Sophisticated Pricing Techniques

Discussion on Most US Firms Paid No Taxes Over 7-Year Span” by Carolyn Said (SF Gate, August 2008)

In Carolyn Said’s article “Most US firms paid no taxes over 7-year span” published in August 2008, Said reveals that about two-thirds of US companies and foreign firms doing business in the US paid no federal income taxes from 1998 to 2005. Although many of these companies were small or new companies who probably were not profitable, a surprising number of large companies did not pay any income taxes.  The US tax system has the second highest corporate tax rate of any developed country, but due to the complicated tax laws, there are many loopholes that companies can use to evade taxes. One of these methods is transfer pricing. Transfer pricing occurs when a parent company is incorporated offshore where there is no tax. The parent company will then charge its US subsidiary large amounts for the use of the corporate logo or trademark. The US subsidiary then reports no income or a loss on the year, due to the fact that they had huge expenses. Transfer pricing and other tax evasion techniques are responsible for a low effective tax rate in the US.

Transfer pricing can be seen as sophisticated pricing techniques on a larger scale. Just as the sophisticated pricing techniques we discuss in class are largely used to increase profits, transfer pricing is used to protect that profit and decrease the loss incurred by taxes. The goal of both is to increase profits. Of course transfer pricing as referred to in this article is a very large-scale tax evasion technique that exploits regular transfer pricing. Regular transfer pricing involves the cost of transferring a product between a company’s divisions.  This transfer pricing just changes the company’s divisions to the company’s subsidiary companies that are subject to different tax rates.

As the article states, most corporations and individuals find loopholes in taxes to minimize the amount they pay.  This saves corporations money and allows them to keep more of their profit. Similarly individuals file taxes and get the most deductions that they can so they can keep more of their income.  This practice is legal, unless a person or corporation takes it beyond the scope of the law, but is this practice ethical?  With so many firms and individuals taking deductions it would be more beneficial to lower the tax rate as a whole, as the article suggests, than allowing all of the tax breaks.  As the article states, the US has the 2nd highest corporation tax rate in the world, and is tied for 4th to last for amount of revenue raised through corporate taxes.  Through the practice of getting deductions firms gain more profit, giving them a competitive advantage.  Firms have the right to work toward a competitive advantage and doing transfer pricing is a way to achieve this goal. 

Another real world example of sophisticated pricing techniques is a 3rd degree price discrimination, where firms charge different groups of consumers different prices for the same good due to differences in elasticities of demand.  For example, in a city the more affluent area of the city is more willing to pay higher gas prices than the less affluent end of the city.  This is because consumers in the less affluent part of the city have a lower reservation price for gas, and therefore demand for gas is more elastic in that part of town.  The differences in elasticity in different parts of town allow for gas companies to charge more for gas in the parts of town that have a higher elasticity of demand.

Posted by Grace, Chrissie, and Jeff (Section 4)

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