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10 September 2008

US Multinational Companies Prefer Paying Offshore Taxes

The GAO reports that US multinational companies are increasingly reporting their income in other countries to save on taxes. Is this a surprise, given that the US has the second highest taxes in the developed world and that it makes its companies pay taxes abroad where they have an operation and then again on that same income in the US?

US companies are increasing their overseas operations and reporting more income in those countries with the lower tax rates. The larger US companies are the ones most effective in lowering their tax rates by this method.

Senate Finance Committee Chairman Max Baucus (Democrat of Montana) is very upset that US companies are shifting operations and income overseas. He believes it is their duty to bring back as many jobs to the US as possible and to report more income in the US.

Domestic income in 2004 was taxed at an average rate of 25.2%. For income reported as earned in other countries, the tax rate paid is less in all but Japan. The largest US companies are then averaging another 4% tax paid to the US on that income reported to and taxed by these other countries. So, it is only favorable to shift income to these other countries when their tax rate is lower than (25.2 - 4)%. In very many other countries, their rate is substantially lower than this threshold rate needed to justify shifting income to them. Of course, when their rates are so low, it also makes sense to shift jobs and capital investment to them also.

The GAO measured US company activities by sales, value added, employment, compensation, physical assets, and net income both in the US and abroad. The GAO concluded that "Most of the countries studied with relatively low effective tax rates have income shares significantly larger than their shares of business measures least likely to be affected by income shifting practices: physical assets, compensation, and employment. The opposite relationship holds for most of the high tax countries studied."

In 2004, the low tax countries included the United Kingdom, China, Switzerland, Singapore, Ireland, Bermuda, and many Caribbean Islands. The high tax countries were Japan, Germany, Italy, Brazil, and Mexico. Of course, only Japan has a corporate tax rate higher than that of the US.

Thanks to Daniel J. Mitchell of the Cato Institute for pointing out the results of this GAO study.

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