Tax reform is now boosting measured GDP
The Financial Times reports that the recent corporate tax reform is beginning to encourage companies to bring intellectual capital back to the US:
Google has overhauled its global tax structure and consolidated all of its intellectual property holdings back to the US, signalling the winding down of a tax loophole estimated to have saved American companies hundreds of billions of dollars.
The internet search company said on Tuesday the move was designed to simplify its corporate tax arrangements and was in line with OECD efforts to limit international tax avoidance, as well as recent changes to US and Irish laws.
Google’s actions came ahead of the close of the so-called “double Irish” tax loophole, which has been used by US companies to channel international profits through Ireland and on to tax havens like Bermuda — putting them outside the US tax net. That led American companies to amass more than $1tn offshore as of the end of 2017, when President Donald Trump’s tax reform changed the treatment of overseas profits.
This action does not impact the actual GDP of the US, as even profits supposedly “held overseas” are in fact owned by US multinationals. It’s an accounting gimmick to avoid taxes, which has no implications for variables such as national income, productivity, exports, etc. But these tax shifting activities do impact measured levels of national income, productivity, exports, etc.
A paper by Fatih Guvenen, Raymond J. Mataloni Jr. Dylan J. Rassier and Kim J. Ruhl provides an example:
Consider the iPhone, which is developed and designed in California but assembled by an unrelated company in China, with components manufactured in various (mostly Asian) countries. Taking some hypothetical ballpark figures, suppose the bill of materials and labor costs of assembly amount to $250 per iPhone and the average selling price is $750, for a gross profit of $500 per phone. For simplicity, assume that there are no further costs of retailing and that all iPhones are sold to customers outside of the United States.
Two important questions arise from this simple scenario: First, defining GDP as total domestic value added, how much should each iPhone contribute to U.S. GDP? Second, given the profit-shifting practices described above, how much of each iPhone’s gross profit is actually included in U.S. GDP?
To answer the first question, note that the $250 paid to contract manufacturers and suppliers in Asia is not part of U.S. GDP, whereas how much of the $500 gross profit should be attributed to U.S. GDP depends on where that value is created. If consumers are willing to pay a $500 premium over the production cost for an iPhone, it is because they value the design, software, brand name, and customer service embedded in the product. If we assume these intangibles were developed by managers, engineers, and designers at Apple headquarters in California (Apple, U.S.), then the entire $500 should be included in U.S. GDP. In the national accounts, the $500 would be a net export under charges for the use of intellectual property in expenditure-based GDP, matched by an increase in Apple’s earnings in income-based GDP.
They suggest that much of this output is actually attributed to tax havens such as Ireland:
Suppose that Apple generates intangible assets in the United States and legally transfers them to a foreign affiliate (e.g., one in Ireland). Payments for the use of intellectual property will accrue in Ireland rather than in the United States, which means that the returns to Apple U.S.’s intangible assets are attributed to an Apple affiliate outside the United States and not included in U.S. GDP.
Productivity in the US, especially in high tech industries, is higher than the reported figures. Until the recent tax reform, this problem had been getting worse over time. They report that the practice of US multinationals parking money in tax havens tends to inflate reported GDP in countries like Ireland and Netherlands by 9% to 13%. In the US, the reduction in measured GDP is closer to 1%.
So far, the effects of the recent tax reform on measured US GDP are relatively small. But if the Google decision is copied by lots of other companies, it has the potential to raise reported GDP, productivity, and exports in the US, without affecting actual GDP, productivity and exports.
This process could disrupt a NGDP targeting regime. Fortunately, the impact would be too small and too gradual to lead to a significant business cycle. More likely the unwinding of overseas IP investments would add a few tenths of a percent per year to reported GDP in the US, at most.
As far as Ireland is concerned, if they ever abandon the euro I strongly suggest they target domestic labor income, not GDP.
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1. January 2020 at 19:04
This is an interesting post, and probably scratches the surface of the topic.
Rather obviously, personal and corporate income taxes have become domestic and international shell games and gong shows. Pin the tail on the donkey, and the donkey is you, if you pay income taxes.
Reportedly, there is $32 trillion and counting in offshore tax havens, but no one really knows.
In Japan, the average resident (man, woman and child) has about $8000 yen equivalent in cash. Paper money, not in banks. In the US that figure is about $5000 and doubling every 10 years.
Capital markets have become globalized, and money is fungible. If the Swiss print-digitize $1 trillion (USD equivalent) in Swiss francs and pump the new money into global capital markets, what does that mean? No one knows, but they did hold the line on franc exchange rates.
Does money printed (digitized) up through central bank QE end up in capital markets of any nation, or global capital markets, or is such money actually spent by consumers?
If money is fungible, and we look at the margin, we can posit that QE-money went to people selling their bonds to finance consumption. That is, no one had to give up consumption, since the Fed was buying the bonds, not another investor.
You know, this stuff is really complicated, and muddy.
2. January 2020 at 03:03
I agree with the idea. Foreign profits attributed to US corporations shouldn’t be part of US GDP and should be of US GNP. Thus he tax change and the IP movement should increase GDP.
Sure.
It’s just that I recall – and my memory’s not all that good – chasing this down years back and Census actually classifies all profits of US corporations – whether foreign profits or domestic – as part of US GDP.
Yes, I know, it shouldn’t be, but when I wrote the following I did go and look it up:
https://www.forbes.com/sites/timworstall/2015/02/03/obamas-repatriated-profits-tax-wont-raise-us-gdp-by-1-5/
2. January 2020 at 05:07
This is like the cat chasing his tail. Recall that one justification for the corporate tax cut was to induce Apple et al. to bring home all those profits held in (for example) Ireland. In what assets did Apple invest all those profits held in Ireland? Sheep? Duh.
Recall that “manufacturing output” includes imported intermediate goods; hence, manufacturing output and GDP can go in opposite directions. That’ confusing. Better still, tariffs on imported intermediate goods typically depress manufacturing output, the opposite of what common sense suggests. Can the stable genius straighten out the confusion? Can the first daughter who is “good with numbers”?
2. January 2020 at 06:16
– Why is increased productivity Always considered to be a good thing ?
– These companies are only bringing back “Intellectual Capital” ? Not the jobs themselves ?
2. January 2020 at 09:25
Scott,
Perhaps an ignorant question but weren’t companies restricted from moving profits back into the U.S. if they had been ‘earned’ outside it, less they would be subject to taxation? My understanding was that this is at least part of the reason that Apple was holding such a large sum of their profits in cash. So does the closing of this loophole make it more feasible for these companies to invest this money in the U.S. or return it to shareholders as dividends? In that case would this change encourage investment that wouldn’t have otherwise occurred?
2. January 2020 at 14:18
Brad Setser is the best international tax avoidance detective around, in my view, and he seems to think that this change by Google is mostly cosmetic. If anything, the recent tax changes have increased the incentive for tech firms to book their profits overseas.
https://twitter.com/Brad_Setser/status/1212444725791395843?s=19
2. January 2020 at 17:40
While closing (and opening) tax loopholes can “create” GDP that is purely an accounting phenomenon, tax loopholes typically lead to inefficient investment, and closing them is generally a good thing. Perhaps, not as good as the accountants would lead you to believe, but nonetheless a good thing.
3. January 2020 at 08:01
Tim, You may be right; I’m just relying on what I read. The authors of the paper I link to seem pretty well informed.
tjnelso, Based on what I read this did not discourage US investment, as firms could borrow against their overseas profits.
stoneybatter, Interesting.
Doug, Yes.
5. January 2020 at 07:04
@Worstall
The US Bureau of Economic Analysis calculates US GDP, not the US Census Bureau.
From the BEA’s GDP Primer
6. GDP captures output produced in the United States.
GDP is a measure of the goods, services, and structures produced by labor and property located within the United States (in the NIPAs, the United States comprises the 50 states and the District of Columbia). 〈Thus, GDP includes the output of U.S. offices or establishments of foreign companies located in the United States, and it excludes the output of foreign offices or establishments of U.S. companies located outside the United States. i/〉 This treatment aligns GDP with other key U.S. statistics associated with the domestic economy, such as population and employment.
As applied to Ireland, the typical arrangement isfor a US company to establish an Irish subsidiary (not an unincorporated Irish branch of the US parent) that purchases the intellectual property from the US parent or the US parent’s domestic subsidiary. Alternatively, the Irish sub is funded and thereafter finances the development of IP, making it the owner of anything that comes out of that R&D (or not). Going forward, the Irish sub then bears the risk (upside and downside) of future income/loss. If the rule for calculating GDP were otherwise, both Ireland and the US would both be credited with an increase in GDP for the same transactions/income. This is essentially the difference between GNP/GNI and GDP. This is also one reason why Ireland’s measured GDP is routinely much higher than its GNP. And, conversely, while I have not looked at recent data, it may suggest that (and explain why) US GNP is higher than its GDP.
5. January 2020 at 09:23
Does this not suggest that GDP should be measured by attributing profits to the personal incomes of shareholders wherever the “profits” are booked in the same way that they should be taxed?
5. January 2020 at 09:27
@ryward
There was lots of “justifications” for the “Tax Cuts for the Rich and Deficits Act.” The only reason was to transfer income from the middle class to high income (but low tax) payers.
5. January 2020 at 11:06
Rayward,
Intermediate goods are counted as imports.
This isn’t even real Econ, it’s just a basic identity equation.
5. January 2020 at 18:01
[…] Prof. Scott Sumner: Tax Reform is Now Boosting Measured GDP (Source: The Money Illusion) […]
6. January 2020 at 08:25
Isn’t the implication that corporate profits should be imputed to owners and taxed as personal income and measured that way?
6. January 2020 at 12:42
@tjnelso: “In that case would this change encourage investment that wouldn’t have otherwise occurred?”
I would think any company stashing cash offshore could more easily invest and still avoid taxes by borrowing at very low interest rates in the US, with debt secured by offshore cash holdings? Then the debt interest partly offsets taxes on profits from the investment, and you don’t pay tax on the profits you still held offshore. Yes/no?
7. January 2020 at 08:35
Interesting stuff in your cities post at econlog. Jane Jacobs used a similar type of rational regarding cities (regions) having their own currencies in cities and the wealth of nations. Like how large local agglomerations within units like states create mismatches in rules… do national currencies create mismatches in monetary conditions across space? Are the pro and cons about the same in both cases?