Both President Barack Obama and Sen. John McCain got some of their
facts on taxes wrong during the presidential campaign.
President Obama argued that multinationals operating in the United States
manage to evade a big chunk of corporate income taxes, while Sen. McCain
claimed that this country’s high tax rates put it at a competitive disadvantage when
compared with other nations.
In reality, U.S.-based multinationals pay neither unusually high taxes nor
do they manage, to any great extent, to avoid them, according to a study by Doug
Shackelford, Kenan-Flagler’s Meade H. Willis professor of taxation, and Kevin
Markle, a Kenan-Flagler graduate student in accounting.
Shackelford and Markle’s analysis of the financial statements of companies
around the world reveals that multinationals operating in the United States paid an
effective tax rate of 27 percent in 2006, after controlling for each firm’s size and
industry. That rate puts the U.S. rate below that of Japan, tied with Germany and
quite close to Great Britain and France but well above developing countries like
China and India.
“There are extreme views in the political debate in the U.S.—either that
nobody would want to do business here because the taxes are too high or that
multinationals don’t any taxes,” Shackelford says. “Our takeaway is that neither is
right. The U.S. is in the middle, a little above average.”
To reach their conclusion, Shackelford and Markle examined financial
statements for more than 10,000 companies in 85 countries over two decades.
Shackelford believes that theirs is the largest study of this sort ever undertaken.
The two scholars do document a modest amount of tax avoidance in the
United States. Lately, the U.S. statutory tax rate for corporate income has been 35
percent. Thus their finding that companies operating here paid an average of 27
percent in 2006 suggests that companies are taking steps to cut their payments to
Digging deeper, Shackelford and Markle conclude that at least some of the
cross-country difference in effective tax rate can be traced to the creation of
subsidiaries in tax havens like Bermuda. Specifically, they find that having a
subsidiary in a tax haven lowers the effective tax rate of a U.S. multinational by
1.6 percentage points.
Though that may seem like a small amount, Shackelford expects that it will
draw the attention of policymakers and the media. After all, tax havens—and the
companies that choose to use them—generate controversy. While a senator, President Obama co-sponsored a bill aimed at discouraging U.S. citizens and
companies from operating in foreign tax havens. Members of the U.S. Senate and
House recently introduced new versions of the bill. The European Union is also
taking steps to stamp out the use of tax havens.
The debate has even ensnared the rock band U2 and its lead singer Bono. In
2006, the band moved its business office to the Netherlands, from the band
members’ native country of Ireland, to take advantage of lower Dutch taxes. Some
people in Ireland chided the band for hypocrisy, pointing out that Bono, one of
rock’s most politically active stars, lobbies for greater aid and services for the poor
while, in effect, evading taxes that might contribute to that aid. U2’s members
have defended the move as simply shrewd business and argued that they still pay
millions a year in taxes in Ireland and elsewhere.
From a tax-planning point of view, Shackelford understands why firms,
whether musical or manufacturing, seek out havens. “Except for the political
controversy, setting up business in Bermuda and other tax-haven countries is easy
and saves taxes,” he explains. “Incorporating there is little more than a lawyer
having a file drawer.”
Some of the activities that get lumped with tax avoidance are really just
legitimate efforts to diversify risk and create new streams of revenue. “If a North
Carolina company gets a contract to pave roads in China,” Shackelford notes.
“they will set up a plant in China. You could look at that and say, ‘There go jobs
and tax revenues out of the U.S.’ But you’re not going to produce asphalt for
China in North Carolina. On the other hand, for some businesses it is difficult to
identify the location where profits are earned. For example, where are the profits
earned for an international phone call—where the call is placed, answered and
routed through? In those types of businesses, if we’re going to have a tax rate
that’s above other countries, then we have to accept that companies will arrange
their affairs to try to report their profits in more tax-friendly places.”
Besides calculating average effective tax rates around the world,
Shackelford and Markle’s study documents a worldwide drop in rates over the last
two decades. They find that rates fell roughly equally across the globe. Thus for
the most part, no nation ended up gaining a competitive advantage. Countries that
had higher rates in 1988 also had them in 2006. And tax havens—besides
Bermuda, such places as the Bahamas, the Cayman Islands and Luxembourg—
likewise had the lowest rates then and now.
“Over the last two decades, both statutory and effective tax rates have been
going down,” Shackelford says. “I don’t know why that happened, and people in
policy positions don’t seem to know, either. But it’s been a dramatic falloff.”
One possibility is that tax reform in the ’80s in the United Kingdom and the
United States kicked off a worldwide vogue. Back then, both countries cut their rates while broadening their tax base—that is, they closed loopholes and made
more kinds of income subject to tax. “That seemed to start a domino effect where
one country after another broadened the base and lowered rates,” he says. “And if
everybody cuts by 20 percent, you end up with roughly the same ranking.”
Thus Japan had the world’s highest tax rate in the ’80s, when it reached 50
percent for multinationals, and it had the highest in 2006, at 36 percent. “Japan is
an unusual culture,” Shackelford says. “Paying high taxes there seems to be
viewed as a patriotic act, whereas, in most of the rest of the world, it’s viewed as
something you do to stay out of jail.”
One country that stands out for slashing its rates is Germany, where the
average effective rate for multinationals fell from 47 percent in 1989 to 27 percent
in 2006. Shackelford chalks that up to social and economic changes that eroded
the country’s status as one of the world’s best places to do business. Between
World War II and the early 1970s, Germany boomed. Its workers were famously
productive, and its companies reported high profits. Firms were hungry to operate
there and willing to pay up for the privilege.
“Eventually, costs increased both to support a highly developed social
welfare system and to unify East and West Germany,” he says. “Now it’s no
longer an unusually profitable place. It has become just another player in the world
market.” Without its special highly profitable status, business weren’t going to
stay, if they had to pay higher taxes than in other countries in the developed world.
Shackelford doesn’t see his and Markle’s study as suggesting particular
steps that policymakers, either in the United States or abroad, should take. Rather,
he hopes that it will bring a measure of reasonableness and objectivity to the often
heated and rhetorical debates over tax policy.
“This would be a sexier paper if we’d said, ‘Look at the pillaging by
multinationals,’” he adds. “And managers might have thought it was sexier if we’d
said that U.S. companies can’t survive because of high taxes. In some sense, the
interesting thing is that we’re in the middle.”