Taxation and the Competitiveness of U.S. Firms in World Markets

June 1, 1994

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Special Academic Paper

Executive Summary A sharp rise in cross-border investments in recent years has raised new questions about the competitiveness of U.S. firms in world markets and the role of tax rules in determining the cost of capital for these firms. Tax rules affect the ability of U.S. foreign subsidiaries to compete in foreign markets with the local companies and with the local subsidiaries of companies based in other countries. The primary channel through which taxes exert this influence is by changing the cost of capital.

Past comparative studies of the cost of capital have been mostly concerned with a comparison of the cost of capital for domestic investment between countries. The cost of capital for domestic investment differs from country to country basically for two reasons. First, the domestic cost of funds may differ across countries. Second, capital income is taxed differently, both at the personal and corporate levels, in each country. Although previous studies did not always reach identical conclusions due to methodological differences, a typical finding of these studies is that during the past decade, the cost of capital gap has been largely attributable to differences in the domestic cost of funds, leaving little room for the role of tax systems.

In the case of multinational investment, however, an international comparison of the cost of capital is complicated by the possibility of overlapping tax jurisdictions and the possibility of raising investment funds in different countries and transferring those funds between the parent and the subsidiary. Thus, comparing the cost of capital for domestic investment between countries may lead to very misleading implications for the competitiveness of multinationals.

The objective of this paper is to estimate the degree to which international tax rules affect the cost of capital with particular attention to U.S. firms competing with firms from other countries in major markets. The paper attempts to modify the conventional cost of capital measure in a way that incorporates the impact of international tax rules.

The analysis involves comparing U.S. firms and their local competitors in major foreign markets, U.S. firms and other foreign multinationals in a given foreign market, and local U.S. firms and foreign firms in the U.S.


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