American based companies reported earning $938 billion in profits overseas in 2008 (most recent data). The U.S. will generally defer levying a tax on this income until it is brought back (repatriated) to the United States, although the countries where American companies operate may tax this income at the time it is earned. The United States' method for taxing American based companies gives rise to two principal issues in the international tax debate. First, American companies can use tax deferral and other techniques to avoid or delay taxes by moving profits out of high-tax countries (or out of the U.S.) and into low-tax countries with little corresponding change in business operations, a practice known as "profit shifting." Second, the ability to defer taxes on income earned abroad allows American companies to reinvest earnings in foreign markets and expand business operations alongside foreign counterparts. This report focuses on the profit shifting aspect of international business behavior in response to taxation. Data on the activities of American based companies with overseas operations is analyzed to understand the degree to which, if any, profit shifting may be occurring. The analysis appears to show that American companies report earning profits in tax haven or tax preferred countries that, when compared to more traditional economies, appear to be disproportionate to hiring and capital investment in those countries. Profits reported by American companies also appear to be disproportionate to national output in the tax haven countries, and in some countries, these reported profits actually exceed total economic output. By all indicators examined in this report, profit shifting has generally trended upward overtime. The findings of this report are in agreement with a large body of economic research that has found evidence that American companies are shifting profits in an attempt to reduce their tax liabilities and that U.S. tax revenues suffer as a result. For example, economist Kimberly Clausing has estimated that profit shifting by American companies cost the government between $57 billion and $90 billion in lost revenue in 2008. Economist Martin Sullivan also estimated significant revenue losses, although they were generally less than half of Clausing's estimates for the most recent year analyzed by both researchers, 2004. Employing a different approach than Clausing and Sullivan, professors Charles Christian and Thomas Schultz have estimated that on net $87 billion was shifted out of the U.S. in 2001, which, at a 35% tax rate would imply a revenue loss of about $30 billion. A number of media outlets have also recently published stories which report that companies such as Apple, Cisco, Facebook, Google, and Microsoft may be using sophisticated tax planning techniques to shift profits to low tax countries and lower their U.S. tax liabilities. Policymakers here at home have taken notice of possible profit shifting. For example, the Senate Permanent Subcommittee on Investigations held a hearing in September 2012 on the methods companies use to shift profits and possible options for curbing such behavior. Witnesses included IRS officials, academics, private tax consultants, and executives from the tax departments at two American companies (Hewlett-Packard and Microsoft). Profit shifting has also been the specific target of several bills that were introduced in the 112 th Congress ( H.R. 2669 , S. 1346 , S. 2075 ), as well as part of broader reform proposals in the 112 th Congress, including S. 727 (Senators Wyden, Begich, and Coats), S. 2091 (Senator Enzi), and a House Ways and Means "discussion draft" (Representative Camp). The issue of profit shifting has also attracted the attention of foreign policymakers. Several recent foreign media stories have called attention to what is perceived by some to be tax avoidance by American companies operating abroad. According to those reports, Prime Minister David Cameron and members of the British Parliament have expressed concern over the rather low tax liability of several American companies operating in the United Kingdom. Furthermore, German Finance Minister Wolfgang Schäuble and British Chancellor of the Exchequer George Osborne, in a joint statement, have called on the G20 countries to coordinate efforts to prevent profit shifting by companies of all nationalities and to protect the global corporate tax base. The Bureau of Economic Analysis (BEA) collects data on where American based companies that operate in foreign markets report profits and various other pieces of business information. These companies, often referred to as U.S. multinational companies (MNCs), are a combination of a U.S. based "parent" company and "affiliates," which are owned by the parent and operate in foreign markets. Because U.S. based parents can have various degrees of ownership, and hence control over their foreign affiliates, the BEA distinguishes between affiliates with a parent that has a majority ownership stake and affiliates with a parent that has any ownership stake. The BEA also distinguishes between bank and nonbank parents and affiliates. This section analyzes the BEA data to determine the extent to which, if any, U.S. MNCs may be shifting profits. To do this, 10 countries, formed into two country groups, are analyzed. The first group consists of the five countries commonly identified as being "tax preferred" or "tax haven" countries, and includes Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland. The second group, which provides a baseline for comparison, consists of the five more traditional economies. This group includes Australia, Canada, Germany, Mexico, and the United Kingdom. The profits reported by foreign affiliates of U.S. MNCs in the two country groups are presented and analyzed. The countries in each respective group were chosen because they consistently ranked among the top places where American companies reported profits. The profits reported by American based companies in the two country groups are then compared with their real economic (business) presence in the country groups. Two measures of the real economic presence of MNCs are considered. The first measure is the share of total foreign affiliate employment in each country group. Foreign affiliate employment represents the number of workers employed by U.S. MNCs outside of the United States. The second measure is foreign affiliate capital expenditures on property, plants, and equipment. Capital expenditures represent investment in physical assets by U.S. MNC affiliates. These two variables were chosen because the BEA data guide describes them as good indicators of the size of U.S.-owned business operations in affiliate countries. It is also likely that these measures are less susceptible to reporting manipulation by firms than say, financial variables, since they involve tangible economic factors. Next, the profits reported in the two country groups are compared with the size of economies that comprise each country group. To measure the size of the economies analyzed, the gross domestic product (GDP) for each country was obtained from the Economist Intelligence Unit . GDP is the value of all final goods and services produced by the citizens and firms in an economy. Alternatively, GDP can be interpreted as the total income earned by the citizens and domestically based companies in a country. Thus, the profits (income) of U.S. MNCs reported in a particular foreign country will not count toward that country's GDP. The GDP figures used in the analysis were adjusted for purchasing power parity (PPP). PPP is the method preferred by economists when making cross-country comparisons. Only U.S. MNCs with a nonbank parent with majority-owned nonbank foreign affiliates were considered in the analysis because the BEA did not start collecting information on firms in the banking and financial industries until 2007, and has only recently begun to collect more information about these firms. The analysis was further limited to majority-owned foreign affiliates because the BEA does not adjust affiliate data for the ownership stake of the parent, which could potentially affect the analysis if affiliates that have a U.S. parent with a minority stake engaged in, or do not engage in, a particular tax strategy. Majority-owned foreign affiliates accounted for 94% of affiliates in 2008. Figure 1 displays the share of profits that foreign affiliates of American MNCs reported in the tax preferred and traditional country groups between 1999 and 2008. The share of overseas profits reported in tax preferred countries has fluctuated around 40% since 2002 after increasing from a low of 24% in 2000. In the most recent data year available (2008), American MNCs reported earning 43% of their overseas profits in the country group comprised of Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland. In comparison, American MNCs reported 14% of all profits earned abroad in 2008 in Australia, Canada, Germany, Mexico and the United Kingdom. The relatively low share of profits reported in the traditional economy group follows a general decline in profits reported in these countries over the last decade. In 1999, for example, the traditional economies accounted for 35% of profits reported abroad. Viewed another way, profits reported in the five traditional county group economies have decreased approximately 60% over the sample period. The trends displayed in Figure 1 could be explained by economic factors. If companies are shifting real production and business activities, then it should be expected that the location of profits would change as well. At the same time, it could be that the location of reported profits has changed without a corresponding change in real business activities. If this is the case, it could be indicative of profit shifting since, by definition, profit shifting involves a disconnect between where profits are reported and where real business activity occurs. The next two sections analyze this further using three measures of business and economic activity—employment, investment, and GDP. Figure 2 shows the share of workers hired (dashed lines) and investments made (solid lines) by American companies outside the U.S. in both groups of countries. Three features of the data are immediately apparent. First, the amount of investment and hiring in the traditional economy group dwarfs that which occurs in the tax preferred countries. In 2008, for example, American companies hired 40% of their foreign labor from and made 34% of their foreign investments in the country group containing Australia, Canada, Germany, Mexico and the United Kingdom.