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This blog post is part of a series dedicated to analyzing the impact of the Tax Cuts and Jobs Act. Click here to see all of the blogs in the #TCJANowWhat series.
The Tax Cuts and Jobs Act (TCJA) fundamentally transformed the US system of international taxation. In a recent paper, I discuss the potential consequences of these new international provisions, using the prior academic literature on related issues to draw initial inferences about their impact. That discussion is extended here to incorporate some early empirical evidence that is now beginning to emerge.
Among the most prominent international provisions of the TCJA is the abolition of the tax imposed upon the repatriation of income from foreign affiliates to their US parent firms. Smolyansky, Suarez, and Tabova (2019) document a dramatic surge in repatriations in 2018. They find that these repatriations have led to a large increase in share repurchases while having little discernible impact on domestic investment. These conclusions are quite unsurprising in light of prior evidence from the repatriation tax holiday implemented in 2005.In lieu of the old repatriation tax, the TCJA imposes a novel tax on the foreign income of US-based multinational corporations (MNCs), known as the global intangible low-taxed income (GILTI) tax. GILTI refers to the income of a US MNC’s foreign affiliates in excess of a presumptive 10 percent return on tangible assets. In a recent paper, I analyze the circumstances in which US-based MNCs are likely to face greater burdens from the GILTI tax compared to the prior regime (which was ostensibly “worldwide” but deferred US taxation until repatriation). Using the observed behavior of firms during the 2005 repatriation tax holiday, this analysis concludes that the GILTI tax — and thus the TCJA as a whole — increases the US tax burden on the foreign activities of many, and perhaps most, US MNCs.
Evidence of the TCJA’s impact on US MNCs is still emerging, and the question is difficult to address until several years of data are available. However, the immediate stock market reactions to the TCJA provide some indication (with the caveat that they reflect initial investor expectations that may not be borne out in the long run). Wagner, Zeckhauser, and Ziegler (2018) find quite substantial negative market reactions for US MNCs (relative to domestic firms) during the legislative events in late 2017 that led to the enactment of the TCJA. This may be surprising to those who view the TCJA as being quintessentially pro-business. However, the TCJA — through the GILTI tax and other provisions such as the base erosion anti-abuse tax — evinces considerable hostility to cross-border business activity, notwithstanding the evidence that the global activities of US-based MNCs lead to higher wages and investment in their US operations (e.g., Desai, Foley, and Hines 2009) and that inbound foreign direct investment raises the wages of US workers (e.g., Setzler and Tintelnot 2019).
One of the central critiques of the prior worldwide tax regime was that it created ownership distortions, notably in circumstances in which a US MNC would be the most productive owner of a foreign asset but was not the highest bidder for that asset due to the US tax on its foreign income. The TCJA exacerbates this problem for those US MNCs that now face a higher US tax burden under the GILTI regime.
In addition, the TCJA creates powerful new incentives for firms to make value-destroying acquisitions and investments. In particular, as argued in Dharmapala (2018) and widely discussed elsewhere, foreign affiliates’ holdings of tangible assets shield US MNCs from the GILTI tax (which exempts a presumptive return of 10 percent of tangible assets). This encourages the acquisition of foreign firms that hold such assets, as well as capital expenditures by foreign affiliates. These responses may be value destroying (apart from the GILTI tax benefit to the MNC), as US MNCs are now artificially tax-favored owners of existing foreign tangible assets (of which they may not necessarily be the most productive owners). Importantly, this point is quite distinct from the question of whether new tangible assets will tend to be located in the US or abroad (Singh and Mathur 2019), as well as from the so-called “offshoring” of existing US tangible assets.
Beyer et al. (2019) find evidence that US MNCs increased their foreign — but not domestic — capital expenditures in the wake of the TCJA, consistent with the incentives created by the GILTI provision. Carroll, Mackie, and Pizzola (2019) document a substantial increase in the volume of cross-border acquisitions by US firms in 2018. They caution that this should not necessarily be attributed to the TCJA. Even if it were, it would not be clear whether such acquisitions represent value-increasing transactions that were previously precluded by the worldwide tax regime or value-destroying transactions motivated by the acquisition of GILTI tax shields. This question awaits further research when more years of data are available.
The discussion above has emphasized ownership and investment distortions due to the TCJA, rather than its effects on revenue. Clausing (2019) estimates that the GILTI tax will raise $8 billion in revenue per year through a reduction in profit shifting. What is of primary relevance, however, is the social gain from this increase in revenue. If it is thought, for instance, that a dollar in the hands of the government is worth $1.05 in social terms, then an additional $8 billion of revenue generates a social gain of $400 million. Thus, even ownership inefficiencies of relatively modest magnitude may well overwhelm the social gains from increased revenue.
Furthermore, the TCJA is likely to increase the resources expended by firms on tax planning (and hence the social costs of tax planning), even if the amount of profit shifted were to fall. This is because tax planning generally entails a substantial fixed cost associated with learning the new law and developing new strategies (e.g., Dharmapala 2014). Thus, it appears reasonable to assess the TCJA’s international provisions primarily with respect to economic efficiency. By this criterion — and perhaps by any other measure — the TCJA does not seem to fare terribly well.
Dhammika Dharmapala is the Julius Kreeger Professor of Law at the University of Chicago Law School.
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Evidence of the TCJA’s impact on US multinational corporations is still emerging, but the immediate stock market reactions provide some indication.
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