1. ASSA 2019 Annual Meeting Atlanta, Georgia January 4, 2019
FDI Return Differentials: An Explanation Based on Offshore Profit Shifting
Jennifer Bruner
(with F. Guvenen, D. Rassier, and K. Ruhl)
ASSA 2019 Annual Meeting
Atlanta, Georgia
January 4, 2019

2. Road map Motivation Formulary apportionment
Measurement challenges related to multinational enterprises (MNEs)
Formulary apportionment
Overview of the method
Implications for key measures in the U.S. economic accounts
Returns on direct investment
Computation
Results
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3. MNEs and Measurement Challenges
Transfer pricing
Lack of market transaction and arm’s length price
Yet subject to regulatory scrutiny and enforcement (Marques & Pinho, 2016)
Business structuring for purposes other than production
SPEs and holding companies
Examples: IP licensing companies, financing companies
Heterogeneous tax laws and other regulations across countries
May facilitate artificial location of production and related income
Measured activity may be incongruent with real economic activity
Institutional units and residence in international statistical guidelines, System of National Accounts (SNA) and Balance of Payments Manual (BPM)
Resident in same economy as parent → no separate institutional unit
Resident in economy other than parent → separate institutional unit

4. Implications for Measurement of U.S. MNEs
OWH Other Western Hemisphere
Source: Based on Lipsey (2010).

5. Implications for Measurement of U.S. MNEs
OWH Other Western Hemisphere
Source: Based on Lipsey (2010) and Rassier and Koncz-Bruner (2015).

6. Research on Profit Shifting and Measurement
Guvenen, Mataloni, Rassier, Ruhl (2017) (GMRR)
Role in offshore profit shifting on measured U.S. productivity slowdown
Time series of adjusted business sector value-added:
Simple model attributes profit shifting to intangible capital
Bruner, Rassier, Ruhl (2018) (BRR)
Role of offshore profit shifting on key U.S. economic accounting measures
Single year of adjusted SNA and BPM measures: 2014
Same methodology and data as GMRR
Broader scope of adjusted measures (outside production account)
Potential implications for common analytic uses (beyond productivity)

7. Research on Profit Shifting and Measurement
Affiliate “owns” intangible capital created by parent
Legal ownership?
Economic ownership?
Affiliate returns on intangible capital under alternative ownership arrangements
Owned by parent – payment to parent: ↑ GDP
Owned by affiliate – underpayment: ↑ income on FDI
Owned by a low-tax affiliate – payment to affiliate: ↑ income on FDI
Income on USDIA increases sharply between 2000 and 2011
Reallocate measures across entities w/in U.S. MNEs
Operating surplus
Income on USDIA
Conceptually Different

8. Reallocation: Formulary Apportionment

9. Reallocation: Accounting Relationships

10. BRR: Changes in Key SNA Measures (2014)
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11. BRR: Changes in Key BPM Measures (2014)
+10.8%
* Net lending (+) or net borrowing (-) based on current and capital accounts

12. BRR: Changes in Key BPM Measures (2014)
-27.8%
+4.0%
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13. Puzzle: Gap in Returns on USDIA and FDIUS
Unadj.
Return USDIA
Unadj. Return FDIUS
USDIA U.S. direct investment abroad
FDIUS Foreign direct investment in the United States
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14. Possible Explanations for a Gap in FDI Returns
Exclusion of intangible assets (McGrattan and Prescott, )
U.S. taxes (Bridgman, 2014)
U.S. tax liabilities
Risk, sunk costs, and age (Curcuru and Thomas, 2012)
Double-counting of holding companies (Albertus, )
Country-level tax rate differentials and profit shifting (Wright and Zucman, 2018)
Age effects (Lupo, Gilbert, and Liliestedt, 1978; Grubert, Goodspeed, and Swenson, 1993; Laster and McCauley, ; and Mataloni, 2000)
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15. Computing FDI Returns
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16. Computing FDI Returns
where:
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17. Computing FDI Returns
where:
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18. Computing FDI Returns
where:
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19. Computing FDI Returns
where:
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20. Returns on USDIA and FDIUS
Unadj.
Return USDIA
Unadj. Return FDIUS
Adj. Return USDIA
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21. USDIA Returns in Tax Havens
Unadj. Haven
Unadj. Total
Unadj.
Non-haven
tax havens included Bahamas, Barbados, Bermuda, Costa Rica, Hong Kong, Ireland, Liechtenstein, Luxembourg, Netherlands, Panama, Singapore, Switzerland, and the U.K. Islands, Caribbean.
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22. USDIA Returns in Tax Havens
Adj. Non-haven
Adj. Total
Adj.
Haven
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23. USDIA Returns by Industry
Chemicals covers industries
Technology computed as the sum of computers and electronic products manufacturing (defined by NAICS-based industries ) and information ( )
Year≥2009: Petroleum sums oil and gas extraction; support activities for oil and gas extraction; petroleum and coal products manufacturing; petroleum and petroleum products wholesale trade; gasoline stations; petroleum tanker operations; pipeline transportation of crude oil, refined petroleum products, and natural gas; and petroleum storage for hire 1
1. Petroleum is an addendum item that sums various petroleum-related industries across a variety of industry sectors. It was not available in the published statistics before 2009.
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24. USDIA Returns by Industry1
1. Petroleum is an addendum item that sums various petroleum-related industries across a variety of industry sectors. It was not available the published statistics before 2009.
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25. Conclusions
Adjustment for profit shifting using the formulary apportionment approach closes (or even reverses) the persistent differences in the rates of return on outward FDI versus inward FDI
Adjustments are largest for tax haven countries, consistent with our hypothesis
Adjustments seem to correlate with known profit shifting industries
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