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How low business tax rates attract MNE activity: Municipality-level evidence from Germany

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  • Becker, Sascha O.
  • Egger, Peter H.
  • Merlo, Valeria

Abstract

Most existing empirical evidences on the impact of profit taxation on multinational firm activity are based on cross-country data. One major drawback of such data is that countries differ not only with regard to taxes but also with other dimensions which might be hard to capture by means of observable characteristics. We compile a database of more than 11,000 municipalities in Germany to analyze the sensitivity of location decisions of foreign MNEs in Germany with respect to business tax rates which are levied directly by the municipalities. We find that higher business tax rates have a negative effect on three alternative measures of MNE activity, after controlling for other determinants of firm location decisions: the number of foreign MNEs, MNE employment, and MNE fixed assets. Our results suggest that tax competition among regional entities for foreign investors is a game of a few. In cross-section instrumental-variable regressions, a one-percent reduction of the municipal business tax rate (equivalent to a decline by about 0.14 percentage points) leads to an increase in the number of legally independent foreign-owned firms by about 0.45. The average municipality would have to reduce its business tax rate by about 2.2 percentage points (or 15%) from its average level to attract one foreign MNE. Hence, municipalities need to be attractive in other dimensions to be able to use tax instruments to attract foreign firms at the margin.

Suggested Citation

  • Becker, Sascha O. & Egger, Peter H. & Merlo, Valeria, 2012. "How low business tax rates attract MNE activity: Municipality-level evidence from Germany," Journal of Public Economics, Elsevier, vol. 96(9-10), pages 698-711.
  • Handle: RePEc:eee:pubeco:v:96:y:2012:i:9:p:698-711 DOI: 10.1016/j.jpubeco.2012.05.006
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    Cited by:

    1. Egger, Peter & Fahn, Matthias & Merlo, Valeria & Wamser, Georg, 2014. "On the genesis of multinational foreign affiliate networks," European Economic Review, Elsevier, vol. 65(C), pages 136-163.
    2. World Bank Group, 2017. "Investment Policy and Promotion Diagnostics and Tools," World Bank Other Operational Studies 28281, The World Bank.
    3. repec:kap:itaxpf:v:24:y:2017:i:2:d:10.1007_s10797-016-9419-y is not listed on IDEAS
    4. Janeba, Eckhard & Osterloh, Steffen, 2012. "Tax and the city: A theory of local tax competition and evidence for Germany," ZEW Discussion Papers 12-005, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    5. Buettner, Thiess & von Schwerin, Axel, 2016. "Yardstick competition and partial coordination: Exploring the empirical distribution of local business tax rates," Journal of Economic Behavior & Organization, Elsevier, vol. 124(C), pages 178-201.
    6. Janeba, Eckhard & Osterloh, Steffen, 2013. "Tax and the city — A theory of local tax competition," Journal of Public Economics, Elsevier, pages 89-100.
    7. repec:kap:itaxpf:v:24:y:2017:i:6:d:10.1007_s10797-017-9446-3 is not listed on IDEAS
    8. Keller, Sara & Schanz, Deborah, 2013. "Tax attractiveness and the location of German-controlled subsidiaries," arqus Discussion Papers in Quantitative Tax Research 142, arqus - Arbeitskreis Quantitative Steuerlehre.
    9. Holzmann, Carolin & von Schwerin, Axel, 2015. "Economic integration and interdependence of tax policy," FAU Discussion Papers in Economics 14/2015, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.
    10. Fossen, Frank M. & Steiner, Viktor, 2014. "The tax-rate elasticity of local business profits," Discussion Papers 2014/28, Free University Berlin, School of Business & Economics.
    11. Baskaran, Thushyanthan, 2015. "The revenue and base effects of local tax hikes: Evidence from a quasi-experiment," Center for European, Governance and Economic Development Research Discussion Papers 257, University of Goettingen, Department of Economics.
    12. Berger, Melissa & Misch, Florian & Voget, Johannes, 2016. "Becoming an Entrepreneur - The Role of Profit Taxes," Annual Conference 2016 (Augsburg): Demographic Change 145559, Verein für Socialpolitik / German Economic Association.
    13. Rahman, Aminur, 2014. "Investment climate reforms and job creation in developing countries : what do we know and what should we do ?," Policy Research Working Paper Series 7025, The World Bank.
    14. Deborah Schanz & Andreas Dinkel & Sara Keller, 2017. "Tax attractiveness and the location of German-controlled subsidiaries," Review of Managerial Science, Springer, pages 251-297.

    More about this item

    Keywords

    Multinational firms; Profit taxation; Regional public finance; Count data;

    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
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • R10 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General

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