The various ways in which companies reduce their tax bills can do some weird things to economic statistics. One startling case in point: The economies of the world appear to be in debt to some extraterrestrial creditor because total global assets are lower than total global liabilities. The reality, of course, is not that Earth owes money to Mars, but rather is due to the use of tax havens. According to Ireland’s national income statistics, the country’s economy—a well-known parking spot for corporate profits—grew at 26.3 percent in 2015.
This same kind of statistical anomaly is apparently also the case in the measurement of U.S. economic productivity. It appears that U.S. corporations’ habit of shifting profits overseas is overstating the decline in productivity growth in the United States. In a new paper, economists Fatih Guvenen of the University of Minnesota, Raymond J. Mataloni Jr. and Dyland G. Rassier of the Bureau of Economic Analysis, and Kim J. Ruhl of Pennsylvania State University look at corporate profit-shifting as a distortion of U.S. economic data. By shifting profits overseas, economic output that should be counted in the United States ends up being registered in other countries.
This shifting appears to have happened in part due to the rise in “intangible assets.” To borrow an example from the four economists, think of a simplified version of the profits from an iPhone. Employees at Apple Inc. design the phone, which is then produced abroad at a cost of $250 and sold to a customer in the United States for $750. If we assume the reason people buy iPhones is the branding and design created by Apple, then a good portion of the $500 net profit is a return on “intangible assets” produced in the United States. But if a company sells the rights to these intangible assets to a subsidiary in a low-tax country, then the profits will end up there.
The result? An increase in the Gross Domestic Product of the low-tax country and a decline in the GDP of the United States without any real change in economic activity.
To see how much U.S. economic output and productivity growth is missed due to profit-shifting, the authors of the paper use data on multinational corporations from the U.S. Department of Commerce’s Bureau of Economic Analysis, the agency that creates GDP data, which includes information on the employment, sales, and research and development expenditures of those companies. They then calculate the amount of profits from each company that could be ascribed to U.S. economy given the amount of people it employs in the country and how much of its sales are in the United States. (This process is known as formulary apportionment.)
Counting profits in this way ends up increasing economic activity by a significant amount. Total value added in the United States economy (a metric similar to GDP) is at least 2.5 percent higher in 2010 after making these adjustments. Labor productivity growth per year from 1994 to 2004 is raised by 0.1 percentage points, while productivity growth from 2004 to 2008 increased by 0.25 percentage points. The difference can be even larger at some points. Productivity growth from 2006 to 2008—after accounting for profit-shifting—was almost a full percentage point higher than unadjusted productivity.
This effect is significant—a few tenths of a percentage point difference can add up to a significant long-term effect—yet it still doesn’t fully reverse the slowdown in U.S. productivity growth since 2004. The U.S. economy could still use a boost to its productive capacity. But it could also use a tax system that doesn’t distort what’s actually happening.