Taxation and Capital Flows in Offshore Financial Companies

Abstract: The 1986 Tax Reform Act introduced changes that potentially alter capital flows into and out of the United States, particularly for financial companies. This paper uses data from 1982 to 1997 to assess the evolution of net U.S. capital outflows (net repatriations) in banking and finance relative to other industries. The results of this paper indicate that net U.S. capital outflows in the banking and finance industry were much lower than in other industries after 1986, even after controlling for general finance company differences, a time trend, exchange rates, tax rates, and country fixed effects. Once controlling for the trend over time, net capital outflows were not different before and after 1986 for industries other than banking and finance, but are significantly lower for banking and finance companies after 1986. The results are interpreted to suggest that TRA86 did not influence net capital outflows for most industries, but that changes in Subpart F for financial companies lead to a significantly lower outflow in the banking and finance industry. 1Taxation of capital is particularly difficult in a world of increasingly mobile capital flows. U.S. international tax law limits the tax advantage of moving capital overseas to a low tax jurisdiction by taxing the worldwide income of U.S. taxpayers (a credit being given for taxe