Boosting Taxes On Foreign Companies Can Backfire

To mitigate against currency swings and dumping suits, many foreign companies have shifted production to the U.S. But that move opens the foreign company to another attack--that it underpays taxes, thanks to some accounting legerdemain that inflates its production costs here. During his election campaign, President Clinton vowed to crack down on these scofflaw corporations, and the Administration may soon seek to boost tax collections from foreign transplants. At the same time, multinational corporations face similar pressures elsewhere: Japan, for example, recently slapped large tax assessments on Coca-Cola, Ciba-Geigy, and Roche to end what Japan perceived as "transfer-pricing" abuses.

Yet a new study by two Columbia University researchers, Jason Cummins and R. Glenn Hubbard, suggests that the costs from governments' looking to crack down on multinational companies could outweigh the benefits of any incremental revenue gains. Specifically, multinationals facing the prospect of sharply higher taxes in foreign markets are very likely to reduce capital investment in those locales. By looking at reports filed by several hundred subsidiaries of U.S. multinational corporations from 1980 to 1991, the pair discovered that each percentage-point increase in the tax-adjusted cost of capital led to a 1 to 2 percentage-point decrease in the annual rate of investment. "There had been an opinion among some economists that taxes didn't matter in foreign direct investment," says Hubbard. "But we found that taxes were a very big determinant of FDI."

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