Volume 9 • 2022 • Number transnational corporations investment and development

6.4. Bilateral profit shifting shares post-Pillar Two: 
γ′
ch
We adopt two scenarios to model bilateral profit shifting shares after Pillar Two 
(section 4.3). The upper bound scenario is straightforward. As profit shifting 
vanishes after the reform,
we
set
γ′
ch
= 0 for all
h ≠ c.
The
baseline
scenario
assumes
that the reform partially reduces profit shifting and thus requires a careful 
empirical calibration of the linear coefficients 
β
1
and 
β
2
in (6).
Laffitte et al. (2021) incorporate corporate income taxation and profit shifting in a 
quantitative trade model and derive a gravity equation for bilateral profit shifting 
flows. Drawing on their contribution, we regress bilateral profit shifting shares on 
the ETR of the FDI host country, the ETR of the OFC, and a vector of gravity-type 
determinants. The latter embeds four bilateral variables all sourced from CEPII, 
namely: (i) bilateral distance (in km and logarithm); (ii) a contiguity dummy; (iii) a 
common language dummy; and (iv) a colonial history dummy. Gravity controls 
allow us to neutralize, to the extent possible, variations in bilateral profit shifting 
shares not attributable to ETRs in host countries and OFCs:
13
ETR

CO
c
=
1
π
∗
lrg
,
c
π
∗
lrg
,
c
−
CO
c
ETR

c
+
CO
c
ETR
c
(7)
= (1
−
CO
SHARE
c
)
ETR

c
+
CO
SHARE
c
ETR
c
∆
ETR
FDI
,
CO
lrg
,
c
=
∆
ETR
FDI
lrg
,
c
−
CO
SHARE
c
(
ETR

c
−
ETR
c
)
(8)
∆
ETR
FDI
,
CO
c
=
ω
c
∆
ETR
FDI
,
CO
lrg
,
c
(9)