R&D and the Rising Foreign Profitability of U.S. Multinational Corporations

We investigate how R&D contributes to foreign profit margins in U.S. multinational corporations (MNCs) through wage savings and tax incentives. Our results suggest that although wage savings increase foreign profit margins attributable to foreign R&D activities, the shifting of income attributable to domestic R&D activities to lower-tax jurisdictions has a larger effect on foreign profit margins. However, additional tests suggest that wage savings are more important than tax incentives in explaining foreign profit margins when the wage discount substantially exceeds the tax differential. Our evidence sheds light on the importance of R&D locations in corporate intangible income shifting that separates the location of economic activity from the location of reported taxable income.