The Three Parties in the Race to the Bottom: Host Governments, Home Governments and Multinational Companies

Most studies of tax competition and the race to the bottom focus on potential host countries competing for mobile capital, neglecting the role of corporate tax planning and of home governments that facilitate this planning. This neglect in part reflects the narrow view frequently taken of the policy instruments that countries have available in tax competition. But high-tax host governments can, for example, permit income to be shifted out to tax havens as a way of attracting mobile companies. Home countries will cooperate in this shift if their companies’ gain is greater than any reduction in the domestic tax base. We use various types of U.S. data, including firm level tax files, to identify the role of the three parties (host governments, home governments and MNCs) in the evolution of tax burdens on U.S. companies abroad from 1992 to 2002. This period is of particular interest because the United States introduced regulations in 1997 that greatly simplified the use of more aggressive tax planning techniques. The evidence indicates that from 1992 to 1998 the decline in effective tax rates on U.S. companies was driven largely by host governments defending their market share. But after 1998, tax avoidance behavior seems much more important. One indication is that effective tax rates on U.S. companies had a much weaker link with local statutory tax rates. After 1997, the new regulations motivated a very large growth in intercompany payments and a parallel growth of holding company income abroad. We attempt to estimate how many of these payments were deductible in the host country, and conclude that by 2002 the companies were saving about $7.0 billion per year by using the more aggressive planning strategies. This amounts to about 4 percent of companies’ foreign direct investment income and about 15 percent of their foreign tax burden.

Repatriation Taxes, Repatriation Strategies and Multinational Financial Policy

Several investment-repatriation strategies are added to the standard model of a multinational in which an affiliate is located in a low-tax country and is limited to two alternatives: repatriating taxable dividends to the parent or investing in its own real operations. In our model, affiliates can invest in passive assets, which the parent can borrow against, or in related affiliates which can be used as vehicles for tax-favored repatriations. We show analytically how the availability of alternative strategies can effect real investment throughout the worldwide corporation. We use firm level data for U.S. multinationals to test for the importance of alternative strategies. The evidence is generally consistent with the theory, particularly the strategies using related affiliates.

Corporate taxes in the world economy: reforming the taxation of cross-border income

Proposals for the reform of the taxation of cross-border income are evaluated within the general context of the corporate tax in an open economy. We focus on the various behavioral decisions that can be affected such as the location of income and its repatriation. The two income tax proposals considered are: (1) dividend exemption and (2) burden neutral worldwide taxation in which all foreign subsidiary income is included currently in the U.S. worldwide tax base, and at the same time the corporate tax rate is lowered and overhead allocations to foreign income are eliminated so as to keep the overall U.S. tax burden on foreign income the same. We also consider the attractiveness of destination-based and origin-based consumption taxes. Our evaluation of reform options makes use of the best available information. We also present new information on the burden of the current system. However, there are many important unknown behavioral parameters required to judge international tax systems and this missing information, some of which may ultimately be unknowable, makes it difficult to make definitive recommendations. The burden neutral worldwide option seems to offer greater efficiency gains among the two income tax options, particularly because of reduced incentives for income shifting which wastes resources and distorts effective tax rates on investment. To be sure, the burden neutral worldwide option would increase effective tax rates on investment in low-tax countries while not increasing the average U.S. tax rate on foreign source income. The option requires a substantial reduction in the U.S. corporate tax rate. We suggest that increased capital mobility makes changing the mix of corporate and personal level taxation of business income appropriate even apart from the special issues of cross-border taxation such as repatriation taxes and income shifting opportunities that are the main subject of the paper

The three parties in the race to the bottom: host governments, home governments and multinational companies

Most studies of tax competition and the race to the bottom focus on potential host countries competing for mobile capital, neglecting the role of corporate tax planning and of home governments that facilitate this planning. This neglect in part reflects the narrow view frequently taken of the policy instruments that countries have available in tax competition. For example, high-tax host governments can permit income to be shifted out to tax havens as a way of attracting mobile companies. Home countries will cooperate in this shift if they think the benefit to their companies is greater than any reduction in the domestic tax base. We use various types of U.S. data, including firm level tax files, to identify the role of the three parties (host governments, home governments and MNCs) in the evolution of tax burdens on U.S. companies abroad from1992 to 2002. This period is of particular interest because the United States introduced regulations in 1997 that greatly simplified the use of more aggressive tax planning techniques. The evidence indicates that from 1992 to 1998 the decline in effective tax rates on U.S. companies was driven largely by host governments defending their market share. But after 1998, tax avoidance behavior seems much more important. Effective tax rates on U.S. companies had a much weaker link with local statutory tax rates. Furthermore, the disparity in the reported profitability of subsidiaries in high-tax and low-tax jurisdictions grew substantially. After 1997, there was a very large growth in intercompany payments and a parallel growth of holding company income. We attempt to estimate how much of these payments were deductible in the host country, and conclude that by 2002 the companies were saving about $7.0 billion per year by using the more aggressive planning strategies. This amounts to about 4 percent of foreign direct investment income and about 15 percent of their foreign tax burden

Repatriation Taxes, Repatriation Strategies and Multinational Financial Policy

Several investment-repatriation strategies are added to the standard model of a parent and its affiliate in which the affiliate is located in a low-tax country and is limited to two alternatives: repatriating taxable dividends to the parent or investing in its own real operations. In our model, the subsidiary can invest in passive assets which the parent can borrow against, making any direct taxable flow to the parent unnecessary. The low-tax subsidiary can also use its earnings to invest in a related high-tax affiliate which becomes the vehicle for tax-free repatriations. Alternatively, the low-tax affiliate can be capitalized by equity injections through an upper-tier sibling. This reduces the tax on repatriations from the low-tax subsidiary because taxes at home on foreign source income are based on a blend of the siblings' tax rates. We show analytically how the availability of these strategies can effect real investment in the low-tax subsidiary and throughout the worldwide corporation. We use firm level data for U.S. multinational corporations to test for the importance of these alternative strategies. The evidence is generally consistent with the theory, particularly the 'triangular' strategies using related affiliates

Taxpayer Responses to Competitive Tax Policies and Tax Policy Responses to Competitive Taxpayers : Recent Evidence

We use information from the tax returns of U.S. multinational corporations to address three questions related to tax competition. First, does tax competition or company tax planning behavior better explain recent decreases in the local effective tax rates faced by U.S. multinationals investing abroad? Second, have countries become more aggressive in their use of tax concessions to attract particular types of foreign capital? And finally, has the role of taxes in the location decisions of U.S. manufacturers increased in recent years? Between 1992 and 2000, the average effective tax rate faced by U.S. manufacturers on income earned abroad fell from 25 percent to 21 percent. Our results suggest that the evolution of country effective tax rates between 1992 and 1998 seems to be driven by tax competition. Countries that lost shares of U.S. manufacturing real capital prior to 1992 cut their rates the most over this period. However, the most recent data suggests that companies may not need tax competition to lower effective tax burdens abroad. The evolution of country effective rates between 1998 and 2000 seems to be driven by company rather than country behavior. This is consistent with the introduction of the ?check the box? regulations in 1997 which made it easier for corporations to use ?self-help? to lower tax burdens. Interestingly, we find that countries were rewarding more mobile companies and those that were perceived to be more beneficial to the local economy with tax concessions as far back as 1984. Finally, although not conclusive, our empirical work suggests that U.S. manufacturers may have become more sensitive to differences in local tax rates across countries in recent years

Shifting the burden of taxation from the corporate to the personal level and getting the corporate tax rate down to 15 percent

We consider three plans for shifting the tax on corporate income to the personal level to achieve a significant reduction in the corporate tax rate. One plan eliminates the corporate tax and taxes dividends and the annual change in the value of publicly traded financial assets at ordinary rates. The second integrates corporate and shareholder taxes. The third lowers the corporate tax rate to 15 percent and taxes dividends and capital gains as ordinary income. To prevent large reductions in capital gains realizations and dividend payouts, an interest charge on taxes deferred during the holding period would be imposed when an asset is sold. We conclude that the third alternative is more robust than the other two

The three parties in the race to the bottom : host governments, home governments and multinational companies

Most studies of tax competition and the race to the bottom focus on potential host countries competing for mobile capital, neglecting the role of corporate tax planning and of home governments that facilitate this planning. This neglect in part reflects the narrow view frequently taken of the policy instruments that countries have available in tax competition. But high-tax host governments can, for example, permit income to be shifted out to tax havens as a way of attracting mobile companies. Home countries will cooperate in this shift if their companies? gain is greater than any reduction in the domestic tax base. We use various types of U.S. data, including firm level tax files, to identify the role of the three parties (host governments, home governments and MNCs) in the evolution of tax burdens on U.S. companies abroad from 1992 to 2002. This period is of particular interest because the United States introduced regulations in 1997 that greatly simplified the use of more aggressive tax planning techniques. The evidence indicates that from 1992 to 1998 the decline in effective tax rates on U.S. companies was driven largely by host governments defending their market share. But after 1998, tax avoidance behavior seems much more important. One indication is that effective tax rates on U.S. companies had a much weaker link with local statutory tax rates. After 1997, the new regulations motivated a very large growth in intercompany payments and a parallel growth of holding company income abroad. We attempt to estimate how many of these payments were deductible in the host country, and conclude that by 2002 the companies were saving about $7.0 billion per year by using the more aggressive planning strategies. This amounts to about 4 percent of companies? foreign direct investment income and about 15 percent of their foreign tax burden

Multinational Financial Policy and the Cost of Capital: The Many Roads Home

The previous literature on multinational financial policy has, for the most part, been restricted to the choice between dividend distributions to the parent and further real investment in the foreign affiliate. We argue that investment in financial assets such as the debt and equity of related affiliates or Eurodollar deposits, for example, offer multinationals attractive alternatives to dividend repatriation. We present theoretical models that illustrate how investment and financial incentives change when the possibility of investing in financial assets is added to the analysis. Our models depart from previous work in several important ways. We drop the standard arbitrage condition in which equity and debt are perfect substitutes from the viewpoint of the firm and instead impose a worldwide financial constraint consistent with a rising cost of debt finance. In our models, parents can borrow against financial assets held abroad and may allocate debt across locations to achieve the lowest cost of capital at home and abroad. We also consider the implications of models in which affiliates can invest in related affiliates in other foreign countries. We use firm level balance sheet data from controlled foreign corporations (CFCs) available in the Treasury tax files to test the implications of our models. Our regression results confirm the importance of tax considerations in explaining CFC holdings of financial assets. We also find that CFCs with more debt distribute more dividends. This provides evidence that greater dividend distributions do not necessarily imply lower real investment by CFCs