Repatriation Taxes and Dividend Distortions

This paper analyzes the effect of repatriation taxes on dividend payments by the foreign affiliates of American multinational firms. The United States taxes the foreign incomes of American companies, grants credits for any foreign income taxes paid, and defers any taxes due on the unrepatriated earnings for those affiliates that are separately incorporated abroad. This system thereby imposes repatriation taxes that vary inversely with foreign tax rates and that differ across organizational forms. As a consequence, it is possible to measure the effect of repatriation taxes by comparing the behavior of foreign subsidiaries that are subject to different tax rates and by comparing the behavior of foreign incorporated and unincorporated affiliates. Evidence from a large panel of foreign affiliates of U.S. firms from 1982 to 1997 indicates that one percent lower repatriation tax rates are associated with one percent higher dividends. This implies that repatriation taxes reduce aggregate dividend payouts by 12.8 percent, and, in the process, generate annual efficiency losses equal to 2.5 percent of dividends. These effects would disappear if the United States were to exempt foreign income from taxation. JEL Classifications: F23, G35, H25, H87. Mihir A. Desai C. Fritz Foley James R. Hines Jr. Harvard Business School Harvard Business School University of Michigan Morgan 363 Morgan 228b Business School Soldiers Field Soldiers Field 701 Tappan Street Boston, MA 02163 Boston, MA 02163 Ann Arbor, MI 48109-1234 [email protected] [email protected] [email protected]