Has Donald Trump inadvertently given away the recipe to the secret sauce that makes US firms much more profitable than those from elsewhere?
That is certainly one of the conclusions of a new working paper* on the US corporation tax regime, and how it helps US business compete against the rest of the world.
In short, the authors believe that profit-shifting facilitated by the US tax code has given US companies a huge competitive advantage over foreign rivals – to the benefit of shareholders in those multinationals. That, and a big tax cut in oil producing countries for the US oil majors after the first Gulf War – a long term payback for the liberation of Kuwait.
It also provides more ammunition to aggrieved countries who believe the tax systems in countries like Ireland, Luxembourg, The Netherlands and Singapore are facilitating this profit shifting based tax-subsidy for US industry.
The authors – US academic Gabriel Zucman of the University of California, Berkley and a UK Treasury official Thomas Wright (working in a private capacity) – have analysed half a century of US corporate tax data.
They were searching for clues about the so called "exorbitant privilege" the US enjoys: how despite the fact that it is the world’s biggest net debtor nation, the US earns a sizeable net income from the rest of the world.
Is there some special feature of the US that allows it to generate permanently higher returns on its foreign assets than its foreign liabilities? They say answering this question is "of core importance for international macroeconomics, including the sustainability of the US current account deficit, the structure of the international monetary system, and global imbalances".
They say their data shows that the effective tax rate paid by US multinationals on their foreign profits have tended to be low, and that this "exorbitant tax privilege" explains about half of the overall return differential enjoyed by the US since 1966.
This breaks down further into two sectors – the oil majors, and the non-oil multinationals. Of the latter group, the key benefit has been the ability of US companies to easily shift profits to low tax jurisdictions like Ireland from about the mid 1990’s.
But more surprising are their conclusions about the oil sector.
They say the oil sector has received "virtually no attention in the literature" on the exorbitant privilege – which in itself is surprising, as the oil multinationals have booked more than one third of the total overseas profits of US multinationals over the half century under review.
The authors say this is probably because of the extensive use of overseas affiliate companies by the oil majors, which makes the task of following the money very difficult. But they took existing global macro accounts, and used corporate income tax returns to the IRS and surveys of multinational operations abroad by the Bureau of Economic Analysis to ferret out figures for the US oil multinationals.
From this they find that the oil majors have earned much higher post tax rates of return than other multinationals. They began to pull away during the oil shocks of the 1970s, but their returns became particularly high in the 2000’s and early 2010’s – another period of rising prices (oil went from $13 a barrel in 1998 to $112 a barrel in 2012). The rise was similar to the oil shocks, but the key difference was the tax rates the oil companies paid.
Up until 1990, the authors say the US oil majors paid an average tax rate of 70%. But since 1991 it averaged 45%. The authors speculate that this reduced tax rate – and long run sharing of oil rents between producer states and the US oil majors – reflected "a return on military protection granted by the United States to oil producing states", following the US led military intervention to liberate Kuwait after its invasion by Iraq.
But of more concern to Irish readers are the findings on the non-oil US multinationals. They produce a long run series of data on the effective tax rates of US multinationals on their foreign earnings – a computation they say was only possible after President Trump's tax reform of last December, which enforces a mandatory repatriation of profits earned abroad (and held "offshore" to postpone paying tax at the previous, higher rate).
They find that the tax rate paid by US companies on foreign earnings fell from around 35% - pretty much the same as the US Federal statutory rate – at the start of the 1990’s, to about 20% in recent years. This breaks down as 17% paid to foreign governments, plus 3–4% owed to the US government.
They explain this fall in tax payments in three ways
1 - changes in foreign statutory rates (there has been a steady downward trend in most countries corporate tax rates over this period).
2. changes in the location of factors of production used by US companies
3. changes in the reported profitability of US affiliates throughout the world.
They find that the quantities of labour and tangible capital used by US companies in low tax countries grew only slightly faster than in high tax countries. But the amount of profit booked in low tax countries (which the authors call tax havens throughout the paper) surged from 20% in the early 1990’s to 50% in recent years. This boosted the after-tax returns of the US on its foreign assets, and they point to the famous "check the box" regulations of 1996 as being the key change to US tax law that enabled this shift.
They point out that profits booked in Ireland "rose immediately after the introduction of the check the box regulations, from 5% of all (non-oil) pre-tax foreign profits in 1996 to 15% by 2002, before stabilising at 15% since then.
"Prominent cases of profit shifting by US multinationals involve Irish subsidiaries and arrangements that would not have permitted US multinationals to avoid taxes absent the check the box regulations," they added.
The authors say profit shifting is primarily a US corporate phenomenon: "No other non-haven OECD country records as high a share of foreign profits booked in tax havens as the United States", they write.
Using recently released OECD data to isolate the share of US direct investment income earned abroad, they note that income earned in Ireland, Luxembourg, The Netherlands, Singapore and Switzerland accounted for 47.5%, other EU states 22% and other OECD states 14.5%.
Citing other research, they suggest "half of all the global profits shifted to tax havens are shifted by US multinationals. By contrast, about 25% accrues to EU countries, 10% to the rest of the OECD and 15% to developing countries".
The authors say their key insight is that natural economic factors are not enough to explain the exorbitant privilege of the US – that geopolitics and the sharing of natural resource rents, and domestic politics, which can make it easy or hard for multinationals to avoid taxes – are key.
They refer to a "vast literature" on the exorbitant privilege (and they name-check Central Bank Governor Philip Lane’s work in this field), but effectively thank Donald Trump for passing the US tax reform that provided them with a crucial bit of missing information to make their calculations.