International Tax Havens: Are Multinationals Gaming the System?

As global economies become increasingly interconnected, multinational corporations (MNCs) have come under fire for activities that illustrate many of globalization’s less desirable effects. Most recently, Apple was criticized for using Ireland as a tax haven for billions of dollars of its profits, a tactic that has been used by Google, Facebook, and many other multinationals since the early 2000s. MNCs have invested vast amounts of time and money in crafting innovative tax plans to exploit legal loopholes and keep money in more tax-advantaged jurisdictions, costing their parent countries billions of dollars in lost revenue. However, in “The Impact of Headquarter and Subsidiary Locations on Multinationals’ Effective Tax Rate,” Kevin Markle and Douglas Shackelford find that despite enormous investment into international tax planning, multinationals headquartered in the US, Japan, and some high-tax European countries still face substantially higher taxes than those headquartered elsewhere.

According to the authors, policymakers face strong arguments from both sides on tax rates for MNCs. Many corporate managers argue that the comparatively high US tax rate on corporate incomes discourages companies from incorporating in the US. This creates a build-up of cash abroad while hurting American competitiveness in the global economy. Others, including Congressional leaders and many scholars, believe that MNCs are able to easily shift their incomes from high-tax to low-tax countries using a variety of mechanisms and can reduce or erase any financial burdens from differing international tax rates.

The authors seek to settle these debates by empirically testing the effect of country headquarters on overall tax rates. Markle and Shackelford extend their previous research to compare Effective Tax Rates (ETRs) for companies with foreign and domestic subsidiaries using firm-level financial information from 42,738 multinationals representing 87 countries from 2006 to 2011. The authors estimate the impact of where a company is headquartered and where its subsidiaries are located by testing the relationship between ETRs and categorical variables of countries. They find that MNCs headquartered in Japan have the highest tax rates, followed by the US, Germany, and France. On the other end of the spectrum, MNCs headquartered in so-called tax havens in the Middle East have ETRs nearly 12.5 percentage points lower than in the US.

These results suggest that the frictions associated with moving headquarters to a lower-tax country are substantial and that “contrary to the assertions of some and despite many successful strategies for shifting profits from high-tax countries to low-tax countries, companies domiciled in high-tax countries still appear to pay much higher global taxes.” The authors also find that despite a documented decline in global ETRs prior to 2006, ETRs appear to have remained relatively stable during the time period analyzed.

Markle and Shackelford also look at differences in ETRs when a company creates a foreign subsidiary in a tax haven country. They further distinguish between types of subsidiaries—while some can be for operating and manufacturing purposes, others are equity holders that act as a financial conduit to funnel resources from the headquarters to another type of subsidiary. Holding companies will therefore prioritize being established in a low-tax country. The authors find that establishing foreign subsidiaries of this kind has the largest reduction effect on ETRs for a firm, although the effect is relatively small, with a mean reduction in the ETR of 0.2 percent.

Further research should explore why companies remain headquartered in high-tax countries and why divergent ETRs persist. While the authors recognize that some substantial frictions must exist for these companies, they do not provide evidence explaining why, for example, a Japanese firm does not move its headquarters to Singapore, where it would experience a 17 percentage point reduction in its ETR. Additionally, even establishment of holding companies in tax haven countries has a minimal overall effect on a firm’s ETR. MNCs may be wise to reassess the benefits of investment in international tax planning. When crafting policy, international tax policymakers should consider the frictions faced by these firms and should recognize the significant role that nationality still plays for MNC profits in the global economy.

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