Advanced Search
MyIDEAS: Login to save this paper or follow this series

How tax policy and incentives affect foreign direct investment - a review


Author Info

  • Morrisset, Jacques
  • Pirnia, Neda
Registered author(s):


    With an increasing number of governments competing to attract multinational companies, fiscal incentives have become a global trend that has grown considerably in the 1990s. Poor African countries rely on tax holidays, and import duty exemptions, while industrial Western European countries allow investment allowances, or accelerated depreciation. Have governments offered unreasonably large incentives to entice firms to invest in their countries? The authors review the literature on tax policy, and foreign direct investment, and explore possibilities for research. They observe that tax incentives neither make up for serious deficiencies in a country's investment environment, nor generate the desired externalities. Long-termstrategies to improve human, and physical infrastructure - and, where necessary, to streamline government policies and procedures - are more likely than incentives to attract genuine long-term investment. But more recent evidence has shown that when other factors - such as infrastructure, transport costs, and political and economic stability - are more or less equal, the taxes in one location may have a significant effect on investors'choices. This effect is not straightforward, however. It may depend on the tax instrument used by the authorities, the characteristics of the multinational company, and the relationships between the tax systems in the home country, and recipient countries. For example, tax rebates are more important for mobile firms, for firms that operate in multiple markets, and for firms whose home country exempts any profit earned abroad (Canada, France) rather than using tax credit systems (Japan, the United Kingdom, the United States). Even if tax incentives were quite effective in increasing investment flows, the costs might well outweigh the benefits. Tax incentives are not only likely to have a negative direct effect on fiscal revenues, but also frequently create significant opportunities for illicit behavior by tax administrators, and companies. This issue has become crucial in emerging economies, which face more severe budgetary constraints, and corruption than industrial countries do. The authors suggest research in five areas: 1) The eventual non-linear impact of tax rates on the investment decisions of multinational companies. 2) the effect of tax policy on the composition of foreign direct investment (for example, green-field, reinvested earnings, and mergers and acquisitions). 3) The development of new technologies, and global companies that are likely to be more sensitive to, and able to exploit incentives. 4) The need for a global approach to the taxation of multinational companies. 5) The question of whether tax incentives should be directed only at (foreign) investors thatmake the"right things"(such as environmentally safe products) or more broadly at those that bring jobs, technology transfers, and marketing skills.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL:
    Download Restriction: no

    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2509.

    as in new window
    Date of creation: 31 Dec 2000
    Date of revision:
    Handle: RePEc:wbk:wbrwps:2509

    Contact details of provider:
    Postal: 1818 H Street, N.W., Washington, DC 20433
    Phone: (202) 477-1234
    Web page:
    More information through EDIRC

    Related research

    Keywords: Public Sector Economics&Finance; Environmental Economics&Policies; Economic Theory&Research; International Terrorism&Counterterrorism; National Governance;


    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. David N. Figlio & Bruce A. Blonigen, 1999. "The Effects of Direct Foreign Investment on Local Communities," NBER Working Papers 7274, National Bureau of Economic Research, Inc.
    2. Michael Devereux & Rachel Griffith, 1996. "Taxes and the location of production: evidence from a panel of US multinationals," IFS Working Papers, Institute for Fiscal Studies W96/14, Institute for Fiscal Studies.
    3. Franklin R Root & Ahmed A Ahmed, 1978. "The influence of policy instruments on manufacturing Direct Foreign investment in developing countries," Journal of International Business Studies, Palgrave Macmillan, vol. 9(3), pages 81-94, September.
    4. Hartman, David G., 1985. "Tax policy and foreign direct investment," Journal of Public Economics, Elsevier, Elsevier, vol. 26(1), pages 107-121, February.
    5. Joel Slemrod, 1989. "Tax Effects on Foreign Direct Investment in the United States: Evidence from a Cross-Country Comparison," NBER Working Papers 3042, National Bureau of Economic Research, Inc.
    6. Bruce A. Blonigen & Matthew J. Slaughter, 2001. "Foreign-Affiliate Activity And U.S. Skill Upgrading," The Review of Economics and Statistics, MIT Press, vol. 83(2), pages 362-376, May.
    7. Haufler, Andreas & Wooton, Ian, 1999. "Country size and tax competition for foreign direct investment," Munich Reprints in Economics, University of Munich, Department of Economics 20408, University of Munich, Department of Economics.
    8. Rauscher, Michael, 1994. "Environmental Regulation and the Location of Polluting Industries," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1032, C.E.P.R. Discussion Papers.
    9. Julie Collins & Douglas Shackelford, 1995. "Corporate domicile and average effective tax rates: The cases of Canada, Japan, the United Kingdom, and the United States," International Tax and Public Finance, Springer, Springer, vol. 2(1), pages 55-83, February.
    10. Haaparanta, Pertti, 1996. "Competition for foreign direct investments," Journal of Public Economics, Elsevier, Elsevier, vol. 63(1), pages 141-153, December.
    11. Markusen, James R. & Morey, Edward R. & Olewiler, Nancy, 1995. "Competition in regional environmental policies when plant locations are endogenous," Journal of Public Economics, Elsevier, Elsevier, vol. 56(1), pages 55-77, January.
    12. Goodspeed, T-J & White, A-D, 1996. "International taxation," Papers, Wellesley College - Department of Economics 96-11, Wellesley College - Department of Economics.
    13. Grubert, Harry, 1998. "Taxes and the division of foreign operating income among royalties, interest, dividends and retained earnings," Journal of Public Economics, Elsevier, Elsevier, vol. 68(2), pages 269-290, May.
    14. Desai, Mihir A. & Hines Jr., James R., 1999. ""Basket cases": Tax incentives and international joint venture participation by American multinational firms," Journal of Public Economics, Elsevier, Elsevier, vol. 71(3), pages 379-402, March.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    1. Pennings, Enrico, 2005. "How to maximize domestic benefits from foreign investments: the effect of irreversibility and uncertainty," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(5), pages 873-889, May.
    2. Danielova, Anna & Sarkar, Sudipto, 2011. "The effect of leverage on the tax-cut versus investment-subsidy argument," Review of Financial Economics, Elsevier, Elsevier, vol. 20(4), pages 123-129.
    3. Sarkar, Sudipto, 2012. "Attracting private investment: Tax reduction, investment subsidy, or both?," Economic Modelling, Elsevier, Elsevier, vol. 29(5), pages 1780-1785.
    4. Lim, Sung-Hoon, 2008. "How investment promotion affects attracting foreign direct investment: Analytical argument and empirical analyses," International Business Review, Elsevier, Elsevier, vol. 17(1), pages 39-53, February.


    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.


    Access and download statistics


    When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:2509. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.