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Tax Competition and Foreign Direct Investment: assessing the role of market potential and trade costs in a "Footloose Capital" framework


  • Vincent Delbecque


This paper investigates the impact of the corporate income tax on the geographical distribution of French firms Foreign Direct Investment port- folio across 26 European countries. The empirical assessment is based on Baldwin (1999) new economic geography model in which we focus on the location of firms with respect to level of taxation. In this model, the magnitude of the impact of taxation on location decision partly depends on the market size and the level of trade costs. Indeed, firms may not only seek lower production costs but better market access and market opportunity when investing abroad. Through panel data regressions, we find a negative impact of the corporate income tax rate on Foreign Direct Investment. We also find that trade costs between source and host coun- try increases Foreign Direct Investment. In advanced specifications we show that increasing trade costs reduce the impact of tax level on capital location.

Suggested Citation

  • Vincent Delbecque, 2008. "Tax Competition and Foreign Direct Investment: assessing the role of market potential and trade costs in a "Footloose Capital" framework," EconomiX Working Papers 2008-18, University of Paris Nanterre, EconomiX.
  • Handle: RePEc:drm:wpaper:2008-18

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    References listed on IDEAS

    1. Fredrik Andersson & Rikard Forslid, 2003. "Tax Competition and Economic Geography," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 279-303, April.
    2. Paul Krugman & Anthony J. Venables, 1995. "Globalization and the Inequality of Nations," The Quarterly Journal of Economics, Oxford University Press, vol. 110(4), pages 857-880.
    3. Beata Smarzynska Javorcik & Mariana Spatareanu, 2005. "Do Foreign Investors Care about Labor Market Regulations?," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 141(3), pages 375-403, October.
    4. Ludema, Rodney D. & Wooton, Ian, 2000. "Economic geography and the fiscal effects of regional integration," Journal of International Economics, Elsevier, vol. 52(2), pages 331-357, December.
    5. Markusen, James R & Maskus, Keith E, 2002. "Discriminating among Alternative Theories of the Multinational Enterprise," Review of International Economics, Wiley Blackwell, vol. 10(4), pages 694-707, November.
    6. Krugman, Paul, 1991. "Increasing Returns and Economic Geography," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 483-499, June.
    7. Thiess Buettner & Martin Ruf, 2007. "Tax incentives and the location of FDI: Evidence from a panel of German multinationals," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 14(2), pages 151-164, April.
    8. Markusen, James R. & Morey, Edward R. & Olewiler, Nancy, 1995. "Competition in regional environmental policies when plant locations are endogenous," Journal of Public Economics, Elsevier, vol. 56(1), pages 55-77, January.
    9. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(2), pages 269-304, June.
    10. Baldwin, Richard E. & Krugman, Paul, 2004. "Agglomeration, integration and tax harmonisation," European Economic Review, Elsevier, vol. 48(1), pages 1-23, February.
    11. Baldwin, Richard E., 1999. "Agglomeration and endogenous capital," European Economic Review, Elsevier, vol. 43(2), pages 253-280, February.
    12. Gordon H. Hanson & Raymond J. Mataloni & Matthew J. Slaughter, 2001. "Expansion Strategies of U.S. Multinational Firms," BEA Papers 0012, Bureau of Economic Analysis.
    13. Clark, Kim B, 1984. "Unionization and Firm Performance: The Impact on Profits, Growth, and Productivity," American Economic Review, American Economic Association, vol. 74(5), pages 893-919, December.
    14. Keith Head & Thierry Mayer, 2004. "Market Potential and the Location of Japanese Investment in the European Union," The Review of Economics and Statistics, MIT Press, vol. 86(4), pages 959-972, November.
    15. Venables, Anthony J, 1996. "Equilibrium Locations of Vertically Linked Industries," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 341-359, May.
    16. 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.
    17. repec:hhs:iuiwop:430 is not listed on IDEAS
    18. Head, C. Keith & Ries, John C. & Swenson, Deborah L., 1999. "Attracting foreign manufacturing: Investment promotion and agglomeration," Regional Science and Urban Economics, Elsevier, vol. 29(2), pages 197-218, March.
    19. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 269-304, June.
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    More about this item


    Corporate taxation; Firm-level data; Foreign Direct Investment; Trade Costs;

    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
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • R38 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Government Policy
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

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