The Effect of Financial Constraints on Income Shifting by U.S. Multinationals

Abstract

When a U.S. multinational corporation shifts income from the U.S. to foreign jurisdictions, it incurs costs and reaps benefits. The benefits may be reduced if the shifted income must be returned to the U.S. as a dividend in the short term and face the same U.S. tax it would have if the income had not been shifted. Firms, then, have incentive to defer repatriation of earnings and to fund domestic cash needs with external financing. The cost of external financing, however, is increasing in financial constraints, leading to the prediction that constrained firms will be unable to defer repatriation and, therefore, will reap no benefits from shifting. Using a new methodology for measuring income shifting, we find, consistent with predictions, that financially constrained firms shift less income from the U.S. to foreign countries than their unconstrained peers. We estimate that financially constrained firms shift out 20 percent less of pre-shifted income than unconstrained firms. Translating this percentage to dollar values, the mean (median) constrained firm shifts $16 million ($7 million) out of the U.S. each year, while the mean (median) unconstrained firm shifts $321 million ($134 million) out of the U.S. each year. Assuming that the inability to defer repatriation is the primary constraint preventing the U.S. worldwide tax system from being a de facto territorial system, we use our findings to estimate that changing to a pure territorial tax system would increase outbound income shifting by U.S. multinationals by 8 percent.

Profit-Shifting Activities in the Mining Sector: Evidence from the Czech Republic

“…The above model's definition of profit shifting is also consistent with earlier models by Hines and Rice (1991), Hines (1999), Devereux and Maffini (2007), Huizinga and Laeven (2008), Klassen and Laplante (2012), Dyreng and Markle (2016), Dharmapala and Riedel (2013) and Merz and Overesch (2016).…”

Does Private Country‐by‐Country Reporting Deter Tax Avoidance and Income Shifting? Evidence from BEPS Action Item 13

“…Consistent with this notion, Hanlon [2018, p. 1] notes that a benefit of public CbCR "might be found in a potential behavioral response on the part of companies to curb income shifting once they have to disclose activities and income on a country-by-country basis." Studies examining the effects of publicly disclosing a geographic breakdown of economic activity, however, provide mixed evidence (Dyreng et al [2016], Joshi et al [2019]).…”

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Strategic Subsidiary Disclosure

“…A growing literature uses Exhibit 21 disclosures to measure firm exposure to different countries, including tax haven use (e.g., Dyreng and Lindsey [2009], Lisowsky [2010], Dyreng, Hanlon, and Maydew [2012], Dyreng, Lindsey, and Thornock [2013], Black, Dikolli, and Dyreng [2014], Law and Mills [2014], Dyreng et al [2015], Hanlon, Lester, and Verdi [2015], Demere, Donohoe, and Lisowsky [2016], Dyreng and Markle [2016], Akamah, Hope, and Thomas [2017], Bozanic et al [2017], Chow, Hoopes, and Maydew [2017], De Simone, Mills, and Stomberg [2017], Dyreng et al [2017], Heckemeyer, Olligs, and Overesch [2017], Law and Mills [2017]). The IRS data provide an opportunity to examine the reliability of Exhibit 21 data when used to generate proxies for subsidiary locations in tax havens and other countries.…”