24 Mar 2009Working Paper Summaries

Securing Jobs or the New Protectionism? Taxing the Overseas Activities of Multinational Firms

by Mihir A. Desai

Popular imagination often links two significant economic developments: the rapid escalation of the foreign activities of American multinational firms over the last 15 years, and rising levels of economic insecurity, particularly among workers in certain sectors. The presumed linkages between these phenomena have led many to call for a reconsideration of the tax treatment of foreign investment. Increasing the tax burden on outbound investment by American multinational firms, it is claimed, offers the promise of alleviating domestic employment losses and insecurity while also raising considerable revenue. HBS professor Mihir A. Desai looks beneath the trends, examining the economic determinants of outbound investment decisions and synthesizing what is known about the relationship between domestic and foreign activities. Key concepts include:

There is no clear evidence of significant negative impacts on domestic investment or employment due to the overseas activities of firms. Foreign activity by multinational firms does not necessarily displace domestic economic activity.
Other factors—such as falling prices of investment goods, and/or trade patterns—may have driven the employment changes that are so worrisome.
When policymakers decide the appropriate taxation of multinational firms, they should resist the tempting logic of protectionism.

Author Abstract

Tax policy toward American multinational firms would appear to be approaching a crossroads. The presumed linkages between domestic employment conditions and the growth of foreign operations by American firms have led to calls for increased taxation on foreign operations—the so-called "end to tax breaks for companies that ship our jobs overseas." At the same time, the current tax regime employed by the U.S. is being abandoned by the two remaining large capital exporters—the UK and Japan—that had maintained similar regimes. The conundrum facing policymakers is how to reconcile mounting pressures for increased tax burdens on foreign activity with the increasing exceptionalism of American policy. This paper address these questions by analyzing the available evidence on two related claims i) that the current U.S. policy of deferring taxation of foreign profits represents a subsidy to American firms and ii) that activity abroad by multinational firms represents the displacement of activity that would have otherwise been undertaken at home. These two tempting claims are found to have limited, if any, systematic support. Instead, modern welfare norms that capture the nature of multinational firm activity recommend a move toward not taxing the foreign activities of American firms, rather than taxing them more heavily. Similarly, the weight of the empirical evidence is that foreign activity is a complement, rather than a substitute, for domestic activity. Much as the formulation of trade policy requires resisting the tempting logic of protectionism, the appropriate taxation of multinational firms requires a similar fortitude.