Should we tax the foreign profits of American multinationals?

“Tax policy toward American multinational firms would appear to be approaching a crossroads. The presumed linkages between domestic employment conditions and the growth of foreign operations by American firms have led to calls for increased taxation on foreign operations - the so-called end to tax breaks for companies that ship our jobs overseas. At the same time, the current tax regime employed by the U.S. is being abandoned by the two remaining large capital exporters - the UK and Japan - that had maintained similar regimes. The conundrum facing policymakers is how to reconcile mounting pressures for increased tax burdens on foreign activity with the increasing exceptionalism of American policy.

This paper address these questions by analyzing the available evidence on two related claims - i) that the current U.S. policy of deferring taxation of foreign profits represents a subsidy to American firms and ii) that activity abroad by multinational firms represents the displacement of activity that would have otherwise been undertaken at home.

These two tempting claims are found to have limited, if any, systematic support. Instead, modern welfare norms that capture the nature of multinational firm activity recommend a move toward not taxing the foreign activities of American firms, rather than taxing them more heavily. Similarly, the weight of the empirical evidence is that foreign activity is a complement, rather than a substitute, for domestic activity.

Much as the formulation of trade policy requires resisting the tempting logic of protectionism, the appropriate taxation of multinational firms requires a similar fortitude.”

Mihir A. Desai, Abstract of “Securing Jobs or the New Protectionism? Taxing the Overseas Activities of Multinational Firms”, Harvard Business School Finance Working Paper, No. 09-107 (20 March 2009).

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1365907

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)


Mihir A. Desai is a professor at the Harvard Business School.

A key policy question now before many countries is what to do with the corporate profits tax, both on domestically generated profits and those attributable to foreign operations. For the past 25 years across the world the statutory corporate income tax rate has been lowered in country after country. In 1982, the average corporate income tax rate in OECD member countries was almost 50 per cent. By 2000, the average had fallen to 33.6 per cent, and by 2007 it had fallen further to 27.6 per cent.

The long-term decline in the average corporate tax rate reflects two concerns. Business taxes in general tend to be distortionary of economic efficiency because they are not applied proportionately across all products and are shifted forward to consumers and backward to stakeholders in ways that cannot be easily assessed. In addition, a high corporate income tax rate reduces the international competitiveness of a country, and income and employment are lost when multinationals leave to establish operations in a more business-friendly country. In an era of globalization, large corporations are not only mobile in their production activities but may raise needed capital internationally, which loosens their ties to their “home” country. One might add that at a time of financial turmoil, many countries are concerned about the financial health of their corporations, and a more favorable treatment of corporate income strengthens them to survive in a much more competitive international trading environment.

At almost 40 per cent, the U.S. corporate tax rate remains among the highest in the world, with only Japan imposing a slightly higher rate than the United States. The distance between the American and Japanese rates and those of other countries can be large.

The President has recently called attention to what he called “off-shore tax havens” and proposes eliminating corporate “tax loopholes” and “tax havens” for high-income Americans. It is difficult to see how making an already unfriendly business environment even more unfriendly is likely to stem the flow of incomes and jobs abroad. Moreover, as Desai points out, the foreign operations of American firms are an integral part of their domestic operations, and help keep their production costs low. Increasing the tax burden of American corporations and interfering with their decisions about how to organize their production can only increase their costs and reduce their competitiveness at home and abroad.

In a word, the Administration’s policy is stupid.