Can a Single Country Increase the Taxes of Multinational Corporations? Evidence from the Impact of the 1993 Corporate Tax Rate Increase on Fortune 500 Companies

• Date: 01 December 2015
• Author: Nathan M. Jensen,Adam H. Rosenzweig
• DOI: http://doi.org/10.1111/jels.12091
• Published date: 01 December 2015

Can a Single Country Increase the Taxes

of Multinational Corporations? Evidence

from the Impact of the 1993 Corporate

Tax Rate Increase on Fortune

500 Companies

Nathan M. Jensen and Adam H. Rosenzweig*

There is a debate in the literature about the ability of multinational corporations to use

legal mechanisms, such as transfer pricing and intercompany debt, to prevent any one

country from meaningfully increasing effective tax rates (ETRs) on corporations.

Evidence suggests that tremendous shifting of profits across borders is occurring, leading

to calls for significant policy responses. At the same time, multinational companies are

also observed relocating their headquarters or reincorporating in foreign jurisdictions, at

least in part for tax reasons. This has led many to claim that international tax in a

globalized world has devolved into a race to the bottom. In response, multinational

organizations such as the OECD and G-20 have called for increased multilateralism and

cooperation as the last, best hope for the international tax regime. Yet, to date little has

been written on the extent to which any one, single country can meaningfully increase

taxes on multinational companies unilaterally through changes in rate. We contribute to

this literature by designing an empirical study of whether and to what extent a largely

unanticipated tax rate increase in a single country affects the ultimate tax liability of

multinational corporations. We do so by examining how an actual increase in corporate

tax rates in the United States impacted worldwide cash taxes for Fortune 500 companies.

Using the 1 percent corporate tax rate increase enacted in 1993, which was enacted for

one year without any accompanying base changes, we find that this rate increase led to an

increase in worldwide cash taxes reported by multinational companies across the board.

We include a number of case studies to further explore the implications of this tax

increase. These case studies support the contention that little tax avoidance occurred

immediately in response to the increase in the tax rate.

*Address correspondence to Adam H. Rosenzweig, Washington University in Saint Louis, One Brookings Dr., CB

1120, St. Louis, MO 63105; email: arosenzweig@wulaw.wustl.edu. Jensen is at George Washington University.

We thank the Center for Programs and Center for Empirical Legal Research at Washington University in St.

Louis for their financial support. Meghana Ayyagari, Kim Clausing, Chia-yi Lee, Mike Miller, and participants at

the 2013 National Tax Association 2013 Annual Conference provided insightful comments and suggestions. Alex

Gremp and David Klein provided excellent research assistance. All errors are our own.

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Journal of Empirical Legal Studies

Volume 12, Issue 4, 757–780, December 2015

I. Introduction

There is a debate in the literature about the ability of multinational corporations to use

legal mechanisms such as transfer pricing and intercompany debt to prevent any one

country from meaningfully increasing the effective tax rates (ETRs) on such companies.

Some argue that these tools make any attempt to raise taxes on corporations futile, if

not counterproductive.

1

Others argue that they make it more important to try to find

effective ways to raise revenue from the corporate tax by shutting down these maneu-

vers. Evidence suggests that tremendous shifting of profits across borders is occurring

(Clausing 2009). Stories range from Starbucks not paying any taxes in the United King-

dom,

2

to tax havens such as the Cayman Islands suspiciously being one of the largest

investment locations in the world.

3

In addition, multinational companies are also being

observed relocating their headquarters or reincorporating in foreign jurisdictions, at

least in part for tax reasons. Not only are these complex and costly transactions, but

they have also proven to be politically sensitive, drawing condemnation from politicians

and the popular press alike.

4

Many government officials and organizations such as the G-20 and OECD have

increasingly pressed tax havens to change their rules, threatened to exit (and have, in

fact, terminated) bilateral tax treaties, and otherwise threatened international action

and across-country coordination to mitigate firms’ shifting of profits across borders. Yet

the common refrain is that firms have the ability to use international networks to avoid

taxation, limiting the effectiveness of corporate taxation to raise revenues.

5

To date,

however, little has been written from an empirical standpoint on whether and, if so, to

what extent, single countries can meaningfully increase the effective tax rate of multina-

tional corporations on a unilateral basis and, if so, whether rate or base changes would

be able to do so.

In this article we focus on the responses of firms to a tax policy change in the

1990s, exploring the effect of a largely unanticipated policy change on multinational

corporations. We cannot claim that our article can address all responses to policy

changes or inform all forms of profit shifting through “paper” transactions or other

types of tax avoidance, such as the recent wave of corporate inversions, but we believe

that the unique setting of this policy reform aids in causal identification. Thus we can

explore the ability of firms to avoid corporate taxes in response to an unanticipated

1

For an excellent overview of the empirical studies on the topic, see Dharmapala (2013).

2

See, for example, http://www.cnbc.com/id/49431602.

3

Hines (2010) notes that the Cayman Islands rank in sixth place as the largest recipient of portfolio investment.

4

See, for example, http://www.nytimes.com/2014/08/06/opinion/the-tax-dodge-goes-on.html.

5

For an excellent overview of the empirical studies on the topic, see Dharmapala (2013).

758 Jensen and Rosenzweig