Study questions impact of tax cuts for multinationals on workers

Policies that lower the foreign taxes of U.S.-based multinational corporations are unlikely to benefit domestic workers, according to a recent academic study.

The study, released in February, examined the impact of two different provisions. First was the 1997 "Check-the-Box" regulations, which lowered effective tax rates abroad by facilitating profit shifting from high tax foreign affiliates to tax havens. The second provision — the 2004 "repatriation holiday" — reduced the tax costs of repatriating foreign earnings for multinationals

Employing a dynamic "difference-in-differences" framework, the researchers estimated that local exposure to Check-the-Box significantly reduced domestic employment and earnings. That seems to imply multinational companies substitute domestic with foreign activity in response to lower effective tax rates abroad. 

As for the repatriation holiday, they found it "had no effects on labor markets, indicating the foreign cash holdings of U.S.-based MNCs are not an important source of financing for domestic business activity," wrote the researchers, Daniel Garrett, assistant professor of finance at the Wharton School of the University of Pennsylvania, Eric Ohrn, associate professor of economics at Grinnell College and nonresident senior fellow at the Brookings Institution, and Juan Carlos Suárez Serrato, a professor of economics at Stanford University and a faculty associate at the National Bureau of Economic Research. "We conclude that policies that lower the foreign taxes of US MNCs are unlikely to benefit domestic workers." 

"People have known about Check-the-Box for a long time, and have had different ideas about what it does, or what it could do," said Garrett. "What we do that's really different than what people have done before is instead of trying to compare firms to each other based on firm characteristics, we're trying to compare places in the U.S. that have more employment and firms that benefit from check the box relative to places in the U.S. that have less firms that benefit from check the box."

They used a local labor markets approach comparing outcomes in more and less exposed domestic markets before and after the provisions are implemented. They determined local exposure to each provision through mapping of the geographic footprints of U.S. multinational corporations across domestic labor markets.

They found that the places in the U.S. with the most exposure to the Check-the-Box rules, by having the most firms operating in 1996 that could benefit from the rules in 1997, experienced substantial declines in employment relative to other places in the U.S. over the next 10 years. 

"This is consistent with firms that benefit from Check-the-Box," said Garrett. "Check-the-Box lowers their foreign effective tax rate by allowing them to engage in new types of profit shifting outside of the U.S. When firms have this opportunity, they're going to cut U.S. investment activity."

Multinationals are benefiting in two ways from the tax changes.. "The way we lower foreign effective tax rates for U.S. multinational corporations is we're making production outside of the U.S. relatively cheaper, and we're also making those firms generally wealthier," said Garrett. 

Making it cheaper to produce outside of the U.S. can be called the "substitution effect" while making firms wealthier relates to the "income effect." 

"What our paper says is that our results are consistent with the substitution effect dominating the income effect, on average, when U.S. firms face cuts to their foreign taxes," said Garrett. "Essentially, their U.S. production and their production outside of the U.S. are more substitutable than I think the academic literature has historically recognized."

This type of profit shifting is being targeted by the Organization for Economic Cooperation and Development's initiatives to combat corporate tax avoidance, including the Pillar Two part of the plan setting a 15% global minimum income tax on multinational corporations.

"As we move toward a territorial world, there will be benefits to U.S. workers of supporting a global minimum tax," said Garrett. "When relative taxes are lower in Germany than in the U.S;, we see firms boost their activity in Germany relative to the U.S. It's very unsurprising that firms will move their production to wherever the after-tax returns are highest. If you change foreign taxes to lower the foreign taxes the firm is paying,"

A global minimum tax under Pillar Two of the OECD's plan, and the Global Intangible Low Taxed Income, or GILTI, tax regime in the Tax Cuts and Jobs Act, may help U.S. workers by keeping the gap between foreign taxes and domestic taxes relatively smaller, Garrett noted. "At a high level, that kind of substitution across places is substantial for U.S. multinational firms," he added.

The Supreme Court decision last month in the case of Moore v. United States upholding the constitutionality of the mandatory repatriation tax from the Tax Cuts and Jobs Act shouldn't have an impact on U.S. multinationals' ability to create jobs at home. "Most of the firms with huge amounts of cash outside of the U.S. still have access to extremely liquid, extremely efficient U.S. capital markets for any investment," said Garrett. 

As for which corporate tax policies seem to work in encouraging more hiring, he pointed to a previous study he's done on bonus depreciation.

"Bonus depreciation in the early and late 2000s was very effective in leading firms to hire more workers to use the machines that they were buying with the bonus depreciation," said Garrett. "There are ways to get firms to hire more workers. I don't think that lowering the foreign effective tax rate on firms is one of them."