International Tax Avoidance by Multinational Firms.

• Author: Zucman, Gabriel

A body of work documents profit-shifting behavior by multinational corporations. According to recent estimates, close to 40 percent of multinational profits--profits booked by firms outside of their headquarters' country--are shifted to tax havens. (1) US multinational companies appear to book a particularly large fraction of their foreign income in low-tax places. (2)

This phenomenon has attracted attention from economists and policymakers. In 2015, the Organisation for Economic Co-operation and Development (OECD) and the G20 launched the Inclusive Framework on Base Erosion and Profit Shifting, with the goal of curbing tax avoidance possibilities stemming from mismatches between different countries' tax systems. In 2017, the United States reduced its corporate tax rate from 35 percent to 21 percent and introduced provisions to limit the erosion of the US tax base and tax some of the earnings booked by US multinationals abroad.

Recent research, however, suggests that these policies have so far made only a relatively small dent in profit shifting. More ambitious action--such as a coordinated minimum corporate income tax, to which more than 140 countries and territories committed in October 2021 -- could reduce corporate profit shifting more significantly.

What Is the Scale of Global Profit Shifting?

Until recently, it was difficult to quantify global profit shifting due to a lack of data on the location of corporations' profits. Companies are generally not required to publish their profits and tax payments on a country-by-country basis.

Thomas R. Torslov, Ludvig S. Wier, and I attempt to address this gap by leveraging macroeconomic data known as foreign affiliates statistics. (3) These data record, among other information, the value added, wages, and profits of foreign firms--defined as firms more than 50 percent owned by foreign shareholders--in each country, including in the main tax havens. These are typically subsidiaries of foreign multinationals.

Using these data, we propose a simple method to infer profit shifting. By combining foreign affiliates statistics with national accounts data that cover foreign and local firms incorporated in each country, we estimate the profitability of foreign versus local firms in tax havens. Foreign firms turn out to be much more profitable than local firms in these territories. The ratio of pretax profits to wages is around 30 to 40 percent for local firms, but it is an order of magnitude larger for foreign firms--as high as 800 percent in Ireland. That is, for [euro]l of wages paid to Irish employees, foreign multinationals book [euro]8 in pretax profits in Ireland, primarily reflecting profit shifting into the country.

Figure 1 shows that the excess profitability of foreign firms over local firms is specific to tax...