Territoriality, Worldwide Principle, and Competitiveness of Multinationals: A Firm-level Analysis of Tax Burdens

Using consolidated firm-level accounting data for about 3,400 companies in 15 OECD countries from ORBIS (2003–2007), this paper compares the tax burden of companies headquartered in worldwide countries with that of companies headquartered in territorial countries. The tax burden is measured by a marginal effective tax rate (METR) and, employing a new methodology, by a marginal effective tax base (METB) which controls for statutory corporate tax rates. A higher METR for entities headquartered in worldwide jurisdictions is explained by higher corporate statutory tax rates rather than by the difference in the taxation of foreign profits. The METB of companies headquartered in worldwide countries is not statistically different from that of companies headquartered in territorial countries. Using corporate presence in tax havens, the paper also investigates the vulnerability of territorial jurisdictions to tax avoidance. The results show that offshore low-tax operations reduce the METR and the METB of multinationals more in territorial systems than in worldwide systems.
 

Do tax burdens depend on whether companies are resident in worldwide or territorial countries?

Since Japan and the UK adopted a territorial system in 2009, the US is the only remaining major country with worldwide system that aims to tax fully foreign source income. This issue is the subject of lively debate in the US, with some arguing for a territorial system while others demand the abolition of deferral to strengthen the US system. One important piece of evidence needed in this debate is the extent to which companies headquartered in countries with worldwide systems systematically face higher tax burdens than those in countries with exemption systems. 

This research project addresses this question using consolidated firm-level accounting data for about 3,400 companies in 15 OECD countries between 2003 and 2007 (when the UK  and Japan had worldwide systems). The research estimates a marginal effective tax rate (METR) which measures the average rise in the tax liability as a result of an extra £1 of profit in the financial report. The results present clear evidence that this METR was significantly higher for companies headquartered in countries that had a worldwide system.

However, there were other differences in taxes between the countries considered, notably in statutory tax rates. To take account of differences in tax rates, we also estimate a marginal effective tax base (METB) that measures the increase in taxable profit resulting from an extra £1 of profit declared in the financial report. In effect this measure controls for differences in tax rates and therefore permits an assessment of the underlying system independently of the rate. The results are again striking; there is no significant difference in the METB  across countries. This indicates strongly that differences in the METR between countries are due primarily to differences in statutory tax rates, rather than in the treatment of foreign income.

This project also investigates the use of tax havens in affecting aggregate tax liabilities. It questions whether having a presence in a tax haven tends to reduce the aggregate tax liability of a company; and more specifically, whether this effect differs according to whether the company is headquartered in a country with a worldwide or territorial system. Consistent with greater opportunities for tax planning, the results suggest that presence in a tax haven reduces the METR and the METB more for companies headquartered in countries with territorial systems.

Giorgia Maffini