Elsevier

Economics Letters

Volume 186, January 2020, 108775
Economics Letters

The heterogenous impact of taxation on FDI: A note on Djankov et al. (2010)

https://doi.org/10.1016/j.econlet.2019.108775Get rights and content

Highlights

  • Taxes joint with the institutional setting matter for the allocation of FDI inflows.

  • For non-OECD countries a 10pp increase in the tax rate reduces FDI up to 3.4pp.

  • Policymakers should be aware of this source of heterogeneity.

  • The diffusion of tax treaties within OECD could explain this heterogeneity.

Abstract

Summary:

Taxes in the host country matter a lot for FDI inflows, but only for non-OECD countries. Taking advantage of the rich dataset constructed by Djankov et al. (2010), we show, for example, that raising the first-year effective corporate income tax rate by 10 pp reduces FDI inflows by 3.4 to 1.9 pp in non-OECD countries; and the effect is null for OECD countries. Not taking this heterogeneity into account upward (downward) biases the estimated impact of the corporate tax on FDI inflows for OECD (non-OECD) countries.

Introduction

Using a dataset of 85 countries in 2004, Djankov et al. (2010) (from now on, DGMRS) study the impact of the corporate income tax on firm investment, foreign direct investment (FDI) and entrepreneurial activity. Tax data come from a rich survey conducted jointly by the authors and PricewaterhouseCoopers. From a cross-country standardized domestic firm, so-called TaxpayerCo, they compute effective corporate tax rates in each nation. As such a standard firm is new, they also compute a five-year-effective corporate tax rate, which allows taking into account the impact of assets’ depreciation. They also compute an effective labor tax rate payable by TaxpayerCo, and another one for the sum of property taxes, business license taxes, financial transactions, and asset and capital taxes also payable by TaxpayerCo. In addition, they have information about tax burden measure at the country level (Doing Business data, World Bank): the annual number of tax payments.

As outcome measures, according to the objective of their analysis, they use gross fixed capital formation, the number of business establishments and the rate of new business registrations as proxies of entrepreneurship, and the net inflow of FDI in each country. These net foreign inflows are aimed at acquiring a lasting management interest of a given firm (ten percent or more of voting stock) in the host country.

For all these outcome measures, and independently of which corporate tax rate is used, the corporate tax exerts a negative impact. In general, results are robust to the inclusion of different sets of controls. In this Note, we will exclusively focus on the impact of taxes on FDI using the same empirical methodology and the same rich dataset of DGMRS, but testing for the presence of heterogeneity.

According to the correlations shown in Fig. 1, results seem to be exclusively driven by non-OECD countries. This is the hypothesis we want to test in this Note, which would have important policy implications. That is why, we re-run all FDI regressions of the DGMRS’s paper accounting for a potential different impact between OECD and non-OECD countries. A regression analysis distinguishing between OECD and non-OECD countries confirms corporate taxes matter a lot for investment, but not for OECD countries. Thus, any specific calculation of the impact of taxes on FDI within the OECD (see, e.g., Skeie, 2017) should be aware of this.

Section snippets

From an aggregate to a disaggregate specification: OECD vs non-OECD countries

Regarding FDI, DGMRS carry out five triples of regressions with different sets of controls. A 10% increase of the statutory corporate tax rate decreases the percentage of FDI over GDP by a magnitude ranging from 2 to 1.1 pp depending on the specification. They estimate similar impacts for the first-year effective corporate tax rate, ranging from 2.3 to 1.7 pp, and for the five-year effective corporate tax rate, from 2.4 to 1.7 pp. These are noticeable reactions.

First of all, we replicate DGMRS’

Conclusions

We find a negative impact of corporate taxes on FDI for non-OECD countries and a null one for OECD countries. What are the factors that might drive this heterogeneity? During the period of analysis, 2003–2005, the OECD market can be considered as market-friendly as to the implementation of international cooperation measures (OECD, 2019a). In particular, this kind of measures ease market freedom eliminating anti-competitive barriers. Interestingly, a strand of the literature shows the quality of

Acknowledgment

We are grateful for the comments received by an anonymous referee.

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Cited by (0)

The authors acknowledge funding from RTI2018-095983-B-I00 (MCIU/AEI/FEDER,UE), and Esteller-Moré from Generalitat de Catalunya [2017SGR796], and Leonzio Rizzo also from FIR 2019 [FIR1979512].

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