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Corporate tax effects on the quality and quantity of FDI

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  • Johannes Becker

    () (Max Planck Institute for Intellectual Property, Competition and Tax Law)

  • Clemens Fuest

    () (Oxford University Centre for Business Taxation)

  • Nadine Riedel

    () (Oxford University Centre for Business Taxation)

Abstract

This paper measures the relative importance of quality and quantity effects of corporate taxation on foreign direct investment. Quantity is affected if corporate taxes reduce the equilibrium stock of foreign capital in a given country. Quality effects arise if taxes decrease the extent to which investment contributes to the corporate tax base and the capital intensity of production. Depending on the sign of the quality effects, the detrimental welfare effects of corporate taxation are either mitigated or aggravated. We derive a number of hypotheses how corporate tax changes may affect the quality of investment. Our hypotheses are then tested using data from a large sample of European multinationals. With regard to corporate tax effects on the corporate tax base, we find that quality effects account for up to fourty per cent of the total effect. With regard to corporate tax effects on labour income, our results suggest that quality effects mitigate the negative quantity effect by nearly sixty percent (as corporate taxes strongly increase the labor intensity of production). An important implication is that governments should not exclusively care about the size of inbound FDI flows but also about their specific characteristics, i.e. their quality.

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Bibliographic Info

Paper provided by Oxford University Centre for Business Taxation in its series Working Papers with number 1013.

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Date of creation: 2010
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Handle: RePEc:btx:wpaper:1013

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Keywords: Corporate Taxation; Foreign Direct Investment; Multinational Firms;

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  1. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  2. Devereux, Michael P & Griffith, Rachel, 2003. "Evaluating Tax Policy for Location Decisions," International Tax and Public Finance, Springer, vol. 10(2), pages 107-26, March.
  3. Simon Loretz, 2008. "Corporate taxation in the OECD in a wider context," Working Papers 0821, Oxford University Centre for Business Taxation.
  4. Andreas Haufler & Frank Stähler, 2009. "Tax Competition in a Simple Model with Heterogeneous Firms: How Larger Markets Reduce Profit Taxes," CESifo Working Paper Series 2867, CESifo Group Munich.
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  6. Dischinger, Matthias, 2008. "Profit Shifting by Multinationals and the Ownership Share: Evidence from European Micro Data," Discussion Papers in Economics 5661, University of Munich, Department of Economics.
  7. Dwenger, Nadja & Steiner, Viktor, 2008. "Effective profit taxation and the elasticity of the corporate income tax base: Evidence from German corporate tax return data," arqus Discussion Papers in Quantitative Tax Research 57, arqus - Arbeitskreis Quantitative Steuerlehre.
  8. Huizinga, Harry & Laeven, Luc, 2007. "International Profit Shifting within European Multinationals," CEPR Discussion Papers 6048, C.E.P.R. Discussion Papers.
  9. Gene M. Grossman & Esteban Rossi-Hansberg, 2008. "Trading Tasks: A Simple Theory of Offshoring," American Economic Review, American Economic Association, vol. 98(5), pages 1978-97, December.
  10. Johannes Becker & Clemens Fuest, 2007. "Quality versus Quantity – The Composition Effect of Corporate Taxation on Foreign Direct Investment," CESifo Working Paper Series 2126, CESifo Group Munich.
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  12. Grubert, Harry & Mutti, John, 1991. "Taxes, Tariffs and Transfer Pricing in Multinational Corporate Decision Making," The Review of Economics and Statistics, MIT Press, vol. 73(2), pages 285-93, May.
  13. Michael P Devereux, 2007. "The Impact of Taxation on the Location of Capital, Firms and Profit: a Survey of Empirical Evidence," Working Papers 0702, Oxford University Centre for Business Taxation.
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Cited by:
  1. Haufler, Andreas & Stähler, Frank, 2009. "Tax competition in a simple model with heterogeneous firms: How larger markets reduce profit taxes," Discussion Papers in Economics 11120, University of Munich, Department of Economics.
  2. Becker, Johannes & Fuest, Clemens, 2011. "Tax competition -- Greenfield investment versus mergers and acquisitions," Regional Science and Urban Economics, Elsevier, vol. 41(5), pages 476-486, September.

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