The Three Parties in the Race to the Bottom: Host Governments, Home Governments and Multinational Companies

40 Pages Posted: 13 Jan 2006  

Rosanne Altshuler

Rutgers, The State University of New Jersey - Department of Economics

Harry Grubert

U.S. Department of the Treasury, Office of Tax Analysis (OTA); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: December 2005

Abstract

Most studies of tax competition and the race to the bottom focus on potential host countries competing for mobile capital, neglecting the role of corporate tax planning and of home governments that facilitate this planning. This neglect in part reflects the narrow view frequently taken of the policy instruments that countries have available in tax competition. But high-tax host governments can, for example, permit income to be shifted out to tax havens as a way of attracting mobile companies. Home countries will cooperate in this shift if their companies' gain is greater than any reduction in the domestic tax base. We use various types of U.S. data, including firm level tax files, to identify the role of the three parties (host governments, home governments and MNCs) in the evolution of tax burdens on U.S. companies abroad from 1992 to 2002. This period is of particular interest because the United States introduced regulations in 1997 that greatly simplified the use of more aggressive tax planning techniques. The evidence indicates that from 1992 to 1998 the decline in effective tax rates on U.S. companies was driven largely by host governments defending their market share. But after 1998, tax avoidance behavior seems much more important. One indication is that effective tax rates on U.S. companies had a much weaker link with local statutory tax rates. After 1997, the new regulations motivated a very large growth in intercompany payments and a parallel growth of holding company income abroad. We attempt to estimate how many of these payments were deductible in the host country, and conclude that by 2002 the companies were saving about $7.0 billion per year by using the more aggressive planning strategies. This amounts to about 4 percent of companies' foreign direct investment income and about 15 percent of their foreign tax burden.

JEL Classification: H25, H73

Suggested Citation

Altshuler, Rosanne and Grubert, Harry, The Three Parties in the Race to the Bottom: Host Governments, Home Governments and Multinational Companies (December 2005). CESifo Working Paper Series No. 1613. Available at SSRN: https://ssrn.com/abstract=875308

Rosanne Altshuler

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Jersey Hall
New Brunswick, NJ 08901
United States

Harry Grubert (Contact Author)

U.S. Department of the Treasury, Office of Tax Analysis (OTA) ( email )

1500 Pennsylvania Ave. NW
Washington, DC 20220
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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