OECD – INTERNATIONAL TAX PLANNING AND FIXED INVESTMENT ECONOMICS DEPARTMENTS WORKING PAPERS N. 1361. This paper assesses how international tax planning affects real business investment by multinationals. Earlier studies have shown that corporate taxes reduce business investment. This paper shows that tax planning multinationals are less sensitive to corporate taxes than other firms in their investment decisions. This is presumably because tax planning multinationals do not face the full tax burden associated with their investments, since they shift part of the resulting profits to lower-tax rate countries. On average across industries, a 5 percentage point corporate tax rate increase is found to reduce investment by 5% in the long term. In industries with a strong presence of multinationals with profit-shifting opportunities, this effect is halved. These results obtained with industry-level data are confirmed by a firm-level analysis. Consistently with these results, the investment of tax planning multinationals is found to be more sensitive to taxes when strong rules against tax planning are in place. 1. Corporate income taxes affect business investment in several ways. By reducing the after-tax return on investment, high corporate taxes can lead firms to reject certain investment projects or reduce their scale, thus reducing the overall level of investment (OECD, 2009; Arnold et al., 2011). Corporate taxes also influence the allocation of investment across industries and countries (Fatica, 2013). All else equal, higher-tax rate countries attract less international investment than lower-tax rate countries, although corporate taxes are only one among many determinants of investment location (Skeie, 2016; Hajkova et al., 2006; Feld and Heckemeyer, 2011). 2. This paper explores whether the effect of corporate taxes on investment is influenced by international tax planning, which is also known as Base Erosion and Profit Shifting (BEPS) (OECD, 2013). The idea is that tax planning allows multinational enterprises (MNEs) to reduce their tax burden, for example by shifting profits to lower-tax rate or no-corporate-tax countries (Johansson et al., 2016a). As a result, the return on investment of an MNE entity in a high-tax rate country is only partially taxed (or not taxed at all) in this country. Reflecting this, tax-planning MNEs are expected to be less sensitive to corporate taxes in their investment decisions than non-tax-planning firms. Indeed, existing single-country studies focusing on US and German MNEs suggest that tax planning can affect the tax sensitivity of investment (Grubert, 2003; Overesch, 2009). The purpose of this paper is to assess this effect systematically across a wide range of countries. 3. This paper confirms that corporate taxes have a negative impact on investment and shows that this negative impact is smaller among tax-planning MNEs than other firms. The analysis is based on a large sample of industry and firm-level data for OECD and G20 countries. A 5 percentage point increase in the effective marginal corporate tax rate is found to be associated with a reduction in investment by about 5% in the long term on average across industries. This effect is lower in industries with a high concentration of MNE entities with profit-shifting incentives, i.e. entities facing a higher statutory corporate tax rate than the average in their MNE group. This definition of profit-shifting incentives is in line with the accompanying paper on the assessment of tax planning (Johansson et al., 2016a). For an industry with a strong presence of MNE entities with profit-shifting incentives (75th percentile of the distribution), the tax sensitivity of investment is nearly halved as compared to the median industry. Results obtained at the firm-level are consistent with these industry-level results. 4. The estimation results also suggest that strong anti-avoidance rules against tax planning (e.g. strict transfer pricing documentation requirements and interest deductibility rules, see Johansson et al., 2016b) increase the tax sensitivity of investment in industries with a strong concentration of profit-shifting MNEs. This confirms that tax planning affects the tax sensitivity of investment. Thus, tax planning opportunities may allow higher-tax rate countries to retain attractiveness as investment destinations for taxplanning MNEs, but this would come at the cost of tax distortions and losses in tax revenues. (By Stéphane Sorbe and Åsa Johansson).
