Tax Evasion and Investment, Trade and Greenhouse Gases, Football and Grades

Travel day today, so it seems as good a day as any to have a post featuring research by colleagues. First, Bruce Blonigen and Nick Sly (and a coauthor, Lindsay Oldenski):

The Growing International Campaign Against Tax Evasion

The growing international campaign against tax evasion, by Bruce Blonigen, Lindsay Oldenski, and Nicholas Sly, Vox EU: The most recent G20 summit led to a multilateral agreement to facilitate information sharing between tax agencies, with the US currently negotiating bilateral tax treaties with the tax havens of Switzerland and Luxembourg. But before celebrations begin, this column points out that cracking down on tax evasion comes at a cost. International investment may well suffer.

One of the few solid agreements that came out of the latest G20 summit in Cannes was that governments will increase their cooperative efforts to curb tax evasion. The agreement, called the Convention on Mutual Administrative Assistance in Tax Matters, allows national tax agencies to request greater amounts of information from foreign governments on the activity of multinational enterprises and private citizens that are otherwise outside their authority to monitor. Under the new agreement, countries can choose voluntarily to transmit tax information about foreign parties in bulk to their resident country’s tax agency. There are also provisions of the convention that will require nations to assist in the recovery of foreign tax claims if a business or individual is in noncompliance.

Several leaders of G20 nations cited reports from the OECD that recent efforts to reduce tax evasion have resulted in more than $14 billion of additional tax revenue being collected, with hints that there are much greater amounts of offshore tax liabilities yet to be collected. With mounting government debt in most nations, the incentives for them to reduce tax evasion are clear.  But if we take a closer look, this may be just the next step in the ongoing efforts of developed countries to recapture lost revenues by multinational firms.  In particular, most bilateral tax treaties include similar requirements for cooperation in sharing of tax information between the two governments. The signing and renegotiation of tax treaties has proliferated in recent decades and Easson (2000) reports that there are nearly 2,500 treaties in force worldwide. The current US activity on tax treaties is also telling.  The US Senate has pending agreements with Switzerland and Luxembourg, two countries that are typically on lists of tax havens, and in June of this year the US Treasury Department announced a plan to renegotiate its tax treaty with Japan, where provisions for information sharing are relatively weak. Deterring tax evasion has long been a priority for governments in coordinating the international tax system.

Despite the recent attention, information-sharing provisions of tax treaties are typically not the first attributes touted. The stated goal of the OECD and UN model for tax treaties is to limit the incidence of double taxation and promote efficient flows of capital in the world economy through the coordination of tax rules and definitions.  For this reason, prior studies of the effect of tax treaties on the FDI activity of multinational enterprises have expected to find positive impacts.

Yet finding systematic evidence of such positive effects has proven elusive. Di Giovanni (2005) fails to observe any significant impact of tax treaties on cross-border mergers and acquisitions, while Louie and Rousslang (2008) find no evidence that tax treaties affect US firms’ required rates of return from their foreign affiliates. Likewise, Blonigen and Davies (2004, 2005) do not find any discernible effect of tax treaties on US and OECD FDI activity. There is some evidence provided by Davies et al (2009) that the number of firms entering a foreign country grows once a new treaty is signed. But many more studies support the conclusion that foreign investment flows do not appear to take advantage of the double-taxation relief afforded by tax treaties.

The lack of evidence that tax treaties impact foreign investment flows between treaty partners is surprising because there is a clear relationship between foreign capital flows and tax rates. Papke (2000) finds that the elasticity of reported foreign earnings to differences in withholding taxes rates is near -1, indicating a tight relationship between the location of reported income and the tax liabilities across countries. Furthermore, Hines and Rice (1994) find that real aspects of multinational firm operations, such as the location of production, employment, and equipment purchases, also respond to differences in tax rates across countries.

In recent work (Blonigen et al 2011) we provide an answer to the puzzling insignificant effects of tax treaties and find it is rooted in the tax-sharing provisions of tax treaties, which are intended to reduce tax evasion and, thus, can have a negative influence on FDI activity. Our premise is that firms in industries which use relatively homogeneous inputs will be most affected by the information-sharing provisions of tax treaties, since arms-length prices for intermediate goods are easily verified in these industries once tax authorities share information and can verify activity across MNEs’ affiliates. In contrast, firms that use fairly differentiated and specialized inputs will retain a much greater ability to mitigate their tax liabilities across countries by engaging in strategic transfer pricing.

We look across more than two decades of investment activity by US multinational firms, spanning 73 different industries and more than 150 countries. During the time span of our sample, 1987–2007, the US signed several new tax treaties, and renegotiated agreements to increase the degree of information sharing with several existing treaty partners.

The evidence strongly supports that provisions for tax-information sharing, such as those included in recent G20 convention, can alter the pattern of international investment activities. For a firm with average use of homogeneous inputs, increased cooperation between national tax agencies when a tax treaty is put into place is associated with a gross reduction in the firm’s foreign affiliate sales by $26 million per year.  Looking at the US economy as a whole, this equates to an estimated reduction of outbound investment activity of $2.29 billion annually. We also find that tax-sharing provisions of tax treaties lead to gross reductions in the number of firms that choose to invest in countries for the average industry as well. 

We do estimate a positive impact of the other features of the tax-treaty agreements, which counterbalances the negative effects from the information-sharing provisions. For the average firm in our sample the average net impact of tax treaties on FDI activity is positive.  Yet, it is clear from our analysis that the negative effects of the information-sharing provisions of tax treaties are large and a main reason why prior studies have puzzlingly found little evidence for any effect of tax treaties on FDI.

Final thoughts

International policy can obviously pursue many different goals.  Our research suggests that governments may be pursuing tax treaties just as much to reduce tax evasion as to promote more efficient international capital allocation.  The recent economic troubles seems to have focused governments even more on the short-run goal of capturing tax revenues, apparent from the G20’s recent signing of the multilateral Convention on Mutual Administrative Assistance in Tax Matters. However, agreements that allow for greater information sharing between governments deter multinational enterprises from engaging in foreign investment in the first place.  It seems that the longer-run policy goal of facilitating international investment has taken a back seat in recent accords.

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This is research by Jason Lindo, Glen Waddell and their student Isaac Swensen:

Are Big-Time Sports a Threat to Student Achievement?

Guys' Grades Suffer When College Football Teams Win, by Rebecca Greenfield, The Atlantic: ...college male's grades tend to go down when their university's football team wins games, new research finds. ... More victories means more celebrating which means less studying. ...

Looking at University of Oregon student transcripts over 8 years and football wins over that same period, researchers Jason M. Lindo, Isaac D. Swensen, Glen R. Waddell calculated that a 25 percent increase in the football team's winning percentage leads males to earn GPAs as if their SAT scores were 27 points lower. ...

In addition to looking at grades, the researchers also collected surveys, asking students if football success decreases study time. "24 percent of males report that athletic success either 'Definitely' or 'Probably' decreases their study time, compared to only 9 percent of females," ... leading them to attribute the grade drop to partying. ...

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Finally, research by Anca Cristea (along with two coauthors):

Trade and Greenhouse-Gas Emissions

Trade and greenhouse-gas emissions: How important is international transport?, by Anca Cristea, David Hummels, and Laura Puzzello, Vox EU: It is well known that international trade leads to greenhouse-gas emissions but policymakers often focus their attention on the production of goods and not their shipment. This column presents findings based on a unique database that allows researchers to calculate emissions for every dollar of world trade. It suggests that international transport emissions warrant serious attention in current climate-change negotiations.

As the first commitment period of the Kyoto Protocol comes to an end in 2012, member countries of the UN’s Framework Convention on Climate Change (UNFCCC) are meeting in Durban, South Africa, to decide on future actions to curb worldwide greenhouse-gas emissions.

International transport is absent from existing agreements on climate change, and negotiations to include this sector in carbon balances are progressing slowly. Differences in the willingness to regulate the greenhouse-gas emissions from international transport became apparent just a few weeks ago, when air carriers and officials around the world reacted strongly against the EU’s decision to include the aviation sector in its emission-trading scheme (Krukowska 2011).

One of the main difficulties in regulating emissions from international transport is the paucity of data on their magnitude and incidence. The little we know about these emissions comes from the ‘life-cycle analysis’ of very specific products such as Kenyan cut-flower exports. Unfortunately it is difficult to extrapolate from these highly detailed case studies to a systematic evaluation of transport emissions in trade.

In a recent paper (Cristea et al 2011) we provide such an evaluation. The key to our analysis was building a database on how goods move; for every product and country pair we track the share of trade that goes by air, ocean, rail, or truck. This allows us to calculate the transportation services (kg-km of cargo moved), and associated GHG emissions, for every dollar of trade worldwide. Combined with data on GHG emissions from production we can calculate total emissions embodied in exports.

International transport is a significant share of trade-related emissions

In our baseline year of 2004, international freight transport generated 1,205 million tonnes of CO2-equivalent emissions, or 146 grammes of CO2 per dollar of trade. By comparison, production of those traded goods generated 300 grammes per dollar of trade, meaning that international transport is responsible for one third of trade-related emissions.

The aggregate numbers understate the importance of transport for many products. Figure 1 shows the share of transport in trade-related emissions, and it varies significantly over industries. At the low end are bulk products (agriculture, mining), and at the high end are manufactured goods. For important categories such as transport equipment, electronics, and machinery, transport is responsible for over 75% of trade-related emissions. Relatively rapid growth in these industries means that transport emissions will loom ever larger in trade.

Once we include transport, clean producers look dirty

Table 1 provides calculations of output and transport emissions per dollar of trade and shows large differences between regions in emission intensities. Differences in output emissions are driven largely by the commodity composition of trade, with manufacturing-oriented exporters at the low end. Less known and perhaps more surprising are the large differences in transport emissions. The transportation of US exports is nearly eight times more emissions-intensive than the transportation of Chinese exports, and six times more emissions-intensive than Europe.

Table 1. Output and transport emission shares and intensities, by region and country

Note: Total emissions per dollar are calculated as the sum of transport and output emission intensities. *For comparability with transport emissions, output emissions are constructed as a weighted average of sector level output emissions, using trade rather than output weights.

Accounting for transport significantly changes our perspective on which regions have “dirty”, or emissions-intensive trade. India’s production of traded goods generates 143% more emissions per dollar of trade than the US, but after incorporating transportation, its exports are less emissions-intensive in total.

We also see a strong imbalance in transport emission intensities between imports and exports. This is a critical issue for mechanism design when regulating emissions. Do international transport emissions ‘belong’ to the exporter, or to the importer? Given the imbalance shown here, the US would presumably prefer an import-based allocation while East Asian countries would prefer the opposite.

The value of trade is a poor indicator of associated transport emissions

To understand the differences across products and regions shown above, we must recognise that transport emissions depend on the scale and composition of trade. Intuitively, as countries trade more they employ more transportation services and emit more GHG. However, the partner and product composition of trade critically affect the type and quantity of transportation services (kg-km of cargo) employed. When France imports from Japan rather than Germany, a dollar of trade must travel much longer distances. A dollar of steel weighs vastly more than a dollar of microchips, requiring greater fuel (and emissions) to lift. And the choice to use aviation rather than maritime transport involves as much as a factor 100 increase in emissions to move the same cargo. This last fact, along with the unusually large reliance on air cargo in US exports, explains why US exports are so emissions-intensive.

Trade can reduce emissions, in some cases

If two countries have similar emissions from output, then increasing trade (ie shifting from domestic production to imports) will require more international transport and higher emissions. However, if a country with high output emissions reduces production in order to import from a low-emissions country, the savings in output emissions could be enough to offset the higher transport emissions from trade. Which of these cases is most likely? We find that trade flows representing 31% of world trade by value actually are net emission reducers. This happens most commonly in those industries in the left side of Figure 1 – where output emissions are both a large fraction of trade-related emissions and very different across producers. It is much less common in manufactured goods where transport emissions dominate.

Figure 1. The contribution of transport to total trade-related emissions

Eliminating tariff preferences will shift trade toward aviation and maritime transport

With a better understanding of the emissions associated with both output and trade we can examine how changes in trade patterns will affect trade-related emissions over time. In a final exercise we simulated likely trade growth from 2004–20 resulting from tariff liberalisation and GDP growth using a dynamic version of the GTAP model.

The trend toward preferential trade liberalisation in regional trading blocs such as the EU and NAFTA means that tariffs are lower for more proximate trading partners and especially for land-adjacent partners. Rail and truck transport dominates these trade flows. Tariff liberalisation that removes current preferences in favour of a uniform MFN structure will shift trade toward more distant partners (higher kg-km per dollar of trade) and increase the use of aviation and maritime transport. This wouldn’t necessarily raise total emissions (maritime has lower emissions than rail and trucking; aviation much more), but it does mean that a rising share of trade will be outside current monitoring efforts. Getting aviation and maritime transport emissions in the system becomes critical.

Growth in the developing world will cause international transport emissions to skyrocket

We forecast that likely changes due to tariff liberalisation would be somewhat modest but likely GDP growth will yield profound changes in output, trade, and GHG emissions. Our projections have the value of output and trade rising at similar rates, accumulating to 75-80% growth by 2020. International transport services will grow twice as fast, accumulating to 173% growth. Why? Simply put, the fastest growing countries (China, India) are located far from other large markets, and their trade requires greater transportation services.

Some propose that international aviation and maritime transport should be treated as separate entities, essentially countries unto themselves, for purposes of allocating and capping emissions. If this approach is employed, as opposed to including international transport in national allocations or simply taxing the GHG emissions from fuel use, it is difficult to see how future trade growth can be accommodated.

Summary and implications

International transport emissions are a surprisingly large fraction of trade-related emissions that will grow relatively fast as world output increases and trade shifts toward more distant partners. Policymakers must carefully consider how to include international transport emissions in protocols designed to slow emissions growth. Our emission calculations – based on the most accurate trade and transportation data available to date – provide some necessary tools to advance the policy debate.