Do Multinational Firms use Tax Havens to the Detriment of Other Countries?

Abstract

The use of tax havens by multinational corporations (MNCs) has attracted increasing attention and scrutiny in recent years. This paper provides an exposition of the academic literature on this topic. It begins with an overview of the basic facts regarding MNCs' use of havens, which are consistent with the location of holding companies, intellectual property, and financial activities in havens. However, there is also evidence of significant frictions that limit MNCs' use of havens. These limits can be attributed to nontax frictions (such as the legal and business environment in different jurisdictions), to tax law provisions limiting profit shifting, and to the costs of tax planning. There is evidence consistent with the relevance of each of these channels. The paper also argues that nonhaven countries have available a range of powerful tax law instruments to neutralize the impact of MNCs' use of havens. To the extent that it is not due to political dysfunction, their failure to deploy these instruments more extensively can be viewed as a deliberate policy choice, attributable either to collective action problems among nonhavens or to the possibility that in certain circumstances MNCs' use of havens increases the welfare of nonhaven countries. In either case, MNCs' use of havens is facilitated in crucial respects by the laws of nonhaven countries. Finally, the paper discusses how the distinction commonly drawn in public finance theory between "tax avoidance" and "behavioral responses to taxation" can illuminate current debates about the magnitude and implications of MNCs' profit shifting to havens. JEL-Codes: H250, F230.

On the Determinants and Effects of Corporate Tax Transparency: Review of an Emerging Literature

“…Fourth, following economic and legal literature, we make a conceptual distinction between legal and illegal practices to reduce the income tax burden (Dharmapala, 2020;Gravelle, 2009Gravelle, , 2015Slemrod & Yitzhaki, 2002). Therefore, we define tax evasion as an intentional illegal activity (e.g., concealing taxable income from the tax authorities), which constitutes a criminal offense in many countries.…”

“…For the purpose of our study, we exclude transparency rules and initiatives that clearly aim at fighting tax evasion due to its distinct legal assessment. These measures are primarily targeted at individuals anyway (Dharmapala, 2020). Instead, we focus on disclosures conveying information about companies' legal efforts to reduce their income tax burden.…”

“…To prevent practical problems of delimitation, we also include the "grey area" of legally questionable activities in this category and collectively refer to it as tax avoidance or tax planning. 7 Within this framework, profit shifting, i.e., the (artificial) allocation of MNEs' profits to low-tax countries, represents one important subset of tax avoidance instruments (Dharmapala, 2020).…”

“…Since corporate decisions on the level of tax avoidance are not made independent of disclosure choices, it is essential to understand which factors determine tax disclosure behavior and how disclosure decisions interact with actual tax avoidance. Prior surveys on corporate tax avoidance comprehensively review studies that examine the tax behavior of multinational firms (Dharmapala, 2020;Dyreng & Hanlon, 2019) as well as the determinants and, more recently, the effects of corporate tax planning (Brühne & Jacob, 2019;Wilde & Wilson, 2018). 4 While tax avoidance is typically measured using financial statements items, existing reviews pay little 3…”

Construction of the data “matrices” underlying the impact assessment

“…exemptions for foreign capital gains and dividends. 68 These rules however move the tax system away from a purely territorial system to tax certain types of income at a worldwide level. 69 Independent of the system of taxation, CFC rules makes the tax liability current and therefore there is no possibility of further deferral.…”