Professor Alfons J. Weichenrieder

Taxes play an important role in the location and investment decisions of multinationals, according to two new research papers.  Two other papers say that it is very difficult to find substantive empirical evidence on the extent to which multinational companies can reduce their overall tax liabilities by moving profits to lower taxed countries – for example, through transfer pricing manipulation, moving debt to higher taxed countries, or simply not repatriating profit.

The papers, published by the European Tax Policy Forum (ETPF), were presented at a joint conference of the ETPF and the Institute for Fiscal Studies on Monday.

One study, by Michael Devereux and Ben Lockwood of the University of Warwick, examines the impact of corporation tax on the investment behaviour of US multinationals. Based on data from a number of OECD countries, they find that taxation has a substantial impact. Specifically, they find that a ten percentage point fall in the effective average corporation tax rate in a host country (such as the UK) would increase inward investment by US multinationals by 60% in the short run. Ultimately this would increase the capital stock owned by US multinationals
in the host country by 15%.

The study distinguishes two decisions of multinationals: where to locate new activity, and, having chosen the location, how much to invest. The results suggest that it is the location decision which is affected by corporation tax; conditional on the location, the size of investment is not responsive to corporation tax.

The study is based on data on the investment of affiliates of US multinationals in 19 OECD countries between 1983 and 1998. Detailed measures of effective corporation tax rates are used.

A second study, by Thiess Buettner and Georg Wamser of the University of Munich, breaks new ground by examining whether other taxes affect foreign direct investment. They study confidential data from the Bundesbank on German multinational companies, and confirm that corporation tax affects their location decisions.

More surprisingly, though, they also find that sales taxes and VAT have a significant effect on investment outside Germany. On average, countries which reduced their tax revenue from sales taxes and VAT by 1 percent of GDP would see an increase in investment by German multinationals of 12%. They also find a significant impact of R&D tax credits. For a smaller sample of countries, they find that income taxes on skilled labour also deter investment.

Despite anecdotal evidence, it is very difficult to find substantive empirical evidence on the extent to which multinational companies can reduce their overall tax liabilities by moving profits to lower taxed countries – for example, through transfer pricing manipulation, moving debt to higher taxed countries, or simply not repatriating profit. There have been no studies of UK companies due to lack of detailed data. However, two new studies, published by the European Tax Policy Forum (ETPF), were also presented at a joint conference of the ETPF and the Institute for Fiscal Studies on Monday.

The first study, by Professor Alfons Weichenrieder of the University of Frankfurt, is based on detailed information on German companies collected by the Bundesbank. He examines whether differences in rates of profit declared by German parent companies and their subsidiaries can be explained by profit shifting induced by differences in tax rates.

He finds:

• German subsidiaries of non-German parent companies have a higher rate of profit in Germany if the parent company is from a high tax country. Specifically, a 10 percentage point increase in the parent’s home country tax rate is associated with a 0.5 percentage point increase in the profit rate of the German subsidiary.
•  The author also compares the profit rate of non-German subsidiaries of German parents, and examines whether the profit rate of subsidiaries is more sensitive to the tax rate if they are wholly-owned – as they would be if German companies shifted profits to subsidiaries in low tax countries. Allowing for differences in debt, there is no difference.
• There is no evidence that German multinationals with subsidiaries in the USA and elsewhere shift profits out of the USA to other subsidiaries.
  Profit shifting by UK companies is, if anything, likely to be less significant than for German companies. This is because the UK in principle taxes the worldwide income of UK companies, while the German government taxes only income generated in Germany.

The second study, by Harry Huizinga (Tilburg Universiy), Luc Laeven (IMF) and Gaëtan Nicodème (European Commission), examines the use of debt in European subsidiaries of multinational companies based in Europe. A higher tax rate in one country would lead a subsidiary in that country to increase its borrowing to take advantage of the deductibility of interest for tax purposes. But the multinational may reduce its borrowing elsewhere prevent its overall liabilities from rising too much. This restructuring of debt is one way in which multinational companies can reduce their total tax liabilities.

The authors find that, for multinationals, a 10 percentage point increase in the corporation tax rate in a country is associated with an increased rate of borrowing in that country of 2.7 percentage points, and a reduction in other countries of 0.6 percentage points. While statistically significant, this represents only a small effect.

• Michael Devereux, University of Warwick: "The effects of international taxation on the activities of multinational companies: a survey of existing evidence"
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• Ben Lockwood, University of Warwick: "How are plant location decisions and capital flows in Europe affected by corporate income taxes?"
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• Thiess Buettner, University of Munich:"Do non-profit taxes affect the location of economic activity? Evidence from the EU"
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• Harry Huizinga, University of Tilberg: "How far do differences in international tax regimes between countries affect financial policies?"
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• Alfons Weichenreider, University of Frankfurt: "Profit shifting within the EU: evidence from Germany"
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• Stephen Bond, IFS and University of Oxford: "Corporate Income Taxation in the EU: An Economic Assessment of the Role of the ECJ"
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