00:00:00
Daniel Garrett: What we're
going to argue in—
00:00:01
in my paper is that
there is also a
00:00:03
substitution effect. That is to
say, instead of just saying
00:00:07
that, yes, the US companies get
wealthier and so they get
00:00:10
bigger, and that has some
positive spill ups for workers,
00:00:12
it's also that they're now facing
marginal tax costs in different
00:00:16
jurisdictions where doing more
business in the US is relatively
00:00:19
more expensive, and doing more
business outside of the US
00:00:22
is relatively cheaper. So
we're going to say, yes, there
00:00:25
is a wealth effect, but there's
also a substitution effect. And
00:00:27
we're going to show through kind
of a particular study of a 1997
00:00:33
regulatory rule that I think
we're going to get to in a
00:00:35
minute— we show that the
substitution effect seems to
00:00:37
dominate when we look at
00:00:38
the local markets in which
these firms operate.
00:00:41
Welcome to <i>The Ripple Effect</i>, the
podcast that takes you on a
00:00:44
journey through the minds of
Wharton faculty. I'm your host,
00:00:47
Dan Loney, and in each episode,
we'll be diving deep into the
00:00:50
inspiration behind the
groundbreaking research that
00:00:53
Wharton professors have
conducted and exploring how
00:00:57
their findings resonate with the
world today.
00:01:00
Dan Loney: Well, there has
been for some time
00:01:02
conversation
about what the tax structure
00:01:05
around international businesses
is, and maybe even should be.
00:01:10
Daniel Garrett is an Assistant
Professor of Finance here at the
00:01:13
Wharton School. He has done some
research recently into this,
00:01:17
especially the potential impact
on companies back here in the
00:01:21
United States, and he joins me
here in studio. Great to see
00:01:24
you. How are you? - I'm doing
well. How are you, Dan?
00:01:26
Thank you. I guess let's start with
kind of looking at the basics of
00:01:30
international tax structure,
because it's a topic that
00:01:33
probably not a lot of people
talk about a lot, but it's
00:01:36
obviously a very important one,
00:01:37
to draw your attention
for this research.
00:01:39
I'll say in my circles, a lot of people
talk about it a lot. A whole
00:01:42
lot, in fact. So the basic
structure of international
00:01:46
taxation can have two flavors.
The way in which it has been in
00:01:50
the US historically has been
what we call a worldwide tax
00:01:52
system, where we have
corporations. So you can imagine
00:01:55
your large corporations, your
Apples and Googles of the world.
00:01:58
They operate not just in the US,
but they operate in many
00:02:00
countries around the world, and
they make income in many
00:02:02
countries around the world. And
so historically, the US has kind
00:02:05
of said we're going to tax all
of your income, regardless of
00:02:08
where it's generated. Another
approach is called territorial
00:02:11
income taxation, which is to
say, instead of taxing Apple's
00:02:14
profits all around the world,
we'll only tax the profits they
00:02:16
generate directly in the US. Of
course, where that gets really
00:02:20
tricky is trying to say exactly,
when you are a big global
00:02:23
company that's making sales,
where are costs allocated, and
00:02:26
where are revenues allocated?
And so such, where the profits
00:02:28
allocated, can be quite tricky,
a tricky thing to pin down.
00:02:32
And so then, when you talk about the
research that you did, part of
00:02:36
it was to look at how all of
these components kind of factor
00:02:40
in and potentially impact
corporations, but also domestic
00:02:44
workers as well.
00:02:45
Yeah. So I think whenever we talk
about tax reform, we're usually
00:02:49
thinking about, the end goal is
trying to come up with
00:02:51
increasing welfare and
increasing opportunity for
00:02:54
people in the US, is usually kind
of the— the political statement
00:02:57
that people are making when
they're saying we want to lower
00:03:00
tax rates. We want to raise tax
rates, et cetera.
00:03:02
What we do in our
00:03:04
research is we try to say, okay,
a lot of countries around the
00:03:08
world have been moving from
worldwide systems where they're
00:03:11
going to tax all of the profit
of the corporations that reside
00:03:15
in their jurisdictions, to only
taxing the local profits. And so
00:03:18
we're trying to say, what does
this do to the way in which
00:03:23
firms invest in local
communities, and what does that
00:03:25
do to the prevalence of local
jobs and that sort of thing? So
00:03:29
yes, to really distill that down, we
want to say, when we cut Apple's
00:03:32
tax rates in Europe, what
happens to the number of people
00:03:35
Apple is employing in the US,
and the number of people that
00:03:38
are being employed in support
roles?
00:03:39
Not just by Apple, but by
other companies.
00:03:41
And I guess to a degree, the
expectation is that there would
00:03:44
be a— maybe a potential backside
benefit here in the United
00:03:48
States, if you have the lower
rates overseas, that there
00:03:50
should be a benefit coming back
to the US at some point. - Yeah.
00:03:53
So the idea is one of an income—
what I'll describe as a wealth
00:03:56
effect, or maybe an income
effect. The idea is we have big
00:04:00
multinational corporations in the
us. Most of the largest
00:04:03
corporations in the world are US
firms. So the idea is, if the US
00:04:06
government can maybe make these
firms just a little bit more
00:04:10
competitive in foreign
jurisdictions— so we'll say,
00:04:13
"Okay, so you have to pay a 21%
tax rate in the US, but sure,
00:04:16
you can only pay a 12 and a half
percent tax rate in other
00:04:18
jurisdictions, so you can be
really competitive. The idea is
00:04:21
that's going to make these US
firms bigger. It's going to make
00:04:23
them more competitive. It's
going to make them wealthier.
00:04:25
And then that's going to kind of
flow down into how many workers
00:04:29
they wind up hiring, or how much
domestic investment they wind up
00:04:32
doing. So that's what I'll call
a wealth effect. What we're
00:04:35
going to argue in my paper is
that there is also a
00:04:39
substitution effect. That is to
say, instead of just saying
00:04:43
that, yes, the US companies get
wealthier and so they get
00:04:46
bigger, and that has some
positive spill ups for workers,
00:04:48
it's also that they're now facing
marginal tax costs in different
00:04:52
jurisdictions where doing more
business in the US is relatively
00:04:55
more expensive, and doing more
business outside of the US is
00:04:58
relatively cheaper. So we're
going to say, yes, there is a
00:05:01
wealth effect, but there's also
a substitution effect. And we're
00:05:03
going to show through kind of a
particular study of a 1997
00:05:08
regulatory rule that I think
we're going to get to in a
00:05:10
minute, we show that the
substitution effect seems to
00:05:13
dominate when we look at the
local markets in which these
00:05:15
firms operate.
00:05:16
And that being the
check the box,
00:05:18
as you refer to in your
research.
00:05:20
We call it check the box. Yes,
00:05:21
that's— that's the
common term for this
00:05:23
particular accounting rule.
00:05:24
Well, when you talk about check the
box regulations, which did have
00:05:30
an impact, I guess, going back
to the— the end of the 20th
00:05:32
century, what kind of impact has
it had over the last— what? I
00:05:36
guess three decades at this
point?
00:05:37
Yeah. So, we look at
check the box,
00:05:40
which was a 1997
rule that essentially
00:05:43
made profit shifting and tax
avoidance for US firms operating
00:05:48
outside of the US much easier.
What we show is that the firms
00:05:52
that benefited most from this
new flexibility to engage in
00:05:57
profit shifting and tax
avoidance in other jurisdictions,
00:06:00
so in non-US jurisdictions, that
these firms seemed to decrease
00:06:04
their investment in the US and
employment in the places where
00:06:07
these firms operate declines in
the US. So showing that,
00:06:10
essentially, these firms are
moving— appearing to move
00:06:14
employment from US operations
into foreign operations.
00:06:18
But this also came kind of full
circle, going back, I guess, to the
00:06:22
first Trump Administration, with
the TCJA and the repatriation
00:06:26
holiday, what, back in 2017, I
guess.
00:06:29
So there's a mandatory repatriation,
00:06:32
kind of a one-time very low tax on
00:06:35
permanently reinvested earnings
abroad and unrepatriated
00:06:39
earnings by US firms. This
happened in 2018. There was an
00:06:42
earlier— I guess it technically,
of course, was passed in
00:06:46
December of 2017. So, some— some
firms started reporting
00:06:50
interactions with this tax in
the fourth quarter of 2017.
00:06:53
It mostly happened in 2018 and
beyond. What we look at is
00:06:57
actually an earlier version of a
repatriation holiday, which was
00:07:01
in 2004 as part of the American
Job Creation Act, AJCA, which
00:07:08
also gave an optional lowering
of repatriation taxes for
00:07:14
earnings that were housed in
corporations outside of the US.
00:07:20
So they would— they would get to
lower their repatriation tax
00:07:22
cost by 85% if they repatriated.
And so what happened in 2004 is
00:07:26
most firms didn't repatriate.
Many firms did repatriate,
00:07:30
and they brought back about $300
billion in 2004, which is much
00:07:33
less than the most recent kind
of bunch of repatriations.
00:07:37
So then, when you have a situation
where you have
00:07:40
check the box regulations
00:07:42
and a repatriation
holiday all kind of in the mix,
00:07:45
does that kind of almost double
the impact that you see coming
00:07:49
back against workers
here in the US?
00:07:51
So we think of these as kind of
two separate but very much
00:07:55
interacting rules. So check the
box says, essentially, you can
00:07:59
engage in profit shifting as
long as you do it outside of the
00:08:01
US. A repatriation holiday says,
okay, so those profits you
00:08:05
shifted outside of the US, now
when you want to bring them back
00:08:07
to the US, they're a little bit
cheaper. So we think that
00:08:11
essentially lowering the tax
rates should kind of change the
00:08:13
marginal cost of operating in
different places, but lowering
00:08:16
the repatriation costs should
essentially allow us to now move
00:08:19
all this cash that we've built
up overseas and bring it back
00:08:21
into the US, potentially. So
those are two kind of very
00:08:28
related ideas, but different
mechanisms that the government
00:08:31
has at their disposal in order
to kind of raise these taxes.
00:08:35
How much focus is this starting to
draw right now, I guess?
00:08:38
Oh, it's drawing a lot. I think it's
actually drawing probably a
00:08:41
little bit less than it did in
the first round of TCJA, and
00:08:45
that most of the mandatory
repatriations have already
00:08:47
happened. So we have a lot less
kind of cash built up overseas.
00:08:51
I think a lot of what we're
going to be talking about is
00:08:53
this marginal tax rates of US
versus non US jurisdictions, and
00:08:58
maybe trying to make those, that—
that gap, a little bit smaller,
00:09:01
maybe making that gap— so I
think that's— that's where I see
00:09:07
a lot of the focus. Not so much,
on the repatriation taxes and
00:09:10
the repatriation holidays.
Which, of course, in my
00:09:12
research, we do find that the
repatriation holiday has very
00:09:15
little impact on domestic
markets, whereas check the box
00:09:19
and lowering foreign effective
tax rates does seem to have a
00:09:22
material impact on domestic
markets, with— with lower foreign
00:09:26
taxes being associated with
lower foreign— or
00:09:29
lower domestic employment.
Excuse me.
00:09:32
In terms of doing this
research, was there anything
00:09:35
that kind of caught your eye,
00:09:36
that maybe surprised
you to a degree?
00:09:38
So let me— let me point out two
things that I think are really
00:09:41
interesting. So in this
research, one of the things
00:09:43
we're able to do that I think
is really cool, is we can tie US
00:09:46
firms, publicly traded firms, to
the global footprint of where
00:09:50
they operate in the US. And we
can show that— of course, they
00:09:53
don't operate everywhere in the
US. Most places in the US have
00:09:55
large publicly traded firms, but
there are very— there are
00:09:57
geographic clusters where they
operate a lot. These clusters,
00:10:00
starting around 1997 and going
through 2006, had pretty
00:10:03
substantial declines in
employment relative to places
00:10:06
where these firms didn't exist.
I think that's an interesting
00:10:09
stylized fact that no one has
ever really shown before that
00:10:11
we're able to show with a bunch
of statistical rigor. The second
00:10:14
thing that I think is really
interesting, that went against
00:10:16
what my intuition was, is that
most of the foreign employment
00:10:20
growth of US firms during this
period was not in developing
00:10:24
markets. It was not in China or
Brazil. It was actually in the
00:10:28
Eurozone. Which, of course, is
kind of commonly thought of as a
00:10:32
very high tax place. But US
firms, who are benefiting from
00:10:34
check the box, are able to pay
very low tax rates while they're
00:10:37
operating in the Eurozone. So I
think there's kind of a little
00:10:41
bit of— I was very surprised when
I started looking through the
00:10:45
BEA data on kind of where US
multinational firms
00:10:48
have non-US employment.
00:10:50
One of the other things that you
noted in your paper is also the
00:10:54
impact of the scale and the size
of the company
00:10:56
in terms of this
process as well.
00:10:59
So this is— there's another
strand of literature that we're
00:11:01
kind of speaking to about the
nature of organizational
00:11:05
complexity. And so, of course,
one of the things that— I told
00:11:08
you check the box kind of allows
profit shifting— or allowed
00:11:13
profit shifting, I'll say. Of
course, a lot of the profit
00:11:17
shifting that was done required
very large and complex
00:11:20
structures, such that firms that
have more subsidiaries in more
00:11:22
places—one of the famous styles
of subsidiary organization that
00:11:27
allowed profit shifting is
called the Double Irish Dutch
00:11:29
Sandwich, that required having at
least two subsidiaries in
00:11:32
Ireland and one in the
Netherlands. And so lots of very
00:11:36
large firms got very large and
very complex around this time.
00:11:40
Now assigning causality to tax
law versus other maybe
00:11:43
regulatory ways in which firms
want to move their costs and
00:11:49
revenues— there could be other
things moving on that we're not
00:11:51
able to kind of rule out
everything, but we do think that
00:11:54
these tax laws are part of what
is driving a lot of this
00:11:56
increasing complexity.
00:11:58
But the dynamic of how some of
these countries have changed,
00:12:01
you know, how they operate their
tax law— Ireland, you mentioned
00:12:06
being one of them that's really
been focused on a lot in the
00:12:09
last few decades— really has
brought a lot of this
00:12:12
conversation, a lot of this
tumult, to the forefront, hasn't it?
00:12:15
Yeah. So yeah, Ireland is a big
one. There are lots of big— what
00:12:19
the literature will refer to as
tax havens. We do think Ireland
00:12:21
is a particularly big part of
the story that we are measuring,
00:12:26
insofar that the US
multinational firms at this
00:12:28
period were really increasing
their employment in Europe a
00:12:30
lot. I don't know if I have too
much to say about the specific
00:12:34
countries that were doing it.
But has been— there have been a
00:12:36
bunch of regime changes.
So the Double Irish was actually
00:12:39
wound down in the last few
years. There are all sorts of
00:12:42
kind of changes in which
countries are vying for getting
00:12:48
US subsidiaries to be formed in
their jurisdictions, and that
00:12:51
sort of thing. But I don't think
we— it's really hard. I'll say
00:12:55
that there's a lot of research
into exactly which jurisdiction—
00:12:58
which foreign jurisdictions are
doing exactly what activities
00:13:02
and how that's impacting US
multinational work. We're kind
00:13:05
of looking at the US side of, how
is the US allowing or
00:13:09
disallowing using those sorts of
mechanisms?
00:13:12
That being said, how much do you
think this continues to be a
00:13:15
policy question as we move
forward? And, how much, you know,
00:13:19
are our corporations
00:13:20
obviously thinking about this
as we move forward as well?
00:13:23
They're thinking a lot
about this. When corporations
00:13:25
are choosing— making location
decisions, they're always, of
00:13:27
course, going to be thinking
about, what is the tax rate? Is
00:13:29
it likely to go up to 28%? Is it
likely to drop to 15%? Those are
00:13:33
kind of substantial differences,
in the required return an
00:13:36
investment needs to make,
depending on kind of what the
00:13:39
what the effective tax rate's
going to be. I think this is a
00:13:42
big discussion going forward.
The last decade or so, the big
00:13:45
discussion has been driven by
the OECD Base Erosion and Profit
00:13:49
Shifting group, which— the BEPS
group— thinking about trying to
00:13:53
push a global minimum tax. I
won't speak to whether that is
00:13:58
politically possible or not
possible at this point, but I do
00:14:00
think we are likely going to
keep talking a lot about this
00:14:05
international tax competition.
And this— in the literature, we
00:14:10
broadly call it the race to the
bottom. And different countries
00:14:13
having an incentive to try to
say, "We want to undercut our
00:14:15
neighbors, so that our neighbors'
firms come to here."
00:14:18
Let me finish up with this,
then. Is there a path that you
00:14:21
could see where the dynamics of
this change, but also there is a
00:14:25
benefit to the domestic worker
as well?
00:14:29
Yeah. So what would benefit a
domestic worker, according to
00:14:33
our paper, would be a— a—
00:14:38
a— I want to call it an
00:14:44
equalization of foreign and
domestic tax rates. So right now
00:14:46
we say there's a tax wedge where
if a firm could choose wherever
00:14:50
they wanted to be, they would
not make the choice of— of the
00:14:53
countries that they operate in.
That's not the same choice they
00:14:55
would make if the taxes were
equalized. - Right. - So insofar
00:14:58
as there's some— some deadweight
loss because of the mismatch
00:15:00
between where firms are
operating and where firms would
00:15:02
like to operate if there wasn't
this sort of tax consideration,
00:15:06
that fixing that could make
things better off, insofar as
00:15:10
if all of the corporate tax
rates hit zero, that might make
00:15:13
things a little bit better. But
then, of course, that makes it
00:15:16
really hard to tax capital
income, which I think there are
00:15:19
other potentially equity reasons
that we might want to tax
00:15:22
capital income. There are lots
of arguments about that in the
00:15:26
literature. But I do think that
we are moving, potentially,
00:15:31
toward a world where those— that
gap between foreign and domestic
00:15:34
effective tax rates is getting a
little bit smaller.
00:15:36
Dan, great to talk to you again.
Thanks very much.
00:15:38
Dan, thank you so much.
00:15:39
Thank you. Daniel Garrett,
who's Assistant Professor of
00:15:41
Finance here at the Wharton
School.
00:15:43
Thank you for listening
00:15:44
to <i>The Ripple Effect</i>. We hope
you found this episode
00:15:47
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00:15:50
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