Final answer:
The IRS can make transfer pricing adjustments when related party transactions do not adhere to arm's length standards, potentially altering income tax revenues.
Step-by-step explanation:
The Internal Revenue Service (IRS) can make transfer pricing adjustments in circumstances where transactions between related parties (such as subsidiaries within a multinational company) are not conducted at arm's length or market value. The IRS scrutinizes such transactions to ensure that profits are not improperly shifted to low-tax jurisdictions, thereby minimizing the company's tax burden. Specifically, adjustments are made when the transfer pricing does not comply with the arm's length principle, which requires that the terms and conditions of intra-company transactions mirror those that would be made between independent entities under similar circumstances.
Economist Arthur Laffer posited that in certain situations, income tax revenue can increase when tax rates decrease. This can occur due to an incentivization effect where lower rates encourage more economic activity, leading to a broader tax base. This idea is embodied in the Laffer Curve concept, suggesting that there is an optimal tax rate that maximizes revenue without deterring economic growth.