The Effect of Global Tax Differentials On US MNC’s Business Decisions
US MNCs have been expanding operations all over the globe to utilize lower labour costs and other advantages for a long time now. Moving operations abroad is now so common in large US firms that for a corporation to be multinational is now the norm rather than the exception. Examined closely, we can see that there are many factors which influence a firm’s decision on whether to go multinational as well as on where to invest its capital. One reasonable and highly researched factor is that of tax rates in foreign countries and their effect on US MNC’s decisions to invest. In this paper, I examine some academic literature focused on answering this question. To keep findings consistent, I have limited my discussion to studies on US Treasury data focusing on the investment decisions of MNC’s in the early late 1980’s and early 990’s years. I focus my discussion on answering five related questions: Firstly, is US MNC’s investment decision sensitive to foreign effective tax rates? If so, what exactly is the correlation between the location of capital investment and the foreign tax rates? Thirdly, I ask if this correlation has been fluctuating in a particular direction recently. The fourth concern I address is whether the corporations choose to shift income to take advantage of lower tax rates in certain jurisdictions. Finally, I briefly address the issue of MNC’s using transfer pricing to shift income ‘on paper’ to avoid taxes in high tax jurisdictions.
A recent research study by economists Harry Gruber and John Mutti addresses the relationship between taxes and US MNC’s investment decisions using US Corporate Tax data from 1992. The study, titled “Do Taxes influence where US Corporations Invest?” sets out to determine if there is indeed a correlation between tax rates and location. The study uses data from U.S. Treasury 1992 corporate tax files covering the activities of more than 500 major U.S. Manufacturing companies in 60 potential foreign locations. The results of the study are based on each different country location. The paper conducts a cross-sectional analysis of the relationship between real capita stock and local tax rates. The overall findings of the study indicate that, for host countries with open trading regimes, total real capital investment is highly elastic with respect to the host country’s effective tax rates. The data point out that, for an after-tax revenue increase of 1% for an MNC due to the host country’s reduction in tax rate, an increase in capital investment of 3% is seen in that location. The results continue to hold even after tax havens and very poor countries have been excluded from the sample. One potential pitfall for error in this study was that only tax data from the year 1992 was considered. To control for this factor, the researchers also represented the tax data by an average for the years 1990 through 1992. The results for this data are again consistent with the initial findings. The study concludes that host country effective tax rates have a highly significant effect on the location and investment decisions of U.S. manufacturing companies abroad.
In the previous discussion we concluded, based on research evidence, that US MNC’s location decisions are in fact sensitive to foreign country tax rates. It naturally follows from the discussion that we analyse just how sensitive their decisions are to foreign tax rates. A recent study conducted by Altshuler, Grubert and Newlon entitled “Has US Investment Abroad Become More Sensitive to Tax Rates?” focuses to probe this issue further to provide a more detailed answer to the question. The study uses aggregate data from US Corporate Tax return files for the years 1984 and 1992 to study this question. The two different data sets allow the researchers to control for noise associated with studying any particular year’s data. The data examined in the...
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