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Labor Taxation and Foreign Direct Investment

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  • Peter Egger
  • Doina Maria Radulescu

Abstract

This paper analyzes the implications of effective taxation of labor for profits and, hence, the location decision of a multinational enterprise. We set up a stylized partial equilibrium model and, presuming that worker effort is a function of net wages, assume that a higher employee-borne tax burden reduces effort. In turn, this raises a firm’s production costs and reduces efficiency. Accordingly, we show that a higher employee-borne income tax negatively influences a multinational’s profit by reducing manager effort. Furthermore, we compile data on personal income tax profiles for 49 economies and the year 2002. We decompose tax profiles into the component borne by employers and that borne by employees. We then determine effective tax rates for employees across four centiles of the distribution of gross wages: 33, 100, 167, and 500 percent of the average, following the OECD’s Taxing Wages Approach. Apart from describing features of the personal income tax data, we use them to shed light on their role for bilateral foreign direct investment (FDI) stocks among the economies considered. Not surprisingly, personal income tax rates turn out relatively less important than profit tax rates for bilateral FDI stocks. The employee-borne part of labor taxes determines bilateral FDI significantly different from zero: both a higher employee-borne tax rate on average wages and, in particular, an increase in the progression from the average wage to five times the average wage is less conducive to headquarters location and, hence, reduces a country’s bilateral outward FDI stocks.
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Suggested Citation

  • Peter Egger & Doina Maria Radulescu, 2011. "Labor Taxation and Foreign Direct Investment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 113(3), pages 603-636, September.
  • Handle: RePEc:bla:scandj:v:113:y:2011:i:3:p:603-636
    DOI: j.1467-9442.2011.01653.x
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    File URL: http://hdl.handle.net/10.1111/j.1467-9442.2011.01653.x
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    References listed on IDEAS

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    1. Devereux, Michael P & Hubbard, R Glenn, 2003. "Taxing Multinationals," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(4), pages 469-487, August.
    2. Pisauro, Giuseppe, 1991. "The effect of taxes on labour in efficiency wage models," Journal of Public Economics, Elsevier, vol. 46(3), pages 329-345, December.
    3. Sascha O. Becker & Karolina Ekholm & Robert Jäckle & Marc-Andreas Muendler, 2005. "Location Choice and Employment Decisions: A Comparison of German and Swedish Multinationals," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 141(4), pages 693-731, December.
    4. James R. Markusen, 2004. "Multinational Firms and the Theory of International Trade," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262633078, January.
    5. Devereux, Michael P. & Griffith, Rachel, 1998. "Taxes and the location of production: evidence from a panel of US multinationals," Journal of Public Economics, Elsevier, vol. 68(3), pages 335-367, June.
    6. Canice Prendergast, 1996. "What Happens Within Firms? A Survey of Empirical Evidence on Compensation Policies," NBER Working Papers 5802, National Bureau of Economic Research, Inc.
    7. J. M. C. Santos Silva & Silvana Tenreyro, 2006. "The Log of Gravity," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 641-658, November.
    8. Edward P. Lazear, 2000. "Performance Pay and Productivity," American Economic Review, American Economic Association, vol. 90(5), pages 1346-1361, December.
    9. Janeba, Eckhard, 1998. "Tax competition in imperfectly competitive markets," Journal of International Economics, Elsevier, vol. 44(1), pages 135-153, February.
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    Cited by:

    1. Juliana D. Araujo & Povilas Lastauskas & Chris Papageorgiou, 2017. "Evolution of Bilateral Capital Flows to Developing Countries at Intensive and Extensive Margins," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(7), pages 1517-1554, October.
    2. Peter Egger & Doina Radulescu & Nora Strecker, 2013. "Effective labor taxation and the international location of headquarters," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 20(4), pages 631-652, August.
    3. Åsa Hansson & Karin Olofsdotter, 2014. "Labor Taxation and FDI Decisions in the European Union," Open Economies Review, Springer, vol. 25(2), pages 263-287, April.
    4. Christian Keuschnigg, 2008. "Corporate Taxation and the Welfare State," Working Papers 0813, Oxford University Centre for Business Taxation.
    5. Stacie Beck & Alexis Chaves, 2011. "The Impacts of Various Taxes on Foreign Direct Investment," Working Papers 11-18, University of Delaware, Department of Economics.
    6. Robert Krämer & Vilen Lipatov, 2012. "Opportunities to Divert, Firm Value, and Taxation: Theory and Evidence from European Firms," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 68(1), pages 17-47, March.
    7. Chia-Lin Chang & Allen, David & McAleer, Michael, 2013. "Recent developments in financial economics and econometrics: An overview," The North American Journal of Economics and Finance, Elsevier, pages 217-226.
    8. Peter Egger & Christian Keuschnigg & Hannes Winner, 2008. "Incorporation and Taxation: Theory and Firm-level Evidence," University of St. Gallen Department of Economics working paper series 2008 2008-20, Department of Economics, University of St. Gallen.
    9. repec:spr:busres:v:11:y:2018:i:1:d:10.1007_s40685-017-0054-y is not listed on IDEAS
    10. Stefan Lutz, 2012. "Effects of taxation on European multi-nationals’ financing and profits," The School of Economics Discussion Paper Series 1214, Economics, The University of Manchester.
    11. Stacie Beck & Alexis Chaves, 2011. "The Impact Of Taxes On Trade Competitiveness," Working Papers 11-09, University of Delaware, Department of Economics.

    More about this item

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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