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U.S. 1. DUSTRY: RESTRUCTUR. GA D RENE nternationa~Tax Police Corporate Research and Development and~nvestment Eclitecl by JAMES M. POTERBA Board on Science, Technology, and Economic Policy National Research Council NATiONALACADEMY PRESS Washington, D.C. 1997
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NATIONAL ACADEMY PRESS · 2101 Constitution Ave., N.W. · Washington, D.C. 20418 NOTICE: The conference from which the papers in this publication were drawn was approved by the Governing Board of the National Research Council, whose members come from the councils of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. The members of the board responsible for the project were chosen for their special competences and with regard for appropriate balance. This publication was supported by the National Aeronautics and Space Administration and the National Science Foundation. Program support for the Board on Science, Technology, and Economic Policy is provided by a grant from the Alfred P. Sloan Foundation Library of Congress Cataloging-in-Publication Data Borderline case: international tax policy, corporate research and development, and investment / Board on Science, Technology, and Economic Policy, National Research Council; James M. Poterba, Editor. p. cm. Papers presented at a conference held at the National Academy of Sciences in Washington, D.C., on February 14, 1997. Includes bibliographical references and index. ISBN 0-309-06368-X 1. Internationalbusiness enterprises Taxation United States- Congresses. 2. Research, Industrial Taxation United States- Congresses. 3. Research and development tax credit United States- Congresses. 4. Capital investments United States Congresses. I. Poterba, James M. II. National Research Council (U.S.). Board on Science, Technology, and Economic Policy. III. Series. HD2753.U6B64 1998 336.24'3'0973 dc21 97-45343 CIP Cover: The emblem appearing on the cover of this publication is an illustration of the bronze medal- lion in the floor of the Great Hall in the National Academy of Sciences building in Washington, D.C. The medallion is the wellhead placed in the floor when the spectroscopic case over which the Fou- cault pendulum swings is lowered below the floor level. The design is based on a map of the solar system published in 1661 by Andreas Cellarius Palatinus. The array of planets is the Copernican system as know to Galileo. Copyright 1997 by the National Academy of Sciences. All rights reserved. Printed in the United States of America
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NATIONAL RESEARCH COUNCIL BOARD ON SCIENCE, TECHNOLOGY, AND ECONOMIC POLICY A. MICHAEL SPENCE, Chairman Dean, Graduate School of Business Stanford University M. KATHY BEHRENS Managing Partner Robertson, Stephens & Company JAMES F. GIBBONS Professor of Electrical Engineering Stanford University GEORGE N. HATS OPOULOS President and CEO Thermo Electron Corporation DALE JORGENSON Frederic Eaton Abbe Professor of Economics Harvard University RALPH LANDAU Consulting Professor Economics Stanford University JAMES T. LYNN Advisor Lazard Freres BURTON J. McMURTRY General Partner Technology Venture Investors MARK B. MYERS Senior Vice President Xerox Corporation JAMES M. POTERBA Professor of Economics Massachusetts Institute of Technology PAUL ROMER Professor of Economics Graduate School of Business Stanford University . . . RUBEN METTLER, Vice Chairman Chairman and CEO (retired) TRW, Inc. WILLIAM J. SPENCER Chairman SEMATECH JOSEPH E. STIGLITZ Senior Vice President and Chief Economist The World Bank ALAN WM. WOLFF Managing Partner Dewey Ballantine Ex-Officio Members BRUCE M. ALBERTS President National Academy of Sciences WILLIAM A. WULF President National Academy of Engineering KENNETH I. SHINE President Institute of Medicine Staff STEPHEN A. MERRILL Executive Director CHARLES W. WESSNER Program Director LENA J. LAWRENCE Administrative Assistant
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STEERING COMMITTEE ON TAXATION OF U.S. ENTERPRISES JAMES M. POTERBA, Chair Professor of Economics Massachusetts Institute of Technology JAMES R. HINES, JR. Professor of Business Economics and Public Policy University of Michigan R. GLENN HUBBARD Russell L. Carson Professor of Economics and Finance Graduate School of Business Columbia University DALE JORGENSON Frederic Eaton Abbe Professor of ~ . Economics Harvard University V RUBEN METTLER Chairman and CEO (retired) TRW, Inc. PETER E. NUGENT Vice President, Controller Merck & Company RAYMOND J. WIACEK Partner Jones, Day, Reavis and Pogue STEPHEN A. MERRILL Project Director
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Contents PREFACE INTRODUCTION James Poterba SECTION I International Tax Policy and Technology Investments 1 THE TAXATION OF FOREIGN DIRECT INVESTMENT OPERATIONAL AND POLICY PERSPECTIVES .... Joel Slemrod 2 INTERNATIONAL TAXATION AND CORPORATION R&D: EVIDENCE AND IMPLICATIONS .......................................................... James R. Hines, Jr. 3 R&D TAX INCENTIVES AND MANUFACTURING-SECTOR R&D EXPENDITURES ............................................................................. M. Ishaq Nadiri and Theofanis P. Mamuneas 4 INTERNATIONAL TAX POLICY, INVESTMENT, AND TECHNOLOGY................................................................................ Harry Grubert v . . V11 .1 11 39 53 65
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v! SECTION II Industry Perspectives on the Impact of International Tax Rules 5 IMPACT OF TAX INCENTIVES ON THE LOCATION OF INVESTMENT: A CORPORATE PERSPECTIVE.. Peter E. Nugent CONTENTS 6 THE VIRTUAL GLOBAL ELECTRONIC ECONOMY 75 Robert N. Mattson 7 OPERATING THROUGH JOINT VENTURES UNDER U.S. INTERNATIONAL TAX RULES: GLOBAL COMPETITION FOR R&D INVESTMENTS Kevin G. Conway SECTION III Tax Reform: Prescriptions and Prospects 8 INTERNATIONAL TAX AND COMPETITIVENESS ASPECTS OF INTERNATIONAL TAX REFORM ...... Peter R. Merrill 9 U.S. TAX POLICY AND MULTINATIONAL CORPORATIONS: INCENTIVES, PROBLEMS, AND DIRECTIONS FOR REFORM........................................ R. Glenn Hubbard 10 DIRECTIONS FOR INTERNATIONAL TAX REFORM. Gary Hufbauer ..81 ..87 109 .133 11 TAX REFORM: PRESCRIPTIONS AND PROSPECTS 143 Thomas A. Barthold GLOSSARY 147 INDEX ..... .151
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Preface In 1991 the National Academies of Sciences and Engineering established the Board on Science, Technology, and Economic Policy as a forum in which econo- mists, technologists, scientists, financial and management experts, and policy- makers could broaden and deepen understanding of the relationships between science and technology and economic performance. In its first three years, the Board's activities focused on the adequacy and efficiency of public and private domestic investment in physical and human capital. The Board's first report, Investing for Productivity and Prosperity, underscored the need for higher rates of national saving and investment. Its principal recommendation was to shift the base for taxation from income to consumption. In the past two years, the Board has turned its attention to more micro- economic concerns technology policies broadly defined and their relationship to international trade relations, determinants of competitive performance in a wide range of manufacturing and service industries, and changes in patterns of R&D and innovation investments. A series of conferences, workshops, and reports, of which this volume is the second, comprises the latter body of STEP work entitled U.S. Industry: Restructuring and Renewal because it represents a broad assess- ment of U.S. industrial performance in an international context at a time of do- mestic economic confidence and optimism but uncertainty about the conse- quences of fundamental changes in the composition of the economy and processes of innovation. Other publications under this title will include reports of work- shops on measurement of industrial research and innovation, commissioned pa- pers on a dozen industries, a review of trends in financing new technology-based enterprises, and the conclusions and recommendations of the Board. This series of projects would not have been possible without the financial support of the vii
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. . . vile PREFACE National Aeronautics and Space Administration and National Science Founda- tion and the personal encouragement of Daniel Goldin, NASA Administrator. With the exception of the Introduction, the papers in this volume were pre- sented at a conference, "International Tax Policy, Corporate Research and Devel- opment, and Investment," held at the National Academy of Sciences in Washing- ton, D.C., on February 14, 1997. The conference was organized by a committee chaired by James Poterba, STEP member and professor of economics at M.I.T., and included James Hines of the University of Michigan (at the time of the con- ference, Harvard University Kennedy School of Government), Glenn Hubbard of Columbia University, Peter Nugent of Merck and Company, and Raymond Wiacek of Jones, Day, Reavis and Pogue, in addition to STEP members Dale Jorgenson and Ruben Mettler. The papers prepared for and the commentaries presented at the conference persuasively make the point that U.S. international tax rules and tax treatment of corporate research and development have important economic consequences through their influence on the investment decisions of multinational companies that account for most of the R&D performed in and most of the goods and ser- vices exported from the United States. Yet these policies have not been consis- tent but subject to the vagaries of federal budget and partisan politics. They deserve more thoughtful attention from policymakers, both in the context of in- cremental changes in the income tax system and in the consideration of funda- mental tax reform. We are grateful to the organizers of the conference, the contributors to and reviewers of this volume, and other participants in the meeting. We wish to acknowledge a special debt to Ray Wiacek and his colleagues at Jones, Day for technical assistance in preparing the manuscript and glossary, which we hope will assist readers in understanding a complex subject. A. MICHAEL SPENCE Chairman STEPHEN A. MERRILL Executive Director
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The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. On the authority of the charter granted to it by Congress in 1863, the Academy has a working mandate that requires it to advise the federal govern- ment on scientific and technical matters. Dr. Bruce M. Alberts is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National Academy of Sciences, as a parallel organization of out- standing engineers. It is autonomous in its administration and in the selection of members, sharing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineering programs aimed at meeting national needs, encourages edu- cation and research, and recognizes the superior achievements of engineers. Dr. William A. Wulf is president of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examination of policy matters pertaining to the health of the public. The institute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Kenneth I. Shine is the president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sciences in 1916 to associate the broad community of science and technology with the Academy's purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in pro- viding services to the government, the public, and the scientific and engineering communities. The council is administered jointly by both academies and the Institute of Medicine. Dr. Bruce M. Alberts and Dr. William A. Wulf are chair- man and vice chairman, respectively, of the National Research Council. Six
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