Tax reform and corporate behaviour: Evidence from the UK

Peter Egger, Martin Ruf, Valeria Merlo, Georg Wamser 09 February 2016



In recent debates, US policymakers have often argued that the US system of international corporate taxation needs a fundamental reform (Summers 2013). Under the US system of taxation (or tax credit system), the worldwide income of US multinational firms is subject to taxes in the US, while a tax credit is provided on the taxes paid abroad. By this design, the US system is an exception rather than the rule; most countries exempt foreign-source income from taxation at home (at the parent firm location) and income is only taxed in the source country (at the locations of foreign affiliates).

The recent Chairman Camp's Tax Reform Plan (Committee on Ways and Means 2014) proposes to replace the current US tax credit system with an exemption system, in order to allow US companies to compete on a more level playing field against foreign multinationals when selling products and services abroad, and to eliminate the ‘lock-out’ effect that results from the US residual tax under current law, which discourages companies from bringing their foreign earnings back to the home country.

The second point is supported by anecdotal evidence suggesting that US multinationals hold large amounts of cash abroad for tax reasons (La Monica 2015). Apple has $203 billion in cash on its balance sheet – the first corporation ever to cross the $200 billion mark. $181 billion of its cash – nearly 90% of the entire amount – is held offshore. Apple is an interesting example, as it appears that the company is waiting for the proposed US tax reform to become effective before it puts more of its cash to use; in the second quarter of 2015 it raised $10 billion in debt – despite the huge amount of cash holdings – to finance stock buybacks and dividends.

However, whether or not a system of tax exemption would allow US companies to compete more on a level playing field and eliminate the lock-out effect on a large scale is not clear, as empirical research on the matter is very rare. The reason for this is that radical changes to countries’ tax systems are also very rare. The latter is obviously related to the inertia in policymaking which seems to be determined by the uncertainty about the effects associated with big reforms – how important the change is on average and, in the extreme, for some taxpayers as well as for the government.

The UK tax reform: New evidence

In 2009, the UK instituted such a change by adopting a system of tax exemption of foreign-earned income of firms, moving from a system of tax credit or worldwide taxation. This reform is utilised in our recent paper (Egger et al. 2015) in order to quantify the behavioural responses of foreign affiliates of UK-owned multinational firms.

Such a significant reform is expected to induce significant changes in firm behaviour. In particular, one would expect to see reactions in UK multinationals’ dividend repatriation behaviour after the reform. While dividends were taxed on repatriation under the old tax credit system, no such taxation applies under the new exemption system.

Using an identification approach that quasi-randomises over the country of residence of the ultimate firm owners, the results of our study suggest that the reform induced firms to pay out significantly more dividends to the UK.

  • The average foreign affiliate of a UK multinational is estimated to have paid out about $2.15 million more in dividends immediately after the reform in year 2009 than it would have done in the absence of the reform (illustrated in Figure 1).
  • Yet, the reform only led to one-time adjustments and did not have any longer-lasting impact, since already by 2010 dividend payments had returned to pre-reform levels.

Figure 1. Dividend payments of treatment and control group

  • An interesting additional finding is that the reform effect varies in host-country corporate tax rates.

This is in line with expectations as the incentives to repatriate depend on the tax differential between foreign and UK tax rates. Figure 2 illustrates how the reform effect (vertical axis) varies in the corporate tax rate of the host country (measured along the horizontal axis). The solid flat (red) line indicates the average effect on dividend repatriation on the average affiliate facing a given corporate tax rate in a host country. The negatively sloped (blue) line indicates the variation of this reform effect in the corporate tax rate of the host country. Notice that the two lines cross at a value of the corporate tax rate of about 0.28 (28%). With the UK’s corporate tax rate of 28%, this is exactly the point where foreign tax incentives to repatriate remained unchanged (zero) before and after the reform. To the left of that point, the effect on dividends is higher than the average for affiliates located in lower tax countries. For affiliates located in countries with a higher tax rate than the UK, the effect is also positive albeit lower than the average. The latter finding is in line with arguments that a tax exemption system tends to reduce compliance costs in general.

Figure 2. Allowing for heterogeneous tax effects

Additional findings show that the average UK-owned foreign affiliate cut investment by about $3.05 million in response to the reform in 2009 associated with the higher payouts to the UK (illustrated in Figure 3). This implies that the reform indirectly affected real outcomes via the change in incentives for profit repatriation – most probably to the benefit of investment projects in the UK (however, for reasons of data availability, our analysis cannot directly find out about investments in the UK). Again, the reform only led to one-time adjustments and did not have longer-lasting effects much beyond 2009, as both dividend payments and investments had returned to pre-reform levels by 2010.

Figure 3. Investment of treatment and control group

Concluding remarks

Overall, this evidence on the causal effect of the UK reform involving a switch to tax exemption suggests that replacing the US tax credit system with an exemption system would also have only short-run effects on repatriations (positive) and foreign investments (negative).

It should be noted, however, that the current system of worldwide taxation as implemented in the US certainly affects more margins and incentives than just repatriation behaviour. For example, in the US policy debate the tax system is held responsible for a large number of cases where US companies avoid US taxes by relocating parts of their businesses to foreign countries (Surowiecki 2016).

More data and studies are needed to evaluate such significant reforms from a broader perspective, covering all relevant economic outcomes and margins of adjustment. Only then it will be possible to judge whether switching to exemption is beneficial to an economy or not in the real world. In particular, policymakers need more evidence on the impact on responses at the extensive margin (relocations) and on how such a reform affects not only investment but also employment.    


Committee on Ways and Means (2014), Chairman Dave Camp: Tax Reform Act of 2014 Discussion Draft Section-by-Section Summary.

Egger, P, V Merlo, M Ruf, and G Wamser (2015), Consequences of the New UK Tax Exemption System: Evidence from Micro-level Data’, Economic Journal 125, 1764-1789

La Monica, P (2015), “Apple has $203 billion in cash. Why?”, CNN Money.

Summers, L H (2013), “Tax reform can aid multinationals, cut deficit”, The Washington Post, 7 July 2013.

Surowiecki, J (2016), “Why Firms are Fleeing”, The New Yorker, 11 January, 2016.



Topics:  Industrial organisation Taxation

Tags:  tax reforms, UK, tax exemption

Professor of Applied Economics, ETH-Zürich; Research Fellow, CEPR

Professor of International Business Taxation, University of Tübingen

Professor of Economics, University of Tübingen

Professor of Economics at the University of Tuebingen

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