  Do low corporate taxes always favor multinational production over economic
integration? We propose a two-country model in which multinationals choose the
locations of production plants and foreign distribution affiliates and shift
profits between them through transfer prices. With high trade costs, plants are
concentrated in the low-tax country; surprisingly, this pattern reverses with
low trade costs. Indeed, economic integration has a non-monotonic impact:
falling trade costs first decrease and then increase the plant share in the
high-tax country, which we empirically confirm. Moreover, allowing for transfer
pricing makes tax competition tougher and international coordination on
transfer-pricing regulation can be beneficial.
