President Barack Obama recently proposed tax law changes that would limit companies' ability to defer U.S. taxes on foreign profits, a change the government estimates would help it raise $86.5 billion over 10 years. New research from Duke University and The College of William & Mary examines the intricacies of corporate tax payments on offshore profits, and tallies the total tax burden of companies' operations outside of the U.S.
Professors Scott Dyreng of Duke's Fuqua School of Business and Brad Lindsey of William & Mary, used public data from corporate annual reports to find that the average US multinational corporation paid 4% of its foreign earnings in US federal tax, an estimate verified by a recent study by the Government Accountability Office. They also find that this 4% federal tax is on top of an average tax of 26% of foreign earnings paid to the foreign governments in which the firms operate. When added together, Dyreng and Lindsey estimate that US multinational corporations are paying an average of 30% tax on foreign earnings to taxing authorities somewhere in the world.
So, how much can the government expect to collect by changing corporate tax rules? Dyreng and Lindsey estimate federal tax on foreign income would increase by about 4.5 percentage points if deferral were eliminated, bringing the total tax on foreign earnings to around 35 %, equal to the current tax on earnings for companies operating domestically. When translated to dollars, this corresponds closely to the $86.5 billion over 10 years estimated by the President.
Is all the effort to tax offshore operations worth it, at least in terms of potential tax revenues collected by the US Treasury? Maybe not. Dyreng and Lindsey also provide evidence that in some cases the US Treasury benefits when multinational firms operate in low-tax foreign countries, including tax havens. Some of these corporations paid high federal tax on foreign earnings compared to corporations in high-tax foreign countries. While this may seem counterintuitive, the result suggests the current US tax system, which is designed to collect incremental federal tax on foreign income taxed at rates lower than the US rate, in fact functions as designed much of the time.
Dyreng and Lindsey's paper has been accepted for publication in the Journal of Accounting Research and is available for download from the Social Science Research Network.