Modeling U.S. and Foreign Multinationals in an OLG-CGE Model
December 9, 2015 | John W. Diamond, George R. Zodrow
Table of Contents
Author(s)
John W. Diamond
Edward A. and Hermena Hancock Kelly Fellow in Public Finance | Director, Center for Public FinanceGeorge R. Zodrow
Baker Institute Rice Faculty Scholar | Allyn R. and Gladys M. Cline Chair of EconomicsIntroduction
Recent discussions of tax reform in the United States have focused on corporate income tax reform. The last fundamental reform of the income tax system, including the corporate income tax, was the much-celebrated Tax Reform Act of 1986 (TRA86), which followed the classic model of a base-broadening, rate-reducing (BBRR) reform that financed significant corporate and personal rate cuts with the elimination of a wide variety of tax preferences. In the interim, however, many countries around the globe have reformed their tax structures. This is especially true for corporate income taxes abroad, where many nations – at least partly in response to the inexorable forces of globalization and international tax competition (Zodrow, 2010) – have dramatically reduced statutory rates while enacting base broadening measures that have kept corporate tax revenues roughly constant as a share of GDP (Bilicka and Devereux, 2012). As a result, the United States, which was a relatively low tax country after TRA86, now has the highest statutory corporate tax rate in the industrialized world, and has also lost its advantage in marginal effective corporate tax rates (which take into account other features of a tax system, including accelerated deductions for depreciation and other investment allowances). Proponents of corporate income tax reform argue that such high tax rates (1) discourage investment and capital accumulation and thus reduce productivity and economic growth, (2) discourage foreign direct investment in the United States while encouraging US multinational companies (MNCs) to invest abroad, and (3) encourage US – and foreign multinationals investing in the US – to engage in income shifting, using a variety of techniques to move revenues to low tax countries and deductions to the relatively high tax United States. In addition, the combination of a high statutory tax rate coupled with a wide variety of tax preferences distorts the allocation of investment across asset types and industries and reduces the productivity of the nation’s assets, while exacerbating the many inefficiencies of the corporate income tax, including distortions of business decisions regarding the method of finance (debt vs. equity in the form of retained earnings or new share issues), organizational form (corporate vs. non-corporate), and the mix of retentions, dividends paid, and share repurchases (Gravelle, 1994; Nicodème, 2008). A separate issue that has attracted a great deal of attention is the tax treatment of US and foreign MNCs under current law. Following recent reforms in the United Kingdom and Japan, the United States is now the only major industrialized country that operates a worldwide tax system under which the foreign-source income earned by US subsidiaries is subject to a residual US tax when repatriated to the US parent, subject to a credit for foreign taxes paid. By comparison, most other countries (e.g., 28 of the 34 OECD nations) operate a territorial system under which the active foreign-source income of their domestically headquartered MNCs is largely exempt from any residual domestic taxation. Proponents of a move toward a territorial tax system in the United States argue that it would improve the international competitiveness of US multinationals and end the current tax disincentive for the repatriation of foreign-source income that arises as firms defer repatriation to avoid paying residual US taxes. These developments have by no means gone unnoticed in the United States. Numerous proposals for reform have emerged, all of which have generally followed the example of TRA86 and taken the form of traditional BBRR reforms. These include the reports of the President’s Advisory Panel on Federal Tax Reform (2005), the National Commission on Fiscal Responsibility and Reform (2010), and the Debt Reduction Task Force of the Bipartisan Policy Center (2010). The most comprehensive recent proposal for reforming the corporate and individual income tax systems – and the focus of this paper – was put forth as a legislative discussion draft on February 26, 2014 by Representative Dave Camp (R-MI), Chairman of the House Ways and Means Committee.1 In this paper, we report the results of a numerical simulation of the macroeconomic effects of the corporate income tax reform proposals contained in the Camp discussion draft (i.e., we hold the personal income tax system constant), using the DiamondZodrow model, a dynamic overlapping generations, computable general equilibrium (CGE) model that is designed to analyze both the short-run and long-run macroeconomic effects of tax reforms. The paper proceeds as follows. In the following section, we outline the corporate tax reform features of the Camp discussion draft that we simulate. The following sections describe the Diamond-Zodrow model. Section III provides a brief description of the domestic (closed economy) features of the model, which are described in detail in Zodrow and Diamond (2013). Sections IV–V provide a detailed description of the international features of the model that have been added to the model since the publication of Zodrow and Diamond (2013). The corporate tax reform simulation results are reported in Section VI. The final section concludes. Read the full paper here.This material may be quoted or reproduced without prior permission, provided appropriate credit is given to the author and Rice University’s Baker Institute for Public Policy. The views expressed herein are those of the individual author(s), and do not necessarily represent the views of Rice University’s Baker Institute for Public Policy.
© 2015 by the James A. Baker III Institute for Public Policy of Rice University