the MNE sets r F as high as possible as long as

d > 0. Therefore, the optimal r F must satisfy d = r H − (r F − τ ) = 0.
The intuition behind this is simple. Even if the MNE lowers the transfer price for the
tax avoidance and strategic motives under AD protection, the decrease of the transfer priceincreases the AD duty by the same amount. Therefore, the marginal cost of the distributionaffiliate in country F does not change and such a decrease in the transfer price neither affects the distribution affiliate’s decision nor its post-tax profits, while the AD duty obviously
reduces the profits of the MNE.

A.2 Proof of proposition 3
From eq.(15), we have,b=γ

2(1 − t F )( x FAD + x F )2(1 − t F )(1 − t F )∆π F
=
=
AD
AD
(1 − t F )∆ F − ∆WF
1 − 2t F + X(1 − 2t F )( x F + x F ) + (1 + 4t F )( x MF + x MF )

where

X≡

AD + xx MF
MF.
ADxF + xF

First, the effect of transfer pricing regulation is computed as,∂bγ2(1 − t F )(1 + 4t F ) ∂X=−.
∂δ
(1 − 2t F + X )2 ∂δ
AsAD + x2( x FAD + x F ) + x MF
∂X
MF
=−
∂δ
3( x FAD + x F )219

∂(r FAD + r F )
∂δ



and
∂(r FAD + r F )(1 + t H − 2t F )( a + c − 2c M − 2τ ) + (1 − t H )τ4{3(1 − t H ) − 2(1 − t F )}
=
+
>0
2
∂δ
[9δ + 8{2(1 − t H ) − (1 − t F )}][9δ + 4{3(1 − t H ) − 2(1 − t F )}]2
γhold, ∂b∂δ > 0 is obtained.

Likewise, we have2(1 − t F )(1 + 4t F ) ∂X
∂b
γ
=−
> 0,
∂τ
(1 − 2t F + X )2 ∂τbecauseAD + x2( x FAD + x F ) + x MF
∂X
MF
=−
AD
2
∂τ
3( x F + x F )∂(r FAD + r F )
∂τ



and
∂(r FAD + r F )2(1 + 3t H − 4t F )3{2(1 − t H ) + 3δ}
=
+1+
> 0.
∂τ
9δ + 8{2(1 − t H ) − (1 − t F )}9δ + 4{3(1 − t H ) − 2(1 − t F )}The above computation concludes Proposition 3. 20

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