Why U.S. Multinationals May Increase Profit-shifting

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Zheli He from the Penn Wharton Budget Model speaks with Wharton Business Daily on SiriusXM about proposals for increasing the tax rate on U.S. corporations’ foreign income.

Reforms proposed by the House Ways and Means Committee would more than triple the U.S. tax rate on multinationals’ foreign income from around 2.1% under current law to 7.4%, according to a brief from the Penn Wharton Budget Model. If the U.S. instead adopted a draft OECD proposal, U.S. multinationals would pay a residual U.S. tax rate of 6.1% (total taxes less credits), the brief added. The U.S. is currently the only OECD country that imposes a minimum tax on the foreign income of its multinationals.

“[The House proposals] would have important consequences for U.S. multinationals’ profit-shifting incentives, and also their competitiveness in the world,” said PWBM economist Zheli He in a recent interview on the Wharton Business Daily radio show on SiriusXM. (Listen to the full podcast here). She co-authored the PWBM brief with Alexander Arnon, associate director of policy analysis at PWBM.

“The scale of profit-shifting [by U.S. multinational companies] has increased dramatically in the past decade,” He noted. Income of U.S. multinationals in tax havens has more than doubled from $120 billion to $250 billion between 2010 and 2018, and much of that income appears to have been shifted from the U.S., she added.

The House proposals are part of a budget reconciliation plan aimed at raising $2.9 trillion in revenue to finance President Joe Biden’s $3.5 trillion economic package that is now making its way through Congress. The Committee on Ways and Means is the chief tax-writing committee in the House of Representatives with jurisdiction over revenue and related issues such as tariffs, reciprocal trade agreements, and the bonded debt of the U.S., according to GovTrack.

The OECD on October 8 announced that it had secured agreement from 136 countries for a global agreement to ensure that multinational enterprises pay a minimum tax rate of 15% from 2023 and to make it harder for them to avoid taxation. Kenya, Nigeria, Pakistan, and Sri Lanka did not join the agreement. The proposal will be delivered to the G20 Leaders’ Summit in Rome on October 29-30.

“The scale of profit-shifting [by U.S. multinational companies] has increased dramatically in the past decade.” –Zheli He

“[The agreement will ensure] that these firms pay a fair share of tax wherever they operate and generate profits,” the OECD statement noted. The deal is estimated to generate around $150 billion in additional global tax revenues annually, and it will reallocate more than $125 billion of profits from around 100 of the world’s largest and most profitable multinational enterprises to countries worldwide, the statement added.

The House proposal would increase the incentive for U.S. multinationals to shift intangible investments and profits to foreign countries with a tax rate below 20.7%, according to another PWBM brief. “Firms with larger profits would have more incentive to absorb the costs of tax planning that are required to shift their profits,” it added. Their decisions on shifting their intangible assets abroad will depend on the cost of setting up complicated tax planning structures and in some cases having to relocate some real activities, He said.

The incentive for U.S. multinational companies to shift profits out of the U.S. depends critically on the effective tax rate they would face in the U.S. compared to that in a foreign country, He said. The effective tax rate is what companies pay on a dollar of their income after tax credits, deductions, and other adjustments. They would also weigh that difference to decide whether to relocate their mobile economic activities to a foreign country or maintain them in the U.S., she added. They would have relatively less flexibility in decisions on relocating tangible investments such as factories and machinery.

The differences between the proposals of the House Ways and Means Committee and the OECD will be in the statutory tax rate and other factors such as the types of income that will be exempted, He said. “One big change is a move towards a country-by-country determination of the effective tax rate,” He noted. In the House proposal, the move towards the country-by-country basis from the aggregate basis accounts for about half of the increase in the effective tax rates for U.S. multinationals, she added.

Four scenarios of U.S. competitiveness

He identified four different scenarios where U.S. multinationals may or may not find themselves competitive compared to foreign multinationals.

  1. House and OECD proposals are adopted: If both proposals are adopted, U.S. multinationals will be more or less on a level playing field with foreign multinationals. That is because the House proposal imposes a country-by-country minimum tax on foreign income of between 16.6% and 17.4%, while the OECD proposes a country-by-country minimum tax of 15%.
  2. House proposal is adopted, but the OECD proposal is not adopted: U.S. multinationals will face a comparative disadvantage. That is because foreign multinationals can continue to use tax havens to reduce their taxes and increase their profits, while U.S. multinationals can no longer take advantage of those tax planning opportunities.
  3. Neither proposal is adopted: The U.S. will face a comparative disadvantage because it would continue to be the only OECD country with a minimum tax on the foreign income of multinationals.
  4. Only the OECD proposal is adopted, but the U.S. keeps its current minimum tax: U.S. multinationals could potentially gain an advantage in terms of their profits and competitiveness.

 

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