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Taxes, institutions and foreign diversification opportunities

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  • Desai, Mihir A.
  • Dharmapala, Dhammika

Abstract

Investors can access foreign diversification opportunities through either foreign portfolio investment (FPI) or foreign direct investment (FDI). The worldwide tax regime employed by the US potentially distorts this choice by penalizing FDI, relative to FPI, in low-tax countries. On the other hand, weak investor protections in foreign countries may increase the value of control, creating an incentive to use FDI rather than FPI. By combining data on US outbound FPI and FDI, this paper analyzes whether the composition of US outbound capital flows reflects these incentives to bypass home and host country institutional regimes. The results suggest that the residual tax on US multinational firms' foreign earnings skews the composition of outbound capital flows -- a 10% decrease in a foreign country's corporate tax rate increases US investors' equity FPI holdings by approximately 10%, controlling for effects on FDI. Investor protections also seem to shape portfolio choices, though these results are not robust when only within-country variation is employed.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 93 (2009)
Issue (Month): 5-6 (June)
Pages: 703-714

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Handle: RePEc:eee:pubeco:v:93:y:2009:i:5-6:p:703-714

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Web page: http://www.elsevier.com/locate/inca/505578

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Keywords: Foreign portfolio investment Foreign direct investment Taxes Investor protections;

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Citations

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Cited by:
  1. Mihir A. Desai & Dhammika Dharmapala, 2007. "Taxes, Institutions and Foreign Diversification Opportunities," NBER Working Papers 13132, National Bureau of Economic Research, Inc.
  2. Federica Liberini, 2014. "Corporate Taxes and the Growth of the Firm," KOF Working papers 14-354, KOF Swiss Economic Institute, ETH Zurich.
  3. Fatica, Serena, 2009. "Taxation and the quality of institutions: asymmetric effects on FDI," MPRA Paper 24179, University Library of Munich, Germany, revised Jun 2010.
  4. Dhammika Dharmapala, 2008. "What Problems and Opportunities are Created by Tax Havens?," Working Papers 0820, Oxford University Centre for Business Taxation.
  5. Mishra, Anil V & Ratti, Ronald A, 2013. "Taxation of Domestic Dividend Income and Foreign Investment Holdings," MPRA Paper 50601, University Library of Munich, Germany.
  6. Jiandong Ju & Shang-Jin Wei, 2010. "Domestic Institutions and the Bypass Effect of Financial Globalization," Working Papers 222010, Hong Kong Institute for Monetary Research.
  7. repec:onb:oenbwp:y::i:142:b:1 is not listed on IDEAS
  8. Wiji Arulampalam & Michael P. Devereux & Federica Liberini, 2012. "Taxes and the Location of Targets," Working Papers 1213, Oxford University Centre for Business Taxation.
  9. Herrmann, Sabine & Kleinert, Jörn, 2014. "Lucas paradox and allocation puzzle: Is the euro area different?," Discussion Papers 06/2014, Deutsche Bundesbank, Research Centre.
  10. Abid, Fathi & Bahloul, Slah, 2011. "Selected MENA countries' attractiveness to G7 investors," Economic Modelling, Elsevier, vol. 28(5), pages 2197-2207, September.
  11. Liberini, Federica, 2014. "Corporate Taxes and the Growth of the Firm," The Warwick Economics Research Paper Series (TWERPS) 1042, University of Warwick, Department of Economics.
  12. Sabine Herrmann & Joern Kleinert, 2014. "Lucas Paradox and Allocation Puzzle - Is the euro area different?," Graz Economics Papers 2014-01, University of Graz, Department of Economics.
  13. Mihir A. Desai & Dhammika Dharmapala, 2007. "Taxes and Portfolio Choice: Evidence from JGTRRA's Treatment of International Dividends," NBER Working Papers 13281, National Bureau of Economic Research, Inc.

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