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Taxes and the location of production: evidence from a panel of US multinationals

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  • Michael Devereux

    ()
    (Institute for Fiscal Studies and University of Oxford)

  • Rachel Griffith

    ()
    (Institute for Fiscal Studies and University of Manchester)

Abstract

This paper investigates a set of strategic decisions facing US firms. We develop a simple theoretical framework in which firms choose whether or not to serve a foreign market, and if so whether by exporting, or by becoming a multinational. The model is applied to a sample of US firms choosing whether and how to supply the European market. We take Europe to be a single market and allow the firms to choose to produce in one of the UK, France and Germany. In the empirical application we find that the average effective tax rate plays an important role in the choice of location. Our central estimate is that, conditional on the firm having decided to locate production in Europe, a one percentage point increase in the average effective tax rate in the UK would lead to a one percentage point reduction in the probability of locating in the UK. The equivalent figure for Germany is around three-quarters of a percentage point, and for France around one-third of a percentage point. This suggests that tax is a quantitatively significant factor in location decisions. However, in general, the evidence suggests that taxation is not a significant factor in the decision of whether to locate in Europe - either as opposed to exporting to Europe or not serving the European market at all. Other factors predicted by the theory also play a significant role. Most striking are the agglomeration benefits of being located close to other firms within the industry which undertake R&D. These agglomeration benefits affect both the decision as to whether to locate abroad and, conditional on that decision, where to locate. Also, firms with high plant level fixed costs are less likely to produce abroad.

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Bibliographic Info

Paper provided by Institute for Fiscal Studies in its series IFS Working Papers with number W96/14.

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Date of creation: Aug 1996
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Handle: RePEc:ifs:ifsewp:96/14

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References

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  1. Robert E. Lipsey & Guy V.G. Stevens, 1992. "Interactions between Domestic and Foreign Investment," NBER Working Papers 2714, National Bureau of Economic Research, Inc.
  2. James R. Hines Jr., 1997. "Altered States: Taxes and the Location of Foreign Direct Investment in America," NBER Working Papers 4397, National Bureau of Economic Research, Inc.
  3. Robert E. Lipsey & Irving B. Kravis & Linda O'Connor, 1983. "Characteristics of U.S. Manufacturing Companies Investing Abroad and their Choice of Production Locations," NBER Working Papers 1104, National Bureau of Economic Research, Inc.
  4. Michael P. Devereux & Rachel Griffith, 1998. "The Taxation of Discrete Investment Choices," Keele Department of Economics Discussion Papers (1995-2001) 98/08, Department of Economics, Keele University.
  5. Swenson, Deborah L., 1994. "The impact of U.S. tax reform on foreign direct investment in the United States," Journal of Public Economics, Elsevier, vol. 54(2), pages 243-266, June.
  6. Alfons Weichenrieder, 1996. "Fighting international tax avoidance," Fiscal Studies, Institute for Fiscal Studies, vol. 17(1), pages 37-58, February.
  7. Horst, Thomas, 1972. "Firm and Industry Determinants of the Decision to Invest Abroad: An Empirical Study," The Review of Economics and Statistics, MIT Press, vol. 54(3), pages 258-66, August.
  8. Jason Cummins & R. Glenn Hubbard, 1995. "The Tax Sensitivity of Foreign Direct Investment: Evidence from Firm-Level Panel Data," NBER Chapters, in: The Effects of Taxation on Multinational Corporations, pages 123-152 National Bureau of Economic Research, Inc.
  9. Magnus Blomstrom & Robert E. Lipsey & Ksenia Kulchycky, 1988. "U.S. and Swedish Direct Investment and Exports," NBER Chapters, in: Trade Policy Issues and Empirical Analysis, pages 257-302 National Bureau of Economic Research, Inc.
  10. Head, Keith & Ries, John & Swenson, Deborah, 1995. "Agglomeration benefits and location choice: Evidence from Japanese manufacturing investments in the United States," Journal of International Economics, Elsevier, vol. 38(3-4), pages 223-247, May.
  11. Michael J. Boskin & William G. Gale, 1987. "New Results on the Effects of Tax Policy on the International Location of Investment," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 201-222 National Bureau of Economic Research, Inc.
  12. Lipsey, Robert E & Weiss, Merle Yahr, 1984. "Foreign Production and Exports of Individual Firms," The Review of Economics and Statistics, MIT Press, vol. 66(2), pages 304-08, May.
  13. Goldberg, Pinelopi Koujianou, 1995. "Product Differentiation and Oligopoly in International Markets: The Case of the U.S. Automobile Industry," Econometrica, Econometric Society, vol. 63(4), pages 891-951, July.
  14. Alan J. Auerbach & Kevin Hassett, 1991. "Taxation and Foreign Direct Investment in the United States: A Reconsideration of the Evidence," NBER Working Papers 3895, National Bureau of Economic Research, Inc.
  15. James R. Markusen, 1995. "The Boundaries of Multinational Enterprises and the Theory of International Trade," Journal of Economic Perspectives, American Economic Association, vol. 9(2), pages 169-189, Spring.
  16. Brainard, S Lael, 1997. "An Empirical Assessment of the Proximity-Concentration Trade-off between Multinational Sales and Trade," American Economic Review, American Economic Association, vol. 87(4), pages 520-44, September.
  17. Michael Devereux & Harold Freeman, 1995. "The impact of tax on foreign direct investment: Empirical evidence and the implications for tax integration schemes," International Tax and Public Finance, Springer, vol. 2(1), pages 85-106, February.
  18. Horstmann, Ignatius J. & Markusen, James R., 1992. "Endogenous market structures in international trade (natura facit saltum)," Journal of International Economics, Elsevier, vol. 32(1-2), pages 109-129, February.
  19. Paul Krugman, 1990. "Increasing Returns and Economic Geography," NBER Working Papers 3275, National Bureau of Economic Research, Inc.
  20. Devereux, Michael P. & Pearson, Mark, 1995. "European tax harmonisation and production efficiency," European Economic Review, Elsevier, vol. 39(9), pages 1657-1681, December.
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