First, American companies can use tax deferral and other techniques to avoid or delay taxes by moving profits out of high-tax countries (or out of the U.S.) and into low-tax countries with little corresponding change in business operations, a practice known as "profit shifting." Data on the activities of American based companies with overseas operations is analyzed to understand the degree to which, if any, profit shifting may be occurring. The analysis appears to show that American companies report earning profits in tax haven or tax preferred countries that, when compared to more traditional economies, appear to be disproportionate to hiring and capital investment in those countries. By all indicators examined in this report, profit shifting has generally trended upward overtime. For example, the Senate Permanent Subcommittee on Investigations held a hearing in September 2012 on the methods companies use to shift profits and possible options for curbing such behavior. Profit shifting has also been the specific target of several bills that were introduced in the 112 th Congress ( H.R. The first group consists of the five countries commonly identified as being "tax preferred" or "tax haven" countries, and includes Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland. The second group, which provides a baseline for comparison, consists of the five more traditional economies. This group includes Australia, Canada, Germany, Mexico, and the United Kingdom. Two measures of the real economic presence of MNCs are considered. Where Profits Are Reported

Figure 1 displays the share of profits that foreign affiliates of American MNCs reported in the tax preferred and traditional country groups between 1999 and 2008. In the most recent data year available (2008), American MNCs reported earning 43% of their overseas profits in the country group comprised of Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland. If companies are shifting real production and business activities, then it should be expected that the location of profits would change as well. In 2008, for example, American companies hired 40% of their foreign labor from and made 34% of their foreign investments in the country group containing Australia, Canada, Germany, Mexico and the United Kingdom. The two profit ratios in Figure 3 would appear to give an indication that the return to real business activities (hiring and investment) in the tax preferred countries are significantly higher than in the traditional economies. Profits Relative to GDP

Further indication of profit shifting is found from a comparison of the business profits reported by U.S. MNCs in the two country groups as a share of GDP. For example, in Bermuda, profits reported by U.S. MNCs affiliates have increased from 260% of GDP in 1999 to over 1000% of GDP in 2008. In Luxembourg, MNC's profits went from 19% of GDP in 1999 to 208% of GDP in 2008. Ireland, the Netherlands, and Switzerland have seen a less dramatic, but still significant increase in profits as a share of GDP—from 5% in 1999 to 20% in 2008 in the case of the Netherlands, from 14% to 42% in the case of Ireland, and from 5% to 15% in the case of Switzerland. By reducing this discrepancy, the incentive to shift profits would be reduced as well.
This report uses data on the operations of U.S. multinational companies (MNCs) to examine the extent to which, if any, MNCs are moving profits out of high-tax countries (or out of the U.S.) and into low-tax countries with little corresponding change in business operations, a practice known as "profit shifting." To do this, the profits reported by American firms in two groups of countries are compared with measures of real economic activity in those locations. The first group consists of the five countries commonly identified as being "tax preferred" or "tax haven" countries, and includes Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland. The second group, which provides a baseline for comparison, consists of five more traditional economies. This group includes Australia, Canada, Germany, Mexico, and the United Kingdom.
Consistent with the findings of existing research, the analysis presented here appear to show that significant shares of profits are being reported in tax preferred countries and that these shares are disproportionate to the location of the firm's business activity as indicated by where they hire workers and make investments. For example, American companies reported earning 43% of overseas profits in Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland in 2008, while hiring 4% of their foreign workforce and making 7% of their foreign investments in those economies. In comparison, the traditional economies of Australia, Canada, Germany, Mexico and the United Kingdom accounted for 14% of American MNCs overseas' profits, but 40% of foreign hired labor and 34% of foreign investment. This report also shows that the discrepancy between where profits are reported and where hiring and investment occurs, as examples of business activity, has increased over time.
Additional evidence that profit shifting has increased over time is found from a comparison of business profits with economic output (gross domestic product) in the two country groups. MNC profits as a share of gross domestic product (GDP) in the traditional economies averaged from 1% to 2% between 1999 and 2008, while their profits in the tax preferred countries profits averaged 33% of GDP in 2008, up from 27% in 1999. Individual countries within the tax preferred group displayed more dramatic increases in the ratio of profits to GDP. For example, profits reported in Bermuda have increased from 260% of that country's GDP in 1999 to over 1000% in 2008. In Luxembourg, American business profits went from 19% of that country's GDP in 1999 to 208% of GDP in 2008.
This report may be of interest to Members of Congress for at least four reasons. First, profit shifting has been the specific target of recent Congressional action, including a September 2012 hearing held by the Senate Permanent Subcommittee on Investigations, as well as several bills introduced in the 112th Congress. Second, anti-abuse provisions have been included in general tax reform proposals in the 112th Congress. Third, most general tax reform proposals would lower the top corporate rate which would diminish the incentive to shift profits. And fourth, to the extent that profit shifting is reduced, federal tax revenues would increase, although the net effect on federal tax revenues would depend on the existence and magnitude of offsetting revenue changes, which, in turn, would depend on the approach taken to curb profit shifting.