American Corporations Drive the Global ‘Race to the Bottom’


Mona Ali over at LSE US Center's blog:

My findings revealed that US-owned subsidiaries were much more profitable than foreign-owned subsidiaries in the US. The former’s rates of return were between 16 percent pre-tax to 10 percent post-tax above the latter. Contrary to the risk-return tradeoff in which high profits are associated with higher risk investment, American investment overseas was also less risky compared to foreign-owned investment in the US.

I also found that research and development (R&D) expenditures were twice as great for US firms overseas compared to foreign firms in the US. While this finding may appear to bolster Hausmann and Sturzenegger’s ‘dark matter’ thesis, to rely on relatively higher R&D expenditures as a proxy for ‘dark matter’ is problematic. For one, foreign firms in the US might choose to locate their R&D expenditures in their home countries. Moreover, intangibles—such as human capital, brand equity and reputation—may be inadequately captured by this proxy measure.

Is tax avoidance partially responsible for the apparently low profits of US-based industries (note that these industries include foreign firms located in the US)? It is clear that taxation is an important consideration in determining where multinational corporations locate their foreign subsidiaries. Modes of tax avoidance have become increasingly complex. Current strategies include extracting royalties and management fees—thereby stripping income from profits—from subsidiaries in high-tax zones or re-locating a firm’s assets to special-purpose entities in tax havens. Larger companies with more extensive transnational networks are more advantaged compared to smaller ones. The current ‘tsunami’ of US firms engaged in corporate inversions—whereby firms reduce their global tax bill by shifting their corporate headquarters overseas when merging with a smaller foreign rival—suggests the skillfulness of US firms at tax avoidance.

Given the confidentiality of firm-level data, it is difficult for tax authorities and statisticians to figure out which modes of ‘tax planning’ are at work. Using industry data, I found that the effective corporate tax burden (corporate income as a share of pre-tax income) was fairly similar for US investment overseas (20 percent) compared to foreign investment in the US (18 percent). However the tax burden for US based firms (which includes foreign firms located in the US) was remarkably lower – around 5 percent. This finding backs Kleinbard’s claim that US-based firms are leaders in tax avoidance. It is worth noting that foreign investment in the US is overwhelming acquired through mergers and acquisitions (M&A). Here profits might artificially suppressed through amortization of goodwill effects and M&A tax avoidance strategies.

More here.