How Do Reductions in Foreign Country Corporate Tax Rates Affect U.S. Domestic Manufacturing Firms?

Abstract

We examine whether reductions in foreign country statutory corporate tax rates affect the competitive environment of U.S. domestic manufacturing firms and how U.S. firms respond. We develop a measure of U.S. domestic firms’ exposure to changes in foreign country corporate tax rates and find U.S. domestic firms’ profitability is adversely affected by decreases in foreign country corporate tax rates, consistent with intensified competition. We find U.S. domestic firms respond by increasing investment in research and development and capital expenditures and by improving total factor productivity. In cross-sectional analyses, we find the impact of foreign tax cuts is concentrated among U.S. domestic firms with low product differentiation. Taken together, these findings suggest that reductions in foreign country statutory corporate tax rates escalate competition faced by U.S. domestic firms, and in response U.S. domestic firms increase investment and become more productive.