Increased profits from tax havens don’t nurture R&D in multinational enterprises

It’s an almost-unfathomable figure: US$21 trillion to US $32 trillion – nearly half of the globe’s annual GDP of $72 trillion – that is estimated by the Tax Justice Network to have been secretly squirrelled away by multinational enterprises (MNEs) in tax havens. That’s money that should, but isn’t, going into the tax coffers of nations like Canada.

Professors Chris Jones and Yama Temouri of Aston Business School in Birmingham, U.K., have undertaken a groundbreaking study, collating the data drawn from the 2002 to 2011 financial reports of more than 30,000 MNEs – 6,000 of which have tax haven subsidiaries in nations like Barbados, Turks and Caicos, and Monaco. The companies included many of the FTSE 100 and were manufacturing firms as well as service-industry corporations. Titled Tax Havens and Firm Performance, the study analyzed the impact of having at least one tax haven subsidiary on the corporation itself. The authors investigated key questions relating to economic dynamism: Avoiding taxes boosts profitability (obviously), but does it increase productivity? Are the extra profits poured back into R&D, technological improvements, and product and process innovation to boost competitiveness?

Perhaps surprisingly, the answer is “no,” says Prof. Temouri, who researches foreign direct investment and the effects on firm performance and labour markets. “We found no productivity or technology improvements for the manufacturing sector,” he says.  “There were, however, some small positive effects in the service sector.”

This result is disturbing, Prof. Temouri says. It means that the home nation where the MNE is headquartered isn’t collecting legitimate tax revenues. It also means that tax haven presence isn’t boosting the home nation’s economic growth in the long term. Furthermore, those firms that choose not to use tax havens have lower profit margins, putting them at a competitive disadvantage, he says.

Prof. Jones emphasizes that the study isn’t intended to provide “an ethical or moral perspective” on tax haven use. He points out that many MNEs use tax havens in order to avoid “double taxation.” For example, an American MNE may have a subsidiary in Germany where it pays taxes, then is forced to pay tax on money transfers coming into the United States. “You need to give some leeway to companies as well,” Prof. Jones says. “Alarmingly, however, it can lead to double non-taxation, where the MNE doesn’t pay tax anywhere.”

Tax havens are considered by some pundits to exemplify the very worst of free-market capitalism. However, they are not a new phenomenon, says Prof. Temouri. It is up to world governments and organizations like the OECD to co-operate with one another to close a multitude of international trade loopholes that allow tax havens to flourish. “Multilateral action is needed; action by individual countries may drive more firms offshore or tempt them to relocate to countries less hostile to tax haven use.”

Tax Havens and Firm Performance by Drs. Yama Temouri and Chris Jones of Aston University, Birmingham, U.K.