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Foreign direct investment in the enlarged EU: do taxes matter and to what extent?

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  • Wolff, Guntram B.

Abstract

Foreign direct investment is of increasing importance in the European Union. This paper estimates the effect of taxes on foreign direct investment (FDI) flows and on three sub-components of these flows for the countries of the en- larged European Union. The model in the spirit of gravity equations robustly explains FDI flows between the 25 member states. Sample selection needs to be addressed in the estimation. We show that the different subcomponents of FDI should and indeed do react differently to taxes. After controlling for unobserved country characteristics and common time effects, the top statutory corporate tax rate of both, source and host country, turn insignificant for total FDI and investment into equity. However, high source country taxes clearly increase the probability of firms to re-invest profits abroad and lower the percentage of debt financed FDI. This might reflect profit re-allocation to avoid taxes. Market size factors have the expected signs for total FDI. Non-productivity adjusted wages as determinants of FDI are less robust.

Suggested Citation

  • Wolff, Guntram B., 2006. "Foreign direct investment in the enlarged EU: do taxes matter and to what extent?," Discussion Paper Series 1: Economic Studies 2006,13, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubdp1:4249
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    More about this item

    Keywords

    Foreign direct investment; FDI; corporate taxes; sample selection model; profit re-allocation;
    All these keywords.

    JEL classification:

    • H8 - Public Economics - - Miscellaneous Issues
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • F2 - International Economics - - International Factor Movements and International Business
    • F3 - International Economics - - International Finance
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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