Tax Policy, Investment and Profit-Shifting

with Katarzyna Bilicka and Michael Devereux

Multinational firms (MNEs) often pay no tax in high-tax countries because they shift a large fraction of their taxable income to tax havens. We build a model of tax policy and investment that incorporates unobserved heterogeneity in MNEs' profit-shifting capability and different costs of setting up a tax minimization network. The model matches the distribution of taxable profit and investment in detailed UK tax returns data. We use the model to quantify the policy tradeoff between raising tax revenue by combating tax avoidance (via, for example, a Global Minimum Tax) and attracting investment. The results solve a longstanding puzzle in the existing profit-shifting literature: our model reconciles the differences between previous micro- and macro-level estimates of profit-shifting elasticities by accounting for extensive margin decisions (to report positive or no taxable profit in a jurisdiction). We test the model's predictions using a reform in Italy that limited the profit-shifting activities of Italian MNEs as a quasi-natural experiment.

(This paper was previously titled 'Optimization Frictions and the Fixed Cost of Profit-Shifting')

Dynamics of Financing Frictions for Investment in R&D

with Eleanor Dickens and Ahmed Tohamy

Measurement and identification issues constitute a challenge in our understanding of the extent of financing constraints as a barrier to investment and innovation. Governments try to alleviate liquidity constraints of innovative firms by providing a range of support schemes, but there is limited evidence on their effectiveness. A special UK policy provides new insights and offers the possibility of carrying out counterfactual policy experiments in a setting with small and medium sized innovating firms that face financing constraints. Firms are offered incentives for R&D, giving loss-makers a choice between taking a cash injection from the government immediately or when they become profitable in the future. Claiming the cash immediately comes at a cost; the rate at which the government pays cash to loss-making firms is significantly lower than a future deduction. Different choices made by the firms are informative about heterogeneities in financing constraints and productivity across firms. The exogenous variation across firms and over time in deduction rates and the availability of the cash option identifies the effects of policy changes on cash flow, and consequently, outcomes of interest such as R&D investment and output. 

(formerly "Quantifying and Alleviating Financing Constraints: Structural Evidence from a Policy Experiment")

Tax Incentives and Start-up Finance, with Xipei Hou and Jing Xing

We examine how investor-level tax incentives affect venture capital funds' investment strategy and financing for start-ups, using the introduction of a generous tax deduction for qualified VC investment in China as a quasi-natural experiment. We find that the tax incentive leads venture capital funds to become more ``patient" and invest more in early-stage start-ups. We also find that affected venture capital funds become more selective, which potentially offsets the risk of investing in early-stage businesses. Consequently, the tax incentive increases funding for eligible start-ups and encourages firm entry into affected industries, especially in cities more exposed to venture capital funds.

Business Location Decisions with a Global Minimum Tax 

with Francois Bares, Michael Devereux and Vikram Patil

In an historic agreement in 2021, 141 countries agreed on imposing a global minimum tax (GMT) on the profits of multinational corporations. Proponents of the GMT argue that the measure will reduce the distortion to businesses' location decisions by reducing the dispersion in tax rates internationally. We investigate the impact of the GMT on business location and investment decisions. To do this, we develop a location choice model based on effective average tax rates (EATRs) augmented with incentives for profit-shifting to low-tax jurisdictions. GMT affects the dispersion of EATRs for new investment in different countries, but its impact is non-monotonic in the threshold rate. For low values of the GMT threshold, the introduction of a minimum tax increases EATRs more in high-tax countries relative to low tax countries, increasing the dispersion of EATRs. As the statutory minimum rate increases, more low-tax countries begin to set their tax rate at the threshold, reducing the dispersion. An increased threshold has heterogeneous cost of capital effects for different countries; we find that a high threshold rate may substantially depress capital accumulation in investment hubs. This analysis provides a novel contribution to the literature on the relationship between taxation and corporate decisions on real activity.

The Role of Intellectual Property in Tax Planning 

with Katarzyna Bilicka and Paul Organ

Multinational enterprises (MNEs) that invest in research and development (R&D) and innovation find it easier to shift profits between their subsidiaries located in jurisdictions with different tax rates. While MNEs invest in R&D and develop intellectual property (IP) across multiple jurisdictions, they can also strategically move profits arising from that IP from high- to low-tax jurisdictions to reduce their overall tax bill. In this paper, we analyze and quantify the importance of two different strategies that MNEs use to move their IP to low-tax jurisdictions: selling a patent developed in a high-tax jurisdiction to a low-tax jurisdiction directly, or signing a cost-sharing arrangement (CSA) between those two jurisdictions to cover the costs of developing further IP. Combining administrative data on CSAs, patent applications and transactions, and US tax returns, we provide novel stylized facts on the use of both those strategies by MNEs. We then show that CSAs increase jurisdiction-level assets, patenting activity, royalty payments, taxes, and profitability, especially the CSAs signed with low-tax jurisdictions. At the MNE level, a new CSA significantly increases firm sales, profitability, and R&D investment, without affecting the MNE's effective tax rates.