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National Tax JournalVol. LIV, No. 4

Abst ract - This paper analyzes the effect of repatriation taxes ondividend payments by the foreign affiliates of American multina-tional firms. The United States taxes the foreign incomes of Ameri-can companies, grants credits for any foreign income taxes paid,and defers any taxes due on the unrepatriated earnings for thoseaffiliates that are separately incorporated abroad. This systemthereby imposes repatriation taxes that vary inversely with foreigntax rates and that differ across organizational forms. As a conse-

quence, it is possible to measure the effect of repatriation taxes bycomparing the behavior of foreign subsidiaries that are subject todifferent tax rates and by comparing the behavior of foreign incor-

porated and unincorporated affiliates. Evidence from a large panelof foreign affiliates of U.S. firms from 1982 to 1997 indicates that 1

percent lower repatriation tax rates are associated with 1 percenthigher dividends. This implies that repatriation taxes reduce ag-gregate dividend payouts by 12.8 percent , and, in the process, gen-erate annual efficiency losses equal to 2.5 percent of dividends. Theseeffects would disappear if the United States were to exempt foreignincome from taxation.

INTRODUCTION

The U.S. system of taxing foreign income attracts a greatdeal of attention both from taxpayers and from reform-ers who feel that sup erior alternat ives are available. Reform

ad vocates point to the systems complexity, the burd en it im-

poses on American companies, and th e inefficient incentives

it creates.1

These considerations are often taken to imply thatthe alternative of territorial taxation, in which income earned

abroad by American multinational comp anies would n ot be

subject to U.S. taxation, would improve efficiency and thereby

enhance the competitive positions of American firms in the

world marketplace. Since American firms would then no

longer pay taxes to the United States on income received from

foreign affiliates, it follows that th ey would be free to arran ge

their financial and other affairs in ways that advance objec-

tives other than avoiding repatr iation taxes.

This paper analyzes the likely impact of territorial taxa-tion on d ividend rep atriations from foreign affiliates. Und er

current U.S. law, American firms owe taxes to the United

Repatriation Taxes

and Dividend Distortions

Mihir A. Desai

Harvard University,

Business School,

Boston, M A 02163

and

National Bureau of

Economic Research,

Cambridge, M A 02138

C. Fritz Foley

Harvard University

Business School,

Boston, M A 02163

James R. Hines Jr.

University of Michigan,

Office of Tax Policy

Research, Ann Arbor,

MI 48109-1234

and

National Bureau of

Economic Research,

Cambridge, M A 02138

1 Hufbau er (1992) is a classic example.

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NATIONAL TAX JOURNAL

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States on all of their worldwide incomes,

thou gh th ey are entitled to claim credits

against these tax liabilities for foreign in-

come taxes paid . In ad dition, the income

of separatelyincorporated foreign sub-

sidiaries, in contrast to that of un incorpo-rated branch affiliates, is untaxed until

repatriated as d ividend s. Since foreign tax

credits attenuate, but often d o not elimi-

nate, U.S. tax liabilities on foreign income,

it follows that th e paym ent of a dividend

from a foreign subsid iary to its American

parent company frequently generates a

tax obligation that might otherwise be

deferred or potentially avoided altogether.

The adop tion of a territorial system wouldremove the incentive to delay paying d ivi-

dends in order to avoid U.S. taxation.

Evaluating th e impact of adop ting ter-

ritorial income taxation entails extrapolat-

ing from observed behavior, inasmuch as

the United States does not currently tax

income on a territorial basis. American

owned affiliates in foreign countries are

taxed at d ifferent rates by foreign govern -

ments, thereby indu cing var iation in the

rates at which the United States taxes divi-

dend repatriation, since the tax rate gen-

erally equals the difference between the

U.S. tax rate and the foreign tax rate.

Hence a comparison of the dividend re-

patriation behavior of otherwisesimilar

affiliates located in countr ies with d iffer-

ing tax rates and with d ifferent organiza-

tional forms provides evidence of the im-pact of repatriation taxes on proclivities

to pay dividends.

This study analyzes the behavior of a

large p anel of U.S.owned affiliates over

the 198297 period, using ann ual affiliate

level information reported to the Bureau

of Economic Analysis (BEA) of the U.S.

Departm ent of Commerce. Three aspects

of this study distinguish it from earlier

stud ies of dividend repatriations that ana-lyze data rep orted on U.S. tax forms (and

that are available only for incorporated

affiliates in certain evennu mbered years).

The first is tha t it is possible to sp ecify the

dividend payout equation as a Lintner

process, in w hich lagged d ividends influ-

ence current year dividend s, since the BEA

data are collected every year. Second, the

BEA data can be used to comp are the d ivi-dend behavior of U.S.owned incorpo-

rated affiliates to th at of U.S.owned for-

eign branches, which is enlightening since

dividend remit tances f rom fore ign

branches do not tr igger U.S. tax liabilities.

Third, patterns revealed in the BEA data

can be compared to those app earing in the

tax return data, thereby offering a check

of the extent to which reporting biases,

accoun t ing conven t ions , and o the r

sources of measurement variation m ay be

responsible for results obtained by ana-

lyzing tax information.

The evidence indicates that dividend

remittan ces from incorporated foreign af-

filiates are sensitive to the associated tax

costs. Ten percent higher repatriation

taxes are associated w ith 10 percent lower

dividends. Remittances from foreign

branches do not trigger repatr iation taxes,

and do not exhibit the same coun try pat-

terns as do remittances from incorporated

foreign affiliates. The Lintner specification

of the d ividend process fits observed be-

havior very well, with lagged dividends

exerting large an d statistically significant

effects on current dividend s, even in speci-

fications that include parent fixed effects.

The results imply that U.S. adop tion of aterritorial system of taxation would in-

crease aggregate dividend payou ts by 12.8

percent, the effects of course varying

sharp ly between affiliates in d ifferent tax

situations.

Repatriation taxes redu ce economic ef-

ficiency by creating stronger incentives to

remit d ividends from som e foreign affili-

ates than th ey do from others. This loss of

econom ic efficiency has the d istributionaland incentive effects of an extra tax im-

posed on Am erican mu ltinational firms

effects that w ould disapp ear if the United

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States were to adopt territorial taxation.2

Base case estimates imply that th e annual

efficiency loss associated with dividend

repatriation taxes equals 2.5 percent of

d ividends. While sizable by itself, such a

figure represents on ly a fraction of the to-tal welfare gains from moving to territo-

rial taxation given the other distortions

associated with the current system.

The second section of the paper reviews

the economic theory of dividend remit-

tances, paying special attention to the tax

costs associated with dividend receipts

from foreign sources. The second section

also surveys existing evidence of the im-

pact of repatriation taxes on prop ensitiesto pay d ividends from foreign subsid iar-

ies and introduces the Lintner framework

for analyzing the influence of repatr iation

taxes on dividend policy. The third sec-

tion describes the available information on

the behavior of the foreign affiliates of

American multinational firms, and ana-

lyzes the tax environments in w hich they

operate. The fourth section presents the

results of estimating the impact of repa-

triation taxes on repatriation behavior. The

fifth section u ses the results obtained from

the dividend regressions to analyze the

potential welfare gains from m oving to a

territorial tax system. The sixth section is

the conclusion.

TAX MOTIVATIONS FOR DIVIDEND

REMITTANCES

Dividend payments from an incorpo-

rated subsidiary abroad to its American

parent may give rise to tax liabilities

within the United States. Accordingly,

these potential tax liabilities may figure

importantly in the determination of divi-

dend policy for American mu ltinationals.

In order to u nd erstand th ese concerns, a

description of some of the relevant fea-

tures of the U.S. tax treatment of Ameri-can multinational firms follows. Several

other concerns, such as the ability to moni-

tor managers overseas and internal capi-

tal budgeting, also might influence divi-

dend policy within firms, and are consid -

ered sep arately in Desai, Foley, and Hines

(2001).

The Taxation of U.S. Multinationals3

Almost all coun tries tax income gener-

ated by economic activity tha t takes place

within their borders. In addition, many

countriesinclud ing the United States

tax the foreign incomes of their residents.

In order to p revent dou ble taxation of the

foreign income of Americans, U.S. law

permits taxpayers to claim foreign tax

credits for income taxes (and related taxes)

paid to foreign governments.4 These for-

eign tax cred its are used to offset U.S. tax

liabilities that w ould otherwise be due on

foreignsource income. The U.S. corporate

tax rate is currently 35 percent, so an

American corporation that earns $100 in

a foreign coun try with a 10 percent tax rate

pays taxes of $10 to the foreign govern-

ment and $25 to the U.S. government,

since its U.S. corpora te tax liability of $35(35 percent of $100) is reduced to $25 by

the foreign tax cred it of $10.

Americans are perm itted to d efer U.S.

tax liabilities on certain unrepatriated for-

eign profits until they receive such prof-

2 It is possible for even a territorial tax system indirectly to discourage dividend repatriations if the system

allocates expense or income items between domestic and foreign sources based on formulas that include

repatriated d ividend s. Altshuler and Grubert (2001) consider a related example of a territorial tax system that

indirectly d iscourages foreign investment.3

Portions of this description are excerpted from Hines (1991, 1999a).4 The United States is not alone in taxing the worldw ide income of its residen ts wh ile perm itting them to claim

foreign tax credits. Other coun tries with such systems include Greece, Italy, Japan , Norw ay, and the Un ited

Kingdom . Und er U.S. law, taxpayers may claim foreign tax credits for taxes paid by foreign firms of wh ich

they ow n at least 10 percent, and only those taxes that qu alify as income taxes are creditable.

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832

its in the form of dividends.5 This defer-

ral is available only on the active business

profits of Americanow ned foreign affili-

ates that are separately incorporated as

subsidiaries in foreign countries. The prof-

its of unincorporated foreign businesses,such as those of Americanowned

branches in other coun tries, are taxed im-

mediately by the United States. Interest,

rent, and royalty income received from

foreign countr ies also represents foreign

source income on which U.S. tax obliga-

tions cannot be d eferred.

U.S. tax law contains provisions de-

signed to prevent American firms from

delaying the repat riation of light lytaxedforeign earnings. These tax provisions

app ly to controlled foreign corporations,

which are foreign corporations owned at

least 50 percent by American ind ividu als

or corporations w ho hold stakes of at least

10 percent each. Und er the Subpart F p ro-

visions of U.S. law, the passive income of

contro l led fore ign corpora t ions i s

deemed distributed, and therefore im-

mediately taxable by the United States,

even if not repatriated as dividend pay-

ments to American p arent firms.6

Because the foreign tax credit is in-

tended to alleviate international double

taxation, and not to red uce U.S. tax liabili-

ties on profits earned within the United

States, the foreign tax credit is limited to

U.S. tax liability on foreignsource in-

come. For example, an American firm

with $200 of foreign income that faces a

U.S. tax rate of 35 percent has a foreign

tax cred it limit of $70 (35 percent of $200).If the firm pays foreign income taxes of

less than $70, then the firm would be en-

titled to claim foreign tax credits for all of

its foreign taxes paid . If, how ever, the firm

pays $90 of foreign taxes, then it would

be perm itted to claim no more than $70 of

foreign tax credits.

Taxpayers whose foreign tax payments

exceed the foreign tax credit limit are said

to have excess foreign tax credits; theexcess foreign tax credits represent the

portion of their foreign tax payments that

exceed the U.S. tax liabilities generated by

their foreign incomes. Taxpayers whose

foreign tax payments are smaller than

their foreign tax credit limits are said to

be in excess limit or to have d eficit for-

eign tax credits. American law permits

taxpayers to use excess foreign tax cred-

its in on e year to red uce their U.S. tax ob-

ligations on foreign source income in ei-

ther of the two previous years or in any

of the following five years.7

In p ractice, the calculation of the foreign

tax credit limit entails certain additional

complications, notable among which is

5 Deferral of hom ecoun try taxation of the unrepatriated profits of foreign su bsidiaries is a common feature of

systems that tax foreign incomes. Other countr ies that perm it this kind of deferral include Canada, Denm ark,France, Germany, Japan , Norw ay, Pakistan, and the United Kingd om.

6 Subpart F income consists of income from passive investments (such as interest and dividen ds received from

investments in securities), foreign base company income (that arises from u sing a foreign affiliate as a cond uit

for certain typ es of international transactions), income that is invested in Un ited States property, money u sed

offshore to insure risks in the United States, and m oney u sed to p ay bribes to foreign governm ent officials.

American firms with foreign subsidiaries that earn p rofits through m ost types of active business opera tions,

and that su bsequently reinvest those p rofits in active lines of business, are not subject to the Subp art F rules,

and are therefore able to defer U.S. tax liability on their foreign p rofits un til they choose to remit d ividend s at

a later date.7 Foreign tax credits are not adjusted for inflation, so are generally the most valuable if claimed as soon as

possible. Barring u nusual circumstances, firms app ly their foreign tax credits against future years only when

un able to app ly them against either of the previous two years.Firms paying the corporate alternative minimum tax (AMT) are subject to the same rules, with the added

restriction that th e combination of net operating loss dedu ctions and foreign tax credits cannot redu ce AMT

liabilities by more th an 90 percent. It is noteworthy that, since the AMT rate is only 20 percent, firms sub ject

to the AMT are considerably m ore likely to have excess foreign tax credits than are firms th at pay the regular

corporate tax.

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833

that total worldwide foreign income is

used to calculate the foreign tax credit

limit. This method of calculating the for-

eign tax credit limit is known as w orld-

wide averaging. A taxpayer has excess

foreign tax credits if the sum of worldw ideforeign income tax paym ents exceeds th is

limit. The combination of worldw ide av-

eraging an d selective repatriation of divi-

dends from su bsidiaries located in coun -

tries with differing tax rates implies that

the average foreign tax rate used to calcu-

late the foreign tax credit limit need not

equal the average foreign tax rate faced

by a firms foreign affiliates.8 The ability

of mul t ina t ional f i rms to adjus t theamount of foreign income received in

nondividend forms (such as interest and

royalties) contributes to their control over

whether or not they have excess foreign

tax credits.

For firms with d eficit foreign tax cred-

its, dividend remittances from foreign

subsidiaries to their American parents

genera te U.S. tax liabilities that a re func-

tions of differences between foreign tax

rates and the U.S. corp orate tax rate. Gen-

erally speaking, firms owe U.S. taxes

based on the difference between the ap-

plicable foreign tax rate and the U.S. rate;

if the U.S. tax rate exceeds the foreign tax

rate, then the effective repatriation tax

equals the difference between the two.9 If,

instead, the foreign tax rate exceeds the

U.S. tax rate, then dividends trigger noadditional U.S. tax liability, and taxpay-

ers can ap ply an y d ifference against U.S.

tax liabilities on other foreign income.

Dividend remittances from unincorpo-

rated foreign branches do not have any

U.S. tax consequ ences (since U.S. taxes are

du e on branch profits whether or not d ivi-dends are paid), and therefore provide a

useful control group against which to

measure the imp act of repatriation taxes

for incorporated foreign su bsidiaries.

Dividend p ayments from foreign subsid-

iaries whose parent companies have ex-

cess foreign tax credits tha t wou ld other-

wise go u nu sed also generate no U.S. tax

liabilities. Since in practice it is d ifficult to

identify such parent comp anies, and sinceforeign tax credit situations are endog-

enous to repatriation behavior and to

other behav ior that is jointly d etermined

with repatriations, the empirical work that

follows does not attempt to adjust repa-

triation taxes for paren t foreign tax credit

situations. As a result, the estimates mea-

sure the average responsiveness of the

whole sample, includ ing the behavior of

any affiliates wh ose parents have chronic

excess foreign tax credits.

Implications for Dividend Remittances

The potential tax liability due upon

d ividend repatriation need not influence

the d ividend policies of American mu lti-

nationals. Applying the new view or

trapped equity view of dividend taxa-t ion as elaborated by King (1977),

8 Average foreign income tax rates paid by foreign affiliates reflect investment decisions as well as transfer

pricing practices that affect the location of reported taxable income. There is ample evidence, surveyed by

Hines (1999a), that both types of decisions are sensitive to their tax implications.9 Foreign governm ents may also imp ose withh olding taxes on dividend paym ents. Withhold ing taxes do not

change th e repatr iation tax liabilities of firms with deficit foreign tax credits, since they necessitate paym ents

to foreign governm ents for w hich such Am erican p arents are eligible to claim imm ediate offsetting foreign

tax credits. For firms w ith excess foreign tax credits, withholding taxes represent net tax liabilities, but since

withholding taxes have permanent characteristics (rates very seldom change), they cannot be avoided and

therefore are unlikely to influence repatriation patterns. An ap prop riate treatment of withholding taxes in a

repatriation equation requ ires an und erstand ing of the timevarying natu re of paren t and a ffiliate tax situa-tions, which is beyond the scope of this paper; as a result, the empirical work omits consideration of with-

holding taxes. This may not be an imp ortant om ission, since these withholding taxes are typically imp osed at

very low r ates. The BEA benchmar k data ind icate that, in 1994, majorityowned nonbank affiliates of non-

bank U.S. parents paid a total of $1.075 billion in withholding taxes on $37.989 billion of dividends, for an

average tax rate of 2.8 percent.

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Auerbach (1979), and Bradford (1981) in

the case of purely domestic companies,

Hartman (1985) demonstrates that repa-

triation taxes represent u navoidable costs

faced by m ature subsidiaries that finance

their investments out of retained earnings.If the repatriation tax rate is constan t over

time, then dividend payout policies that

maximize the present discoun ted value of

pretax flows from foreign subsidiaries

also maximize afterrepatriationtax re-

ceipts by their parents. Conversely, tran-

sitory changes in the repatriation tax rate,

including changes in the excess or deficit

foreign tax credit status of parents, will

affect d ividend behavior and firm valua-tion. As a result, some empirical studies

emphasize the distinction between tem-

porary and permanent changes in repa-

triation taxes and the associated effects of

those changes on dividend payou ts.

Hines and Hubbard (1990) analyze a

crosssection of U.S. multinationals using

tax return data from 1984 in an effort to

determine the sensitivity of multinational

dividends to tax costs. In their sample,

Hines and H ubbard note that large aggre-

gate payouts are the resu lt of selective and

infrequent dividend payments by affili-

ates. Using th is crosssection of data, they

conclude that a 1 percent decrease in the

repatriation tax is associated w ith a 4 per-

cent increase in dividend payout rates.10

The evidence provided in Hines and

Hu bbard su ggests that tax considerationsare very important determinants of the

timing of dividend repatriations.

The crosssection used by Hines and

Hubbard makes it impossible to distin-

guish th e effects of transitory and perm a-

nent changes in repa t r ia t ion taxes .

Altshuler, Newlon, and Randolph (1995)

attemp t to identify permanent and tran-

sitory tax costs by creating an un balanced

panel of subsidiaries using tax returns

from 1980, 1982, 1984, and 1986. Perma-

nent repatriation tax costs for subsidiar-

ies are constructed from a firststage re-

gression that uses as explanatory variables

statutory withholding tax rates and aver-age tax rates of other subsidiaries in the

same country. Altshuler, Newlon, and

Rand olph find , as predicted by Har tman

(1985), that transitory tax costs influence

dividend p ayments while permanent tax

costs do not. The effort to disentangle the

permanent and temporary tax costs of

dividends is limited , however, by the very

small num ber of annual observations for

each firm .Grubert (1998) and Grubert and Mutti

(2001) repor t tha t d ividends are sensitive

to tax costs in their analyses of crosssec-

tions of tax retu rns for 1990 and 1992, re-

spectively. Hines (1994, 1995) and Grubert

(1998) offer evid ence that the use of alter-

natives to dividend s, such as interest and

royalty payments, likewise respon d to the

tax costs associated with repatriation.

Gruber t (1998) presents somewhat

anomalous results suggesting that levels

of retained earnings are insensitive to tax

costs. This evidence is consistent w ith the

sensitivity of dividends to repatriation

taxes un der Gruberts interpretation that

repatriation taxes do not affect net invest-

men t by subsid iaries, since firms can su b-

stitute alternatives to dividend s in order

to repatriate income to parents.11

The complexity of the existing system

of taxing American multinationals has

promp ted renewed interest in the ad op-

tion of a system of territorial taxation char-

acterized by the exemp tion from taxation

of dividend s received from foreign affili-

ates. Evaluation of a potential transition

to dividend exemp tion, as envisioned by

Grubert an d Mutti (2001) for examp le, re-

10 Dividend p ayou t rates are calculated as dividends over assets. In the Hines and H ubba rd samp le, only 16

percent of subsidiaries with parents filing return s report paying d ividend s. Altshuler and New lon (1993) find

similar patterns in a related sam ple with a slightly redu ced elasticity of dividend s to tax costs.11 See also the evidence reported by Altshuler and Grubert (forthcoming), who examine methods used by for-

eign subsidiaries to defer repatr iation taxes.

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quires estimating the revenue conse-

quences of such a change, the responses

of mu ltinational firms to changed invest-

ment incentives, and the efficiency costs

of the existing system. Grubert and Mutti

(2001), along with Grubert (2001a), sug-gest that U.S. government revenu e wou ld

actually increase under a territorial tax

regime, as cur rent revenues are m inimal

and the revenue consequences of changed

expense allocation un der dividend ex-

emption would more than offset any

losses. Regarding investment incentives,

Grubert and Mutti (2001) and Altshulter

and Grubert (2001) project a limited

change in the investment patterns of mu l-tinationals und er d ividend exemption

given the low repatriation taxes currently

paid by U.S. multinationals investing in

lowtax countries. The analysis that fol-

lows complements these efforts by em-

ploying a Lintner framework to estimate

the efficiency consequences of the current

system of repatriation taxation and the

likely response of dividend policies to

moving to a territorial tax regime.

The Lintner Analysis of Dividend Policy

In order to estimate th e impact of repa-

triation taxes on intrafirm d ividends, it is

useful to begin with a framew ork that in-

corporates the variety of tax and nontax

factors that influence dividend policy.

Lintner (1956) provides such an analyticframework for the determinants of divi-

dends paid by domestic firms to their

comm on shareholders. Using interviews

and case studies, Lintner hypothesizes

that firms construct targets based on cur-

rent earnings, and that they adjust their

actual d ividend s gradually to targets over

time.12 Letting target dividend s be linear

functions of earnings, D*it

= + kitE

it, in

which D*it

is target dividends, is a con-

stant term,Eit

is aftertax earnings, kit

is a

possibly timevarying desired rate of pay-

out from marginal earnings, the subscript

i indexes firms and the subscript tindexestime, this relationship can be sum marized

in an estimating equation as:

[1] Dit

=(D*it

Dit1

) + it

.

In equ ation [1], Dit

is the change in firm

is dividend s between t 1 and t, is an

adjustment parameter, and it

is an error

term. Substituting for the d efinition of tar-

ge t d iv idends and combin ing t e rmsyields:

[2] Dit

=+ kitE

it+ (1 )D

it+

it.

Equation [2] suggests that if firms pay

their target dividends every period, then

the coefficient on lagged dividends will

equal zero as the adjustment parameter

is unity. If, however, annual adjustment

is only p artial, then lagged d ividend s will

enter the payou t equation with a positive

coefficient, and target payout ratios can

be inferred from the estimated constant

term and the coefficients on lagged divi-

dend s and current earnings.13

This framework can usefully be ex-

tended to the relationship betw een foreign

affiliates and their American parents in

order to isolate the imp ortance of repatr ia-tion taxes in influencing dividend pay-

ments. As developed in Desai, Foley, and

Hines (2001), the Lintner equation rep re-

sented in equation [2] corresponds to a

manager setting a target affiliate payout

rate from marginal earnings, kit, in re-

sponse to the tax cost associated w ith pay-

ing out earnings. Actual dividend pay-

12

While the mod el developed in Lintner (1956) was based on case studies of dividend policy, the accomp anyingemp irical work em ployed aggregate timeseries data for the U.S. econom y. Beginning w ith Fama and Babiak

(1968), several studies have implemented Lintner models with firmlevel data to understand the determi-

nan ts of dividend policy.13 Estimating variants of equation [2] without constant terms (as in Desai, Foley, and Hines, 2001) produces

results that are very similar to those obtained by estimating equ ation [2] with constants.

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NATIONAL TAX JOURNAL

836

ments reflect partial adjustment (governed

by the param eter ) to that target rate in

response to a variety of nontax concerns.

For examp le, managers might redu ce tar-

get payou t rates in respon se to higher re-

patriation taxes and adjust their ratiosbased on n ontax factorssuch as mon i-

toring or liqu idity concernsthat d ictate

how dividends are used w ithin a firm.

Since target payou t rates reflect tax pen-

alties associated with paying dividends,

variations in repatriation taxes can be used

to estimate the responsiveness of divi-

dends to repatriation taxes in the Lintner

framework. In particular, variations aris-

ing from organizational formdividend sfrom incorporated affiliates trigger a re-

pa t r ia t ion tax whi le d iv idends f rom

branches do n otand from local coun try

tax rates can be employed to estimate th e

behavioral response to such taxes. The

analysis below estimates Lintner equa-

tions separately by organ izational form,

interacting local tax rates with current

earnings in ord er to assess the responsive-

ness of payou t rates to repatriation taxes.

DATA AND DESCRIPTIVE STATISTICS

The Bureau of Economic Analysis

(BEA) Annual Survey of U.S. Direct In-

vestment Abroad from 1982 throu gh 1997

provid es data on the financial and oper-

ating characteristics of U.S. firms op erat-

ing abroad . These surveys require respon-dents to file detailed financial and oper-

ating items for each foreign affiliate and

provide information on the value of trans-

actions between U.S. parents and their

foreign affiliates. The International Invest-

ment and Trade in Services Survey Act

governs the collection of the data an d the

Act ensures that use of an individual

companys data for tax, investigative, or

regulatory purposes is prohibited. Will-ful noncompliance with the Act can result

in penalties of up to $10,000 or a prison

term of one year. As a result of these as-

surances and pen alties, BEA believes that

coverage is close to complete and levels

of accuracy are h igh.14

U.S. direct investment abroad is definedas the d irect or ind irect ow nership or con-

trol by a single U.S. legal ent ity of at least

10 percent of the voting securities of an

incorporated foreign business enterprise

or the equ ivalent interest in an un incor-

porated foreign business enterprise. A U.S.

mu ltinational entity (MNE) is the combi-

nation of a single U.S. legal entity th at has

made the direct investment, called the U.S.

parent, and at least one foreign bu sinessenterprise, called the foreign affiliate. In

order to be considered as a legitimate for-

eign affiliate, the foreign business enter-

prise should be paying foreign income

taxes, have a substantial physical presence

abroad, have separate financial records,

and should take title to the good s it sells

and receive revenue from sales. In order

to determine ownership stakes in the p res-

ence of indirect ownership, BEA deter-

mines the percentage of parent ownership

at each link in the ownership chain and

then mu ltiplies these percentages to com-

pute the parents total effective owner-

ship.

BEA collects sufficient information to

link affiliate level data through time to

create a panel. By checking the status of

all affiliates that filed forms in the p revi-ous year an d are expected to fall within

reporting requirements, BEA identifies

which enterprises leave the sample. By

mon itoring news services for information

on m ergers, acquisitions, and other activi-

ties of U.S. companies, BEA identifies

which new enterprises should be includ ed

in the sample. To check the integrity of

reported data, BEA accountants confirm

that informat ion satisfies certain integr itychecks. For examp le, BEA checks wheth er

14 Mataloni (1995) provides a detailed description of the BEA data .

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the owners equity at time t is roughly

equal to the ow ners equity at time t 1

plus any retained earnings, plus addi-

tional paidincapital, plus unrealized

gains and losses, and plus an y translation

ad justments that accoun t for changes inthe value of foreign currencies that are not

picked up in net income calculations.

The foreign affiliate survey forms that

U.S. MNEs are requ ired to comp lete vary

depend ing on the year, the size of the af-

filiate, and the U.S. paren ts percentage of

ownership of the affiliate. The most ex-

tensive data are available for 1982, 1989,

and 1994, when BEA conducted Bench-

mark Surveys. In th ese years, all affiliateswith sales, assets, or net income in excess

of $3 million in absolute value, and their

parents, were required to file reports. In

nonbenchmark years between 1982 and

1997, exemption levels were high er. From

198388, all affiliates with an absolute

value of sales, assets, or net income less

than $10 million were exempt, and this

cutoff increased to $15 million from 1990

93 and $20 million from 199597. While

the BEA does estimate data in order to

arrive at universe totals, the following

analysis exclud es estimated data.15

To classify the industrial activities of

parents and affiliates, BEA assigns each

domestic and foreign entity to an interna-

tional surveys industry (ISI) classification

code that is based on the Standard Indu s-

trial Classification (SIC) scheme. A typi-cal ISI code roughly covers the same scope

of activities as a threed igit SIC cod e. The

classification of foreign affiliate d ata tend s

to be p recise because parents can consoli-

date foreign affiliate op erations for BEA

reporting only if they are in the same

coun try and the same threedigit ISI in-

dustry or if they are integral parts of the

same business operation. Since the inter-

nal financial policies of firms primarilyengaged in financial services is likely to

differ substantially from that of other

firms, all affiliates of mu ltinationals that

have a paren t in finan cial services and all

affiliates in such ind ustries are excluded.16

Figure 1 illustrates the changing orga-

nizational forms of the foreign affiliates

of American multinat ionals from 1982 to

1997. Figure 1 illustra tes the grow ing im-

por tance of majorityowned incorporatedaffiliates relative to both m inorityowned

incorporated affiliates and branch affili-

ates over the period. Over the period from

1982 to 1997, majorityowned incorpo-

rated affiliates grew from 71.5 percent to

86.3 percent of the u niverse, wh ile minor-

ityowned incorporated affiliates de-

clined from 15.3 to 8.8 percent,17 and

branch affiliates declined from 11.4 to 4.4

percent of the u niverse.

Table 1 provides descriptive statistics

for the panel data employed in the em-

pirical work tha t follows. For both major-

ityowned incorporated affiliates and for

bran ches, this table first reports informa-

tion on the number of affiliates in the

sample and the frequency and size of pay-

out ratios for the years 1985, 1990, and

1995. As seen in Figure 1, the number ofmajorityown ed incorp orated affiliates

increases over the samp le period while the

nu mber of branches decreases. As a result

of changes in reporting requ irements, the

15 BEA uses reported data to estimate universe totals when surveys cover only larger affiliates or when only

certain affiliates provide information on p articular survey forms. Estimated data is unlikely to have a signifi-

cant impact on the BEAs published data at the industry or country level as data based on actual reports

exceed 90 percent of the estimated totals of assets and sales in each of the years betw een 1982 and 1997. To

avoid w orking w ith estimated data, only affiliates required to p rovide all the information associated with a

par ticular analysis are considered.16 Specifically, all affiliates prim arily operating in, or with parents that are classified as p rimarily operating in,

ISI codes 600 through 679 are exclud ed. This includes affiliates classified as hold ing comp anies.17 Desai and Hines (1999) offer evidence that the d eclining share of m inorityown ed incorporated affiliates is at

least in p art attributable to U.S. tax law changes.

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Figure1.

The

ChangingOrganizationalForm

ofU.S.DirectInvestmentAbro

ad,198297

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nu mber of affiliates reporting d ividends

declines substantially in 1994.18 The per-

cent of a f f i l ia tes paying a pos i t ive

dividend is around 30 percent over the

entire samp le, and the p revalence of pay-

ers is higher among incorporated than

unicorporated affiliates in 1985 and 1990.

Payout ratios of incorporated affiliates

also appear to be slightly lower than pay-

out ratios of branches.19 Table 1 also dis-

18 The sample of foreign affiliates reporting d ividends varies from year to year. In the non benchmark years before

1994, all surveyed majorityowned incorpor ated affiliates and branches report d ividends. In the nonbench-

mark years after 1994, BEA introdu ced a long and short form for majority owned affiliates, and only those sur -

veyed affiliates that filed the long form, or those w ith an absolute value of sales, assets, or net income in excess of

$50 million, reported d ivided information. The details of reporting requ irements are more complicated in bench-

mark years. In 1982, all surveyed affiliates report total d ividend paym ents. In 1989, all surveyed affiliates report

dividen ds pa id directly to the U.S. parent. This figure is converted to total dividen ds simp ly by dividing it by the

fraction of an affiliate owned by its parentunder the realistic assumption that dividends are distributed pro

rata to all own ers. In 1994, all surveyed affiliates with an absolute valu e of sales, assets, or net income greater

than $50 million report total d ividends and a ll other surveyed affiliates report dividen ds paid d irectly to the U.S.

parent. For these smaller affiliates, total dividends are again calculated by d ividing paren t dividend s by the

parents ownership fraction. Some affiliates are owned indirectly by their paren t compan ies through chains of

foreign subsidiaries; since par ents receive dividends only ind irectly from such foreign affiliates, it is imp ossibleto calculate total dividends from d istributions to parents. The sample excludes observations of such affiliates in

1989, and those sma ll affiliates for which total d ividend information is not available in 1994.19 The survey forms specifically distingu ish between net income and remittances for incorporated and un incor-

porated affiliates. In particular, the forms classify d ividend s paid by unincorporated affiliates as the amou nt

of curren t and p riorperiod net income remitted to owners.

TABLE 1

DESCRIPTIVE STATISTICS FOR TH E PANEL OF MULTINATION AL AFFILIATES

MajorityOw ned Incorporated Subs idiaries

Cross Sectional Data

Nu mber of entitiesNu mber of entities reporting d ividend s

Number of associated parent organizations% of affiliates reporting positive d ividendsMedian r atio of dividends to n et income for payers (%)

198297 Panel Summary Statistics

AssetsNet incomeDividendsInteraction of country tax rate and n et incomeInteraction of affiliate tax ra te and net income

Branch Affi liates

Cross Sectional Data

Nu mber of entitiesNu mber of entities reporting d ividend sNumber of associated parent organizations% of affiliates reporting positive d ividendsMedian r atio of dividends to n et income for payers (%)

198297 Panel Summary Statistics

AssetsNet incomeDividendsInteraction of country tax rate and n et incomeInteraction of affiliate tax ra te and net income

1985

5,3435,343

82335.967.7

Mean

99,7856,2963,8211,9262,357

1985

676676

7227.491.3

Mean

79,4996,6295,0141,8903,270

1990

7,1687,168

1,15429.772.3

Median

31,6111,573

469588

1990

40940949

20.094.5

Median

22,8171,132

256398

1995

7,3894,263

76529.072.2

StandardDeviation

294,48421,38020,189

6,8477,099

1995

359172

3130.283.1

StandardDeviation

187,65428,31226,540

9,68012,297

Note: The top panel provides cross sectional data for 1985, 1990, and 1995 and panel summary statistics forincorporated affiliates. The bottom p anel provid es cross sectional data for 1985, 1990, and 1995 and pan el sum-mary statistics for u nincorporated branch a ffiliates. All dollar figures are in thou sand s.

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plays summary statistics for the entire

198297 panel for incorporated affiliates

and branches. Incorporated affiliates tend

to be larger than branches, as measured

by mean an d median assets.

Analysis of the resp onsiveness of a ffili-ates to varying tax costs requires an esti-

mate of the relevant tax rate facing an af-

filiate. Table 2 provides weighted means

and s tandard devia t ions by year for

the coun try tax rates and affiliate tax

rates that are employed in the regression

analysis described below. Both m easures

are compu ted using th e samp le of affili-

ate observations with p ositive net income.

Tax rates are first constructed for eachaffiliate in every year as the ratio of for-

eign income taxes paid to the su m of for-

eign income taxes and net income. The

country tax rate measure represents the

median of these affiliate tax rates for all

Am erican affil ia tes op erat ing w ithin

a country.20 The means and standard de-

viations of those medians, weighted by

affiliate aftertax net income for affiliates

with positive net income, are presented

in the first two columns of Table 2. Regres-

sions u sing these coun try tax rates as in-

dependent variables base their findings oncrosscountry variation that obscures in-

tracountry variation in tax rates. The al-

te rna t ive aff i l ia te tax ra tes , annual

weighted m eans of which are reported in

column 3 of Table 2, capture the intra

country variation in tax rates; this mea-

sure is simply the tax rate calculated

above by affiliate after trimming tax

rates at 0 and 100 percent.21 Unsurpris-

ingly, the standard deviation of affiliatetax rates over the sample period is 20.9

percent, or nearly twice the standard d e-

viation of country tax rates. The decline

in affiliate tax rates presented in Table 2

corresponds to the decline in average for-

eign tax rates documented in Grubert

(2001b).

TABLE 2

FOREIGN TAX RATES, 198297

Country Tax Rates (%) Affiliate Tax Rates (%)

Year

1982198319841985198619871988198919901991199219931994199519961997198297

38.634.135.534.134.534.434.034.031.831.830.629.428.228.228.627.831.3

12.714.111.915.314.114.013.112.213.712.612.511.611.212.313.212.513.2

37.934.035.233.729.928.527.428.925.323.724.021.722.022.622.221.125.7

22.024.323.924.321.521.420.219.321.719.719.920.118.719.019.118.520.9

Mean Standard DeviationMean Standard Deviation

Note: Tax rate calculations are based on a ll affiliates reporting foreign income taxes paid and positive net income.The affiliate tax rate is the r atio of foreign income taxes paid to the su m of net income and foreign income taxespaid for a particular affiliate in a particular year. The country tax rate is the median of this ratio amongall affiliates in a p articular country d uring a particular year. Tax rates are trimmed at 0 and 100 percent. Meansand stand ard d eviations are weighted by aftertax affiliate income.

20 Country tax rates are trimmed to lie between 0 and 100 percent, which requires adjustments to 112 of the

131,358 affiliateyear observations.21 Out of 95,779 observations on tax rates, 4,723 negative tax rates are tr immed at 0 percent and 890 tax rates

above 100 percent are trimmed to 100 percent.

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RESULTS

This section p resents the results of esti-

mating dividend payout equations on

subsets of the 198297 panel described

above. Separate equations are estimatedfor incorporated and unincorporated af-

filiates. Distingu ishing by organizational

form offers a check of whether any ob-

served sensitivity of dividend payou t ra-

tios to repatriation taxes (as captured by

foreign tax rates) among incorporated af-

filiates also appears for unincorporated

affiliates.22 If sensitivity to taxes were

present across both organ izational forms,

the results might be interp reted as reflect-ing something other than tax incentives.

The data are fit to Lintner specifications

and are estimated both by OLS and Tobit

procedures, the latter motivated by the

relatively small fraction (rough ly 30 per-

cent) of the sample paying nonzero divi-

dend s. Fixed effects for American p arent

companies are included in some specifi-

cations in an effort to control for the effect

of unobserved p arent characteristics thatmay be correlated w ith affiliate tax rates.

Since the Lintner framework requires in-

formation on d ividend s and lagged d ivi-

dends, the regression analysis only u ses

observations of affiliates tha t also report

data for the p revious year. As a result, all

affiliates that report data only once, and

all observations of affiliates rep orting for

the first time, are exclud ed.23

The estimation results consistently in-dicate that higher repatriat ion taxes

reduce target payout ratios. Table 3 pre-

sents the results of estimating Lintner

equations on the sample of separately

incorporated foreign affiliates, using

country tax rates as proxies for the rel-

evant creditable taxes available upon re-patriation. Column 2 reports coefficients

from a simp le OLS specification. In ord er

to calculate target steadystate payout

ratios in the Lintner fram ework, it is nec-

essary to sum the estimated coefficient on

net income and the ratio of the constant

term to net earnings; this sum is then d i-

vided by one m inus the estimated coeffi-

cient on lagged dividends. Using the

sample mean income of $6,296 (in thou-

sand s), the estimated constant term of 273,

the 0.33 coefficient on net income, and the

0.26 coefficient on lagged dividends to-

gether imply that incorporated affiliates

with mean income in zerotax locations

set target payout ratios of 0.51 [0.51 = (0.04

+ 0.33)/ (1 0.26)]. The 0.27 coefficient on

the in teraction of Coun tryTax Rates and

net income imp lies that incorporated af-filiates in locations with 30 percent tax

rates instead set target payout ratios of

0.62 [0.62 = (0.04 + 0.33 + 0.27*0.3)/ (1

0.26)]. The 0.26 coefficient on lagged divi-

dend s implies an adjustment p arameter

of 0.74. As with the firms studied by

Lintner, incorporated affiliates partially

adjust their dividends to targeted pay-

outs.

The results are robust to alternativespecifications explored in the regressions

22 This exercise takes an a ffiliates organizational form to be independ ent of its repatriation p olicy. Multina-

tional firms choose wh ether to make their affiliates foreign branches or foreign subsid iaries; to the extent th at

these choices are dictated by anticipated future repatriation rates, then a comparison of repatriation rates

between affiliates with different organizational forms w ill overstate the imp act of tax rate differences. Other

characteristics differ between br anches and subsidiaries that could be correlated with tax rates and repatria-

tion proclivities. Branch affiliates are concentrated in certain ind ustr ies, includ ing petroleum, wholesale trad e,

and services, though not en tirely; in the 1997 sample, 26.4 percent of branch affiliates were in n onpetroleum

man ufacturing, compared with 52.1 percent of incorpora ted affiliates. While the geograph ic distributions of

branches and su bsidiaries were not iden tical, the med ian foreign tax rate p aid by br anch affiliates in 1997 was30.4 percent, compared to 31.1 percent for incorporated affiliates. Based on th is information there is no strong

reason to suspect that a comparison of the repatriation patterns of branches and subsidiaries would encoun-

ter d ifficulties du e to sp urious correlation w ith local tax rates.23 In order to ensu re the robu stness of the results, the samp le excludes affiliates in top 0.5 percent and bottom 0.5

percent of net income each year in each regression.

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reported in columns 36.24 Columns 3

and 4 report regressions that add fixed

effects tha t are sp ecific to parent compa-

nies and that therefore remain un changed

across time and between affiliates belong-

ing to the same parent group. Inclusion

of these fixed effects d oes not substantially

change the estimated coefficients on

lagged dividend payments, net income,

and net income interacted with tax rates.

Colum ns 5 and 6 report coefficients esti-mated with a Tobit procedu re that controls

for the nonn ormality of the residuals in-

duced by the fact that dividend p ayments

cannot be negative. The estimated Tobit

coefficients are generally larger than their

OLS counterparts. The estimated coeffi-

cients in column 6 suggest that the differ-

ence in steadystate desired dividend

payout ratios for incorporated affiliates in

zerotax locations an d those in 30 percent

tax rate locations is 0.23 [0.23 = (0.52*0.3)/

(1 .32)].

Table 4 presents estimated coefficients

from the same specifications but for thesamp le of un incorporated affiliates. Before

considering the differential impact of

taxes on the d ividend behavior of incor-

24 The results are likewise robust to alternative specifications not reported in Tables 36. The regression equ a-

tion specification takes responses to repatriation taxes to be the same every year. Since the timevarying

natu re of variables such as the U.S. tax rate influences the fraction of American firms w ith excess foreign tax

credits, it follows that respon siveness to repatr iation taxes are likely to differ over tim e, in w hich case the

regression estimates represent something like sample averages. As a check of the importance of time varia-

tion, the regressions reported in Table 5 were rerun add ing interactions between the affiliate tax rate and

income variable and a d um my va riable for the post1986 period. Despite a greater fraction of firms w ithexcess foreign tax credits after the 1986 U.S. tax reduction, only one of these regressions offers any ev iden ce

of reduced sensitivity of dividend s to repatriation taxes in the post1986 period . Estimated coefficients

from that (Tobit) specification imp ly that higher repatriation taxes in the p ost1986 period continue to re-

du ce dividend payou ts, though the imp lied coefficient is 0.71 instead of the 0.75 report ed in colum n 5 of

Table 5.

TABLE 3LINTNER DIVIDEND SPECIFICATIONS FOR INCORPORATED AFFILIATES, COUNTRYMEDIAN TAX RATES

Depend ent Variable: Dividend Paymen ts by MajorityOwned Incorpor ated Affiliates

Constant

Net Income ofAffiliate

Lagged DividendPayments

Interaction of Coun tryTax Rate and Net Income

Paren t Fixed Effects?Tobit or OLS?

RSquaredLogLikelihoodSigmaNo. Obs

(1)

298.4515

(97.1920)

0.4107(0.0220)

0.2673(0.0297)

NoOLS

0.3610

77,766

(2)

273.2120

(98.1784)

0.3334(0.0401)

0.2638(0.0293)

0.2725(0.1217)

NoOLS

0.3625

77,766

(3)

350.0693

(106.3705)

0.4113(0.0227)

0.2515(0.0295)

YesOLS

0.3705

77,766

(4)

327.2801

(107.6823)

0.3435(0.0422)

0.2490(0.0292)

0.2382(0.1286)

YesOLS

0.3716

77,766

(5)

23,283.7300

(1241.0240)

0.5967(0.0301)

0.3251(0.0359)

NoTobit

324,77629,53577,766

(6)

23,308.5600

(1242.4130)

0.4499(0.0445)

0.3177(0.0352)

0.5196(0.1292)

NoTobit

324,68129,46677,766

Note: The dependen t variable in all specifications is the dollar value of dividend p aymen ts by majorityownedincorporated affiliates. "Net Income of Affiliate" is the afterforeign tax net income of the affiliate in the sameyear. "Lagged Dividend Paymen ts" is the dollar value of dividend paym ents by the affiliate in the previous year."Interaction of Coun try Tax Rate and Net Income" is the product of the country tax rate, as defined in the text,and "Net Income of Affiliate." Colu mn s 1 and 2 presen t OLS specifications withou t fixed effects. Colum ns 3 and4 present OLS specifications w ith p arent fixed effects. Column s 5 and 6 present Tobit specifications.Heteroskedasticityconsistent stand ard errors are presented in parenth eses.

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porated and un incorporated affiliates, it

is instructive to compare estimated coef-

ficients from the basic Lintner specifica-

tions in columns 1, 3, and 5 of Table 3, with

their coun terparts reported in columns 1,

3, and 5 of Table 4. The results are very

similar across the incorporated an d u nin-

corporated subsamples. The estimated

target payou t ratios of incorporated affili-

ates in column 1 of Table 3 is 0.63 [0.63 =

(0.05 + 0.41)/ (1 0.27)], while this est i-mated ratio for branches in column 1 of

Table 4 is 0.75 [0.75 = (0.06 + 0.45)/ (1

0.33)]. The estimated adjustment param-

eters for incorporated an d u nincorporated

affiliates are 0.73 and 0.67 respectively. Of

course, examining the data at th is level of

aggregation across tax rate environm ents

masks the heterogeneity related to d iffer-

ences in the tax treatments of incorporated

and branch affiliates.Since American taxpayers owe U.S.

taxes on the foreign incomes of unincor-

porated affiliates, wh ether or n ot that in-

come is repatriated, it follows that host

country tax rates shou ld have no effect on

d ividend p ayment rates to the extent that

these tax rates captu re the imp act of repa-

triation taxes. The coefficient estimates

reported in Table 4 confirm the absence

of a significant effect of host coun try tax

rates on the d ividend p ayout ratio of un -

incorporated foreign affiliates. The 0.13

coefficient on the interaction of country

tax rates and net income, reported in col-

umn 2 of Table 4, is not statistically sig-nificant and is much smaller than its coun-

terpart reported in column 2 of Table 3.

Similar results app ear in the fixed effects

regressions reported in column 4. Even in

the Tobit specification rep orted in column

6 of Table 4 the estimated coefficient on

the interaction of coun try tax rates and net

income remains small and insignificant.

The 0.12 coefficient on country tax rates

interacted with net income, reported incolum n 6 of Table 4, is particularly small

comp ared with the estimated 0.52 coeffi-

cient on the same interaction in the incor-

porated affiliate regression reported in

TABLE 4

LINTNER DIVIDEND SPECIFICATIONS FOR BRANCHES, COUNTRYMEDIAN TAX RATES

Depend ent Variable: Dividend Paymen ts by Branch Affiliates

(1)

396.2181

(260.3451)

0.4461(0.0645)

0.3282(0.0927)

NoOLS

0.5482

6,373

Constant

Net Income ofAffiliate

Lagged DividendPayments

Interaction of Coun tryTax Rate and Net Income

Paren t Fixed Effects?Tobit or OLS?

RSquaredLogLikelihoodSigmaNo. Obs

(2)

397.0999

(256.5044)

0.4108(0.0978)

0.3272(0.0927)

0.1257(0.2434)

NoOLS

0.5489

6,373

(3)

472.9865

(299.3231)

0.4528(0.0656)

0.3041(0.0940)

YesOLS

0.5650

6,373

(4)

480.6146

(299.5311)

0.4238(0.1055)

0.3037(0.0939)

0.0991(0.2709)

YesOLS

0.5654

6,373

(5)

28,637.4900

(2971.3050)

0.6519(0.0772)

0.3461(0.1050)

NoTobit

24,54733,547

6,373

(6)

28,615.9100

(2974.9200)

0.6170(0.1071)

0.3449(0.1052)

0.1247(0.2311)

NoTobit

24,54633,522

6,373

Note: The dependen t variable in all specifications is the dollar value of dividend p aymen ts by unincorporatedbran ch affiliates. "Net Income of Affiliate" is the afterforeign tax net income of the affiliate in the same year."Lagged Dividend Payments" is the dollar value of dividend payments by the affiliate in the previous year."Interaction of Coun try Tax Rate and N et Income" is the prod uct of the country tax rate, as defined in the text,and "Net Income of Affiliate." Colu mn s 1 and 2 presen t OLS specifications withou t fixed effects. Colum ns 3 and4 present OLS specifications with p arent fixed effects. Column s 5 and 6 present Tobit specifications.Heteroskedasticityconsistent stand ard errors are presented in parenth eses.

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column 6 of Table 3. This result suggests

that country tax rates have little if any

impact on payout ratios of un incorporated

affiliates while they do affect payout ra-

tios of incorporated affiliates.

Tables 5 and 6 report the results of re-gressions that parallel those reported in

Tables 3 and 4, but that employ different

methods for estimating the relevant tax

costs associated with repatriation. Instead

of the country tax rate measures used in

the regressions repor ted in Tables 3 and 4,

the regressions repor ted in Tables 5 and 6

employ the affiliate tax rates described

above. In Tables 5 and 6, either the affiliate

tax rate is simp ly substituted for the coun-

try tax rate or the coun try tax rate is used

as an instrument for the affiliate tax rate.

Use of these tax rates reduces the sample

size from 77,766 observations to 60,477 ob-

servations for incorp orated affiliates, since

the affiliate tax ra te is defined only for af-

filiates repor ting p ositive net incomes.

The results reported in column 1 of Table

5 are similar to those reported in colum n

2 of Table 3, with one difference: the esti-

mated coefficient on the interaction of thetax rate and net income is much larger in

the regression reported in Table 5. The co-

efficient on this interaction is 0.56 in the

regression rep orted in Table 5 that uses the

affiliate tax rate, w hile the same coefficient

is 0.27 in the equivalent regression re-

ported in Table 3 using country median tax

rates. Estimated coefficients on net incom e

withou t tax rate interactions are 0.33 both

in Table 3 and in Table 5, wh ile estimatedcoefficients on lagged dividends are 0.26

in Table 3 and 0.23 in Table 5.

The different results stemming from the

use of country and affiliate tax rates are

consistent w ith tw o alternative explana-

Constant

Net Income ofAffiliate

Lagged DividendPayments

Interaction of AffiliateTax Rate and Net Income

Paren t Fixed Effects?Tobit or OLS?IV with Country Tax Rates?

RSquaredLogLikelihoodSigmaNo. Obs

TABLE 5

LINTN ER DIVIDEND SPECIFICATIONS FOR INCORPORATED AFFILIATES, AFFILIATE TAX RATES

Depend ent Variable: Dividend Paymen ts by MajorityOwned Incorpor ated Affiliates

(1)

607.0329(154.6309)

0.3286(0.0294)

0.2250(0.0296)

0.5635(0.0903)

NoOLSNo

0.3907

60,477

(2)

581.9756(165.0086)

0.3473(0.0413)

0.2306(0.0308)

0.4690(0.1787)

NoOLSYes

60,477

(3)

609.1335(175.9349)

0.3398(0.0312)

0.2094(0.0293)

0.5479(0.0949)

YesOLSNo

0.4011

60,477

(4)

572.7080(190.1521)

0.3638(0.0444)

0.2161(0.0305)

0.4260(0.1957)

YesOLSYes

60,477

(5)

20,351.0100(1,126.0550)

0.3973(0.0333)

0.2851(0.0356)

0.7519(0.0991)

NoTobitNo

299,99529,31660,477

(6)

20,323.7500(1070.787)

0.4143(0.0437)

0.2910(0.0370)

0.6644(0.1841)

NoTobitYes

300,02529,31060,477

Note: The dependen t variable in all specifications is the dollar value of dividend p aymen ts by majorityownedincorporated affiliates. "Net Income of Affiliate" is the afterforeign tax net income of the affiliate in the sameyear. "Lagged Dividend Paymen ts" is the dollar value of dividend paym ents by the affiliate in the previous year."Interaction of Affiliate Tax Rate and Net Income" is the product of the affiliate tax rate, as defined in the text, and"Net Income of Affiliate." Colum ns 1 and 2 presen t OLS specifications withou t fixed effects. Colum ns 3 and 4present OLS specifications with paren t fixed effects. Colum ns 5 and 6 presen t Tobit specifications. Tobit IVestimates are obtained u sing the procedu re recomm ended by New ey (1987). In column s 1 through 5,heteroskedasticityconsistent standard error s are presented in pa rentheses. In column 6, bootstrapped stand arderrors are presented in paren theses. The num ber of bootstrap repetitions is chosen following Andrew s andBuchinsky (2000) so that the percentage d eviation in standard error estimates from u sing an infinite num ber ofbootstraps is less than 10 percent w ith p robability 0.95.

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tions. If different affiliates in the same

coun try face d istinct effective income tax

rates then using country tax rates as a

proxy for the tax rates affiliates face wou ld

be a source of measurement error. Mea-

surement error would explain why the

coefficient on the interaction of country tax

rates and net income is lower than th e co-efficient on the interaction of affiliate tax

rates and net income. While this explana-

tion favors the use of affiliate tax rates,

sensitivities measured from affiliate tax

rates might instead reflect a p articular be-

havioral relationship. If affiliates target

fixed values of d ividend s then payou t ra-

t ios would mechanical ly appear high

when an affiliate faces a high tax rate since

that affiliate wou ld then have to p ay ou t a

larger fraction of net income. Use of the

country tax rate to instrum ent for the af-

filiate tax rate overcomes the limitations

of using either of the tax rates on its own.

This procedure captures withincountryheterogeneity in affiliate tax rates but re-

duces the imp act of behavioral mechanics

associated w ith fixed payout targets. These

concerns recomm end the use of country

tax rates as instruments for affiliate tax

rates, as performed in the regressions re-

ported in columns 2, 4, and 6 of Table 5.25

25 The first stage equation, in which net income interacted with affiliate tax rates is regressed on net income

interacted with country tax rates (as well as other ind epend ent variables), exhibits an excellent fit. In the firststage regression for incorporated affiliates, the coefficient on the net incomecountry tax rate variable is 0.69

with a tstatistic of 18, and the first stage Fstatistic (3, 60,477) is 606, which is significant at any desired

confidence level. In the first stage regression for branch affiliates, the coefficient on the net incomecoun try

tax ra te variable is 0.89 with a tstatistic of 14, and the first stage Fstatistic (3, 4,598) is 63, which is sign ificant

at any desired confidence level.

TABLE 6

LINTN ER DIVIDEND SPECIFICATIONS FOR BRANCH ES, AFFILIATE TAX RATES

Depend ent Variable: Dividend Paymen ts by Branch Affiliates

Constant

Net Income ofAffiliate

Lagged DividendPayments

Interaction of AffiliateTax Rate and Net Income

Paren t Fixed Effects?Tobit or OLS?IV with Country Tax Rates?

RSquaredLogLikelihoodSigmaNo. Obs

(1)

1,036.1550

(453.2230)

0.4294(0.0872)

0.2566(0.0921)

0.3633(0.1585)

NoOLSNo

0.5695

4,602

(2)

1,028.5280

(457.8351)

0.4768(0.1004)

0.2726(0.0966)

0.1624(0.2679)

NoOLSYes

4,602

(3)

983.8666

(554.3380)

0.4403(0.0940)

0.2322(0.0943)

0.3595(0.1760)

YesOLSNo

0.5885

4,602

(4)

995.0818

(565.0190)

0.5017(0.1183)

0.2482(0.0990)

0.1157(0.3364)

YesOLSYes

4,602

(5)

24,297.9700

(2,476.2230)

0.4891(0.0987)

0.3268(0.1082)

0.4257(0.1716)

NoTobitNo

22,77834,2604,602

(6)

24,222.1900

(2485.687)

0.5586(0.1088)

0.3511(0.1180)

0.1265(0.2610)

NoTobitYes

22,77934,125

4,602

Note: The dependen t variable in all specifications is the dollar value of dividend p aymen ts by unincorporatedbran ch affiliates. "Net Income of Affiliate" is the afterforeign tax net income of the affiliate in the same year."Lagged Dividend Payments" is the dollar value of dividend payments by the affiliate in the previous year."Interaction of Affiliate Tax Rate and Net Income" is the product of the affiliate tax rate, as defined in the text, and"Net Income of Affiliate." Colum ns 1 and 2 presen t OLS specifications withou t fixed effects. Colum ns 3 and 4present OLS specifications with paren t fixed effects. Column s 5 and 6 presen t Tobit specifications. Tobit IVestimates are obtained u sing the procedu re recomm ended by New ey (1987). In column s 1 through 5,heteroskedasticityconsistent standard error s are presented in pa rentheses. In column 6, bootstrapped stand ard

errors are presented in paren theses. The num ber of bootstrap repetitions is chosen following Andrew s andBuchinsky (2000) so that the percentage d eviation in standard error estimates from u sing an infinite num ber ofbootstraps is less than 10 percent w ith p robability 0.95.

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Use of coun try tax rates as instruments

for affiliate tax rates red uces the estimated

coefficient on the in teraction of tax rates

and net income from 0.56 to 0.47, bu t th is

coefficient rem ains large comp ared to its

counterpart in Table 3. The introductionof parent fixed effects in the regressions

reported in colum ns 3 and 4 has very little

imp act on the estimated coefficients other

than those on the net income and tax

rate interactions, which fall slightly (e.g.,

from 0.47 in column 2 to 0.43 in column

4). The results of the Tobit equation re-

ported in column 5 of Table 5, in which

un instrumented affiliate tax rates are in-

teracted w ith net income, differ somew hatfrom the results of the equivalent regres-

sion reported in column 6 of Table 3. While

the net income and lagged dividend coef-

ficients are moderately smaller in the

Table 5 Tobit regression than they are in

its Table 3 counterpart, the most impor-

tant d ifference appears in the effect of the

interaction of tax rates and affiliate in-

come. The estimated 0.75 coefficient on

this var iable reported in colum n 5 of Table

5 is significantly larger than the 0.52 coef-

ficient reported in column 6 of Table 3.

Colum n 6 of Table 5 reports the results of

instru menting for affiliate tax rates in the

Tobit specification;26 these results are very

similar to those appearing in column 5.

Table 6 reports the results of conduct-

ing the analysis presented in Table 5 on

the unincorporated affiliate subsample.Constru ction of the affiliate tax rate vari-

able reduces the sample size from the

6,373 observations reported in Table 4 to

4,602 observations. Despite this smaller

sample, a comparison of the results re-

ported in Tables 5 and 6 indicates that

payou t ratios of unincorporated affiliates

exhibit significantly less sensitivity to lo-

cal tax rates relative to payout ratios of

incorporated affiliates.

Column 1 of Table 6 reports results of

the simple OLS specification of the branch

payout equation that interacts affiliate

and yearspecific tax rates with net in-

come . Al though incorpora ted and

unicorporated affiliates exhibit similaradjustment param eters, their estimated

payout ratios vary with tax rates in dis-

tinct ways. Moving from a zerotax loca-

tion to a 30 percent tax rate location in-

creases an incorporated affiliates target

payout ratio from 0.30 [0.30 = (0.33 0.10)/

(1 0.23)] to 0.52 [0.52 = (0.33 0.10 +

0.56*0.3)/ (1 0.23)], but the chan ge for a

branch affiliate is only from 0.37 [0.37 =

(0.43 0.16)/ (1 0.26)] to 0.51 [0.51 = (0.430.16 + 0.36*0.3)/ (1 0.26)]. While the use

of uninstru mented affiliate tax rates p ro-

duces results in which tax interaction

terms have positive and significant coef-

ficients for unincorporated affiliates, in-

strumenting for affiliate tax rates with

country tax rates (to add ress the problems

discussed above) removes this result. The

estimated coefficient on the interaction of

the tax rate and net income falls to 0.16 in

the regression reported in column 2 of

Table 6, and does not d iffer significantly

from zero. This 0.16 coefficient is signifi-

cantly sm aller than the 0.47 coefficient on

the same variable in the incorporated af-

filiate regression repor ted in colum n 2 of

Table 5.

Colum ns 3 and 4 of Table 6 present re-

sults of specifications that add parentfixed effects to the same regressions re-

ported in colum ns 1 and 2. The results are

generally similar to those appearing in

columns 1 and 2, though the estimated

coefficient on the net income and tax rate

interaction falls still furth er to 0.12 in the

instrumental variables regression re-

ported in column 4. Column 5 of Table 6

reports the resu lts of a Tobit specification

of the d ividend payout equ ation that in-

26 The instrumental variables Tobit estimation is based on a technique d etailed by Newey (1987). The analysis uses

bootstrap methods to estimate standard errors. The number of bootstrap repetitions was selected using a proce-

du re recomm ended by Andrew s and Buchinsky (2000). Their procedu re yields a num ber of repetitions such that

the p ercentage d eviation from using an infinite number of bootstrap s is less than 10 percent with probability 0.95.

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847

teracts uninstrumented affiliate tax rates

with net income. The 0.43 estimated coef-

ficient on this interaction is positive and

differs significantly from zero, though it

is also significantly smaller th an the 0.75

estimated coefficient for incorp orated af-filiates reported in column 5 of Table 5.

Column 6 of Table 6 reports the instru-

mental variables Tobit results, in which all

other coefficients are similar to those in

column 5, but the estimated effect of the

interaction of net income and tax rates is

much smaller (0.13) and does not differ

significantly from zero.

Comp arison of the behavior of incorpo-

rated and unincorporated affiliates, to-

gether with the evidence obtained by

estimating the behavior of the samp le of

incorporated affiliates, consistently ind i-

cates that higher repatriation taxes are

associated with reduced payout ratios.

With the exception of the use of un-

instrum ented affiliate tax rates, the results

indicate that incorporated affiliates are

sensitive to repatriation taxes in a way thatunincorporated affiliates are not.

Taking the estimated effect of the inter-

actions of tax rates and net income for in-

corporated affiliates as repor ted in column

2 of Table 5, one percent tax rate differ-

ences are associated with 0.61 [0.61 = 0.47/

(1 0.23)] percent differences in payout

ratios. Since the ratio of mean dividend

paym ents to mean net income for incor-

porated affiliates equals 0.61, this corre-spon ds to a 1.0 percent d ifference in total

d ividend paym ents. This estimated effect

exceeds the estimated tax rate sensitivi-

ties reported by Mutti (1981), Hines and

Hubbard (1990), Altshuler and Newlon

(1993) , and Al tshuler , Newlon, and

Randolph (1995), all of whom analyze tax

return data.27 A lower bou nd on the esti-

mated tax rate effect is available by sub-

tracting the estimated 0.16 coefficient onthe interaction of tax rates and n et income

for branches (as reported in colum n 2 of

Table 6), thereby yielding that 1 percent

tax rate differences are associated with

0.40 [0.40 = 0.31/ (1 0.23)] percent d iffer-

ences in payout ratios, or 0.66 percent d if-

ferences in total d ividend paym ents.

WELFARE CONSEQUENCES OF

REPATRIATION TAXES

These findings carry several implica-

tions for the debate on the transition to

an exemption system. Given that divi-

dend payments by foreign affiliates ap-

pear to be highly sensitive to repatr iation

taxes, the adoption of a territorial tax re-

gime w ould be associated with liberated

financial flows between parent comp anies

and their foreign subsidiaries. Part of the

efficiency cost of the current foreign tax

credit and deferral system can be imp uted

from d ividend repatriation d istortions in

this system. In particular, it is possible to

estimate the deadweight loss associated

with repatriationbased taxation of for-eign income from the degree to which

firms change their payout ratios in re-

sponse to the presence of repatriation

taxes.

In order to estimate the effect of a tran-

sition to an exemp tion regime it is neces-

sary to calculate the likely impact of re-

moving repatriation taxes on the mean

level and distribution of dividend pay-

ments from foreign affiliates. Table 2 re-ports that th e average foreign tax rate fac-

ing American affiliates in 1997 was 21.1

percent; the w eighted m ean tax rate fac-

ing the subsample of separatelyincorpo-

rated foreign subsidiaries was 22.2 per-

cent, and its stand ard deviation was 18.6

percent. The U.S. federal income tax rate

that year was 35 percent. Repatriation

taxes would have no effect on repatria-

tions whenever the timing and magnitud eof dividend payments from foreign sub-

27 The results reported by Grubert (1998), based on an an alysis of tax return d ata, could imp ly a greater sensitivity

of dividend s to repatriation taxes, but d ifferences in method and description make such a comparison infeasible.

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sidiaries does not influence the present

value of tota l tax liabilities. As a practical

matter, this occurs in situations when for-

eign tax ra tes equal the U.S. tax rate, trea-

ties reduce crossborder withholding

taxes to zero, and th e recognition of add i-tional foreign income for U.S. tax pu rposes

does not increase tax liabilities throu gh in-

come and expense allocations. Taking th e

last two considerations roughly to net

each other ou t, it follows that foreign tax

rates of 35 percent would remove incen-

tives to adjust dividend payments in an-

ticipation of associated domestic tax li-

abilities. Since the average foreign tax

rate for foreign subsidiaries was 22.2percent in 1997, this chan ge corresponds

to a 12.8 percent higher foreign tax rate,

which in turn is associated with 12.8

percent greater dividend paym ents from

foreign subsidiaries. The econometric

estimates imply that home country ex-

emp tion of foreign income w ould increase

annual d iv idend f lows f rom fore ign

affiliates by this amount, roughly 12.8 per-

cent.

The average effect of repatriation taxa-

tion conceals a great d eal of variation be-

tween affiliates, since the tax system si-

multaneously encourages some affiliates

to distribute much greater d ividend s than

they would in the absence of tax incen-

tives, while d iscouraging others from p ay-

ing dividends. Much of the inefficiency

associated with repatriation taxes stemsfrom this variation, which is masked in

the aggregate figures.

In ord er to estimate th e efficiency costs

associated with repatriation taxes it is

helpful to consider the simp le Harberger

triangle associated with the distortions

introdu ced by homecoun try taxation of

repatriated income.28 Letting denote theimp act of repatr iation taxation on procliv-

ity to pay d ividends out of net income, it

follows that the effect of repatriation taxa-

tion on payments of dividends from af-

filiate i is: yi(

i

US), in which y

iis the

afterforeigntax income of affiliate i, iis

the tax rate it faces in the foreign country,

an d US

is the home coun try tax rate. The

efficiency cost of this distortion equals

1/ 2 times the product of this induced divi-dend flow and the tax wedge.29 Aggregat-

ing this figure for all affiliates yields the

following expression for the total ineffi-

ciency:

[3]

in w hich is the measure of the loss of

economic efficiency, and is any constan t.

Equation [3] can be evaluated most con-

veniently by setting equal to the mean

tax ra te facing foreign affiliates, weighted

by their aftertax incomes. The m agnitud e

ofin 1997 can be calculated by taking

US

to equ al 0.35 (its 1997 valu e), using the

estimated value of 0.61 for , and using

0.222 and 0.035 for th e mean and varianceof the tax rates facing foreign subsidiar-

ies in 1997. This calculation yields th at the

=2

y i(i US)2 = 2y i1

n

i=1

n

i=1

28 Hines (1999b) and Auerbach and Hines (2001) review the ap plication of H arberger triangles to calculate the

magn itudes of inefficiencies d ue to taxation.29 A critical aspect of this welfare calculation is that tax distortions be prop erly measured . To the extent that

dividends respond to transitory and not permanent tax rate differences, as argued by Hartman (1985) and

Altshuler, Newlon, and Randolph (1995), then the tax rate differences on which the estimates reported in

Tables 36 are based reflect the imp act of tran sitory tax rate differences. The relevant tax wed ge for the

welfare calculation then is the anticipated difference between tran sitory and perm anent tax rates, or, to ex-

press the sam e idea a d ifferent way, the d ifference between the present value of the cost of paying a d ividendthis year and the cost of paying a d ividend n ext year. Unless the anticipated cost of paying futu re dividend s

is zeroeither because firm conditions are expected to change, or the policy environment is expected to

changethen the relevant tax wedge for paying dividends this year will be less than the measured wedge

that ignores future costs. Consequently, the welfare calculations that follow produce upper bou nd s on actual

welfare costs.

[(i )2 + 2

i(

US) + 2

US 2],

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total inefficiency in repatriation patterns

due to repatriation taxes equals 1.55 per-

cent of the net income of foreign subsid-

iaries. The inefficiency associated with

d ividend repatriation taxes (expressed as

a fraction of subsidiary net income) hasnot changed markedly over time, since the

same calculation using 1984 values (in-

cluding a statu tory U.S. tax rate of 46 per-

cent) prod uces a Harberger triangle equal

to 2.0 percent of net income. To put the

1997 number in perspective, it corre-

spon ds to 2.5 [2.5 = 1.55/ 0.61] percent of

total dividends.

This Harberger triangle figure2.5 per-

cent of dividendsrepresents the effi-ciency loss due to the incentives created

by repatriation taxes. This loss in effi-

ciency occasioned by repatriation taxes

equals approximately 15.2 percent of the

homecoun try tax revenu e generated by

repatriation taxes, since, at an average

home coun try tax rate of 35 percent and

an average foreign tax rate of 22.2 percent,

firms pay home country taxes equal to

16.5 percent of d ividends.30 The total bur-

den of repatriation taxes equals the sum

of the efficiency cost, 2.5 percent of divi-

dends, and the tax obligation, 16.5 percent

of d ividend s, for a total of 19.0 percent. It

is noteworthy that these estimates corre-

spond to inefficiencies in dividend poli-

cies conditional on investment; since re-

patriation taxes also affect investment

patterns, corporate finance, and a host ofother decisions, the associated ineffi-

ciency, and ultimate burden, is greater

still.31

CONCLUSION

This paper demonstrates that the repa-

triation taxes imposed by current U.S. tax

ru les redu ce the volume and efficiency of

finan cial flows between affiliates and their

American paren ts. Evidence from a large

continuous panel of foreign affiliates of

American firms ind icates that yearly d ivi-

dend payouts are determined by gradual

adjustment to desired longrun d ividend s

conditional on earnings. Highly taxed for-eign affiliates have higher d esired payou t

rates than do more lightly taxed subsid-

iaries, reflecting the lower repatriation

taxes associated with receiving dividends

from h eavily taxed affiliates. Unincorpo-

rated foreign affiliates, from whom receipt

of dividend s does not tr igger repatr iation

taxes, do not exhibit the same large and

significant association between tax rates

and dividend payout ratios. Comparisonof tax sensitivities across organizational

forms implies that U.S. repatriation taxes

reduce aggregate dividend repatriations

by 12.8 percent ann ually. The ann ual effi-

ciency loss associated with taxmotivated

d ividend repatriation behavior equals 2.5

percent of d ividends.

This paper employs the Lintner divi-

dend mod el, initially developed to un der-

stand corporate dividend payments to

common shareholders, to analyze divi-

dend payouts from foreign affiliates to

the