Tax Complexity and Inward Investment
The negative relationship between host-country tax rates and FDI has been tested in a large number of papers. This paper looks at a different channel through which tax systems could affect FDI, namely the complexity of the tax system. Complying with tax authority requirements can be extremely time consuming for business and this implies an additional cost for more complex tax systems. We use measures of the time taken to deal with tax obligations and the number of tax payments for a representative firm compiled by the World Bank to examine their effect on FDI selection and flows from 16 OECD FDI-source countries to 57 host countries. We find a negative and significant effect of tax rates in line with other studies. In addition, the tax complexity measures are found to have a significant inhibiting effect on the presence of FDI for a country pair, but have little impact on the level of the FDI flow once it is established. In other words, the complexity measures affect FDI primarily through the extensive margin. A 10% reduction in tax complexity is found to be comparable in its effect on FDI to a one percentage point reduction in the effective corporate tax rate. The results are robust to the inclusion of other proxies for bureaucracy in the host country.
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