THE EFFECT OF TAXES ON THE CHOICE BETWEEN EXPORTS AND FOREIGN PRODUCTION (MULTINATIONAL CORPORATIONS, INCOME TAXES)

This paper examines the effect of taxes on the international production patterns of U.S. multinational corporations (MNCs). The Tax Reform Act of 1986 (TRA 86) triggered a production location tax incentive for many MNCs by reducing corporate tax rates and introducing other provisions which dramatically increased the number of MNCs facing binding foreign tax credit (FTC) limitations. FTC rules allow MNCs with binding limitations to exempt 50 percent of export earnings from tax, so the FTC rules create an incentive for these firms to use exports in lieu of profitable foreign production.; This research examines the impact of these binding FTC limitations on exports by investigating the hypothesis that a positive cross-sectional relation exists between the magnitude of the FTC incentive and the proportion of exports versus foreign production MNCs use to serve their foreign markets. In supporting tests, U.S. Department of Commerce data for 1982 and 1989 are used to examine the hypothesis that a positive relation exists between host country tax rates and the aggregate mix of exports versus foreign production MNCs use to serve each foreign market.; Consistent with hypotheses, results indicate the magnitude of the FTC incentive is positively related to the proportion of exports versus foreign sales MNCs use to serve their foreign markets. Also as predicted, a positive relation between tax rates and exports exists at the country-level, and this relation is significantly stronger after TRA 86 than before the Act. Economically, the results suggest the export tax incentive is associated with mean additional exports of approximately {dollar}70 million per firm.