This paper considers the effect of taxation on the location of foreign direct investment (FDI) and taxable income reported by multinational firms. Confidential affiliate–level data are used to compare the investment and income–reporting behavior of American–owned foreign affiliates. Ten percent higher tax rates are associated with 5.0 percent lower FDI, controlling for parent company and observable aspects of local economies, and 0.66 percent lower returns on assets, controlling for parent company and level of FDI. Tax effects are particularly strong within Europe, where ten percent higher tax rates are associated with 7.7 percent lower FDI and 1.4 percent lower returns on assets. Indirectly owned foreign affiliates exhibit even stronger tax effects, ten percent higher tax rates being associated with 15.3 percent lower FDI and 1.6 percent lower returns on assets. American firms finance a growing fraction of their foreign operations indirectly through chains of ownership, which now account for more than 30 percent of aggregate foreign assets and sales. Ownership chains are particularly concentrated among European affiliates. Since multinational firms from countries other than the United States face tax environments similar to those faced by indirectly owned affiliates of American companies, these results suggest a greater sensitivity of FDI to taxes for non–American firms. The results also suggest that European economic integration may have the effect of intensifying tax competition between European jurisdictions.
578_chains_of_ownership.pdfThis paper investigates the determinants of corporate expatriations. American corporations that seek to avoid U.S. taxes on their foreign incomes can do so by becoming foreign corporations, typically by "inverting" the corporate structure, so that the foreign subsidiary becomes the parent company and U.S. parent company becomes a subsidiary. Three types of evidence are considered in order to understand this rapidly growing practice. First, an analysis of the market reacton to Stanley Works's expatriation decision implies that market participants expect its foreign inversion to be accompanied by a reduction in tax liabilities on U.S. source income, since savings associated with the taxation of foreign income alone cannot account for the changed valuations. Second, statistical evidence indicates that the large firms, those with extensive foreign assets, and those with considerable debt are the most likely to expatriate – suggesting that U.S. taxation of foreign income, including the interest expense allocation rules, significantly affect inversions. Third, share prices rise by an average of 1.7 percent in response to expatriation announcements. Ten percent higher leverage ratios are associated with 0.7 percent market reactions to expatriations, reflecting the benefit of avoiding the U.S. rules concerning interest expense allocation. Shares of inverting companies typically stand only at 88 percent of their average values of the previous year, and every ten percent of prior share price appreciation is associated with 1.1 percent greater market reaction to an inversion announcement. Taken together, these patterns suggest that managers maximize shareholder wealth rather than share prices, avoiding expatriations unless future tax savings – including reduced costs of repatriation taxes and expense allocation, and the benefits of enhanced worldwide tax planning opportunities – more than compensate for current capital gains tax liabilities.
576_expectationsandexpatriations.pdfThis paper analyzes the determinants of partial ownership of the foreign affiliates of U.S. multinational firms and, in particular, why partial ownership has declined markedly over the last 20 years. The evidence indicates that whole ownership is most common when firms coordinate integrated production activities across different locations, transfer technology, and benefit from worldwide tax planning. Since operations and ownership levels are jointly determined, it is necessary to use the liberalization of ownership restrictions by host countries and the imposition of joint venture tax penalties in the U.S. Tax Reform Act of 1986 as instruments for ownership levels in order to identify these effects. Firms responded to these regulatory and tax changes by expanding the volume of their intrafirm trade as well as the extent of whole ownership; four percent greater subsequent sole ownership of affiliates is associated with three percent higher intrafirm trade volumes. The implied complementarity of whole ownership and intrafirm trade suggests that reduced costs of coordinating global operations, together with regulatory and tax changes, gave rise to the sharply declining propensity of American firms to organize their foreign operations as joint ventures over the last two decades. The forces of globalization appear to have increased the desire of multinationals to structure many transactions inside firms rather than through exchanges involving other parties.
575_international_joint_ventures.pdfHarvard Business School Working Paper 03-017, July 2002.
This paper argues that cross–border human capital flows from developing countries to developed countries over the next half–century will demand a new set of policy responses from developing countries. The paper examines the forces that are making immigration policies more skill–focused, the effect of both flows (emigration) and stocks (diasporas) on the source countries, and the range of taxation instruments available to source countries to manage the consequences of those flows. This paper emphasizes the example of India, a large source country for human capital flows, and the United States, an important destination for these human capital flows and an example of how a country can tax its citizens abroad. In combination, these examples point to the significant advantage to developing countries of potential tax schemes for managing the flows and stocks of citizens who reside abroad. Finally, this paper concludes with a research agenda for the many questions raised by the prospect of large flows of skilled workers and the policy alternatives, including tax instruments, available to source countries.
559_kapuretalworkingpaper.pdfWCFIA Working Paper 02–06, September 2002.