This evening I attended the annual Tillinghast Lecture on international taxation at NYU Law School. The speaker was John Samuels of General Electric, who has been called the leading in-house corporate tax counsel in the US today.
I have met Samuels several times over the years when presenting papers at the International Tax Policy Forum in DC, which he directs. My post about my most recent appearance there, where my interlocutors, including Samuels, succeeded in stirring some doubts concerning how I have been thinking about international tax policy, is here.
But this time John was on the firing line, not me. And I was very interested in hearing about the alternative (and as it happens, more pro-US multinationals) view of international tax policy that he holds and had effectively argued for at my ITPF session.
John started by criticizing the standard US (at least in pro-government circles) view of international tax policy as aiming to promote worldwide economic welfare (as distinct from national economic welfare) by advancing capital export neutrality (CEN), which urges, among other applications, that US companies face as high a tax rate on outbound investment as on home investment, so that they will go for the investment with the highest pre-tax yield. He condemned the foolishness of pursuing WW welfare when everyone else is pursuing national welfare.
There was a missing piece at this stage of the talk, but one that he was, I think, prepared to supply. Under the long-standard economic analysis, dating back to Peggy Musgrave's early-1960s work, the right thing to do from a selfish standpoint with outbound investment of your own nationals is to be less generous than the current US international tax regime - not more so. Musgrave describes "national neutrality," under which nations make no effort to ameliorate double taxation, merely allowing deduction of dollars paid to foreign governments on outbound investment. Result under the standard analysis: outbound investment is greatly deterred to everyone's WW detriment. For example, if France and the US both have 40% tax rates, a US firm earning $100 in France ends up with only $36 ($40 French tax leaves $60, then 40% US tax on this residue). Only, within the standard analysis, the US has no reason to change its behavior here unless there is reciprocal forbearance - i.e., France as well as the US retreats on revenue claims via foreign tax credits or exemption of foreign source income. Big difference from free trade, where everyone benefits from being a good guy even if it is unilateral. Here, it has to be reciprocal. Hence, my paper from the above-noted ITPF session where I talked about it in terms of prisoner's dilemmas.
Often when the US tries to clobber its multinationals on outbound investment, this is rationalized as cooperating when everyone else is defecting, from the standpoint of tax harmonization versus tax competition. John's talk was highly critical of US policy on this point, leaving unrebutted the critique that what we're doing might alternatively be rationalized as moving closer to national neutrality by increasing US taxation of outbound investment by shaving foreign tax credits.
The central bone of contention, and of John's answer to this national neutrality point, and of the responses to my article at ITPF the other month, goes to whether US outbound investment is a substitute or a complement for home investment. Substitute is what you'd expect if a given US company has a fixed pool of capital. E.g., we have $10M to invest, and we'll put it either here or there. Tne national neutrality view depends on substitution, rather than complementarity, thus rationalized in terms of where you spend your finite budget. But research by Mihir Desai, Jim Hines, and others fails to find substitution and instead finds complementarity. In other words, making more foreign investments if anything increases a US firm's home investments, rather than crowding them out.
How can this be, when the idea of budget constraints is among the most fundamental in economics? The idea is that the various firms from around the world are competing for capital. Assume for now it's loan capital not equity they are competing for. They're battling each other to borrow money in order to invest it at a high return.
Let's make it concrete. GE or MacDonald's is considering investing in China. Given home country bias in where people buy stock, we assume that these US companies are mainly US-owned, so the profits are going ultimately to US individuals who own the shares. GE or MacDonald's is competing with a German firm (a) to make a given investment in China that is expected to be profitable, and (b) to borrow $$ on worldwide capital markets to fund the iinvestment.
John argues that the US firm can't compete with the German firm if it has to pay more tax due to the US international tax system. Problem # 1: paying a higher tax rate doesn't necessarily make you non-competitive. Example: a 40% taxpayer and a 30% taxpayer can compete without competitive advantage to the former (other than, e.g., in generating funds internally). Both will price their goods for the highest pre-tax profit, the 30% guy simply gets to keep more of it. If the bank offers 10% interest, the 30% guy isn't going to out-compete the 40% guy to put money there; he'll simply do better after-tax (but the home country government does better in the 40% case, making it in this sense potentially a wash).
Problem # 2: Why does GE or MacDonald's have this profitable investment opportunity? Multinationals are set up, modern corporate theory has it, to exploit rents that are available to them through the most efficient ownership structure to exploit these rents. In plain English, MacDonald's has that stupid name that people value, so they can sell manure-filled cow slop for big bucks. GE has internal knowhow and valuable patents or something like that. Rents in this lingo are special opportunities to realize extra-normal returns. Economic theory says that you can tax rents (once established) without changing behavior. E.g., if Michael Jordan's best opportunity is to earn $30 million playing basketball, and second best is to earn $100,000 playing baseball, tax his basketball earnings at 90% and it's still the best thing he's got going.
So why can't one tax the rents, also why are there rents if the Germans are out there competing with GE. Don't they get competed away? Why doesn't it all boil down to Americans getting the normal return on their saving, meaning that we ain't gonna get no richer unless we save more.
Next problem: if GE or MacDonald's isn't tax-deterred from making this investment, how is it going to fund it, as a complement rather than a substitute for home investment, absent a magical money machine? The answer, presumably, is that it raises the money - not from Americans, who aren't saving any more, but from foreign investors on WW capital markets. But now the rent ceases to be captured by Americans unless we posit that GE or MacDonald's, despite being able to attract the rent in China notwithstanding German competition, and despite being so readily tax-deterred on the US side if we don't treat them as favorably as Germany treats the German firm, can decline to share it with the foreign investors. They ostensibly lack the market power to do any more than get the normal rate of return on debt, leaving the extra profit still to be captured by the American shareholders.
Something about this story still doesn't compute for me. I am starting to think that what Samuels is showing is WW inefficiency, not national inefficiency. The world loses if the capital goes through the German firm rather than through GE, despite GE's being the more efficient operator, because the suppliers of WW capital would rather go through that firm in order to get the corporate residence company tax savings. That sounds like a decent WW efficiency argument. But why is it a US problem if Americans, not being the suppliers of the extra capital, aren't going to be the ones who reap the extra profit?
Perhaps at best he's saying that the US tax regime will generate WW inefficiencies while doing little for us given the escape hatch of investing through a foreign firm. So we don't really gain that much, he may be saying, and WW efficiency suffers. But the case he thought he was making was that US living standards will be hurt if GE doesn't get to make that foreign investment that is being competed against by the Germans and that is funded at the margin by foreign capital from somewhere or other. And I am finding it hard to make this story stand up.