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Foreign Direct Investment in a World of Multiple Taxes

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  • Mihir A. Desai
  • James R. Hines Jr.

Abstract

While governments have multiple tax instruments available to them, studies of the effect of tax policy on the locational decisions of multinationals typically focus exclusively on host country corporate income tax rates and their interaction with home country tax rules. This paper examines the impact of indirect (non-income) taxes on the location and character of foreign direct investment by American multinational firms. Indirect tax burdens significantly exceed foreign income tax obligations for these firms and appear to influence strongly their behavior. The influence of indirect taxes is shown to be partly attributable to the inability of American investors to claim foreign tax credits for indirect tax payments. Estimates imply that 10 percent higher indirect tax rates are associated with 9.2 percent lower reported income of American affiliates and 8.6 percent lower capital/labor ratios. These estimates carry implications for efficient tradeoffs between direct and indirect taxation in raising revenue while attracting mobile capital.

Suggested Citation

  • Mihir A. Desai & James R. Hines Jr., 2001. "Foreign Direct Investment in a World of Multiple Taxes," NBER Working Papers 8440, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8440
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    JEL classification:

    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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