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Tax Competition and Foreign Direct Investment: assessing the role of market potential and trade costs in a "Footloose Capital" framework

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Vincent Delbecque

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Abstract

This paper investigates the impact of the corporate income tax on the geographical distribution of French firms Foreign Direct Investment port- folio across 26 European countries. The empirical assessment is based on Baldwin (1999) new economic geography model in which we focus on the location of firms with respect to level of taxation. In this model, the magnitude of the impact of taxation on location decision partly depends on the market size and the level of trade costs. Indeed, firms may not only seek lower production costs but better market access and market opportunity when investing abroad. Through panel data regressions, we find a negative impact of the corporate income tax rate on Foreign Direct Investment. We also find that trade costs between source and host coun- try increases Foreign Direct Investment. In advanced specifications we show that increasing trade costs reduce the impact of tax level on capital location.

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Paper provided by University of Paris West - Nanterre la Défense, EconomiX in its series EconomiX Working Papers with number 2008-18.

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Length: 19 pages
Date of creation: 2008
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Handle: RePEc:drm:wpaper:2008-18

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Related research
Keywords: Corporate taxation; Firm-level data; Foreign Direct Investment; Trade Costs;

Find related papers by JEL classification:
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
R38 - Urban, Rural, and Regional Economics - - Production Analysis and Firm Location - - - Government Policies; Regulatory Policies
C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data

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