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Corporate taxation and FDI within the EU25

Explore the impact of tax differentials on foreign direct investment within the EU, considering factors such as imperfect competition, agglomeration economies, and policy implications for small and large countries.

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Corporate taxation and FDI within the EU25

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  1. Corporate taxation and FDI within the EU25 Amina Lahrèche-Révil CEPII 2nd EUROFRAME Conference on Economic Policy Issues in the European Union Vienna, Friday 3 June 2005

  2. What do we know? • Traditional tax competition literature • Increasing integration  pressure on tax policies • Small countries more prone to tax competition • Race to the bottom ? EU enlargement context • Imperfect competition • Trade costs + scale economies  home bias, higher taxes in the largest countries (Haufler & Wooton, 1999) • Agglomeration economies  agglomeration rents, tax competition = limit pricing (Baldwin & Krugman, 2004) Do tax differentials really affect FDI?

  3. The enlarged EU • What may happen in the EU? • Increasing integration  competition? • Small (competition) vs. large countries (agglomeration) • What happens in the OECD? • Tax differentials do affect FDI location decisions • But only higher taxes divert FDI • Non-linearity according to the size of tax differentials and the double-taxation regime in the investor’s country. • Competition from third countries

  4. Outline Stylized facts Econometric methodology Results Conclusion

  5. Decreasing statutory corporate taxes in the UE15...

  6. … and in the NEM

  7. Convergence in (mainly statutory) tax rates

  8. Ex-post taxation is more cyclical - NEM

  9. EU15

  10. FDI flows mostly to the EU15

  11. Empirical analysis • Theoretical foundations • tax = cost  FDI should react • But • Transfer pricing and intra-firm debt  profit  location • Tiebout (1956): taxation and public-goods provision • Markusen (1995): structural determinants > taxation • High tax = high pre-tax return • Imperfect competition: taxes = location rents • Empirical literature • Semi-: -3.3/-4.0, high variance (De Mooij & Ederveen, 2003)

  12. Estimation strategy Bilateral, gravitational setting, market potential 1990-2002, annual Tax measurement: statutory + ex-post taxation (GDP/VA) Results Gravity significant, distance < 0 Statutory not significant, ex-post significant and < 0

  13. Cost and competitiveness 1 • Unit labor cost differential +/or bilateral real exchange rate • 7 positive  higher costs attract more FDI (labor quality?) • 8 positive  improved competitiveness attract FDI • 7 + 8 no sign change • Tax variables • not very robust • Tax < 0 with competitiveness

  14. Cost and competitiveness 2 • Geographic dummy • When d  EU15  relative ULC significant, positive • When d  NEM  bilateral real exchange rate, positive • With both variables, relative ULC only for EU15. RER for both but elasticity higher for NEM. • Taxation • Statutory taxation not significant • Ex-post taxation significant.

  15. ULC mostly affect EU15, RER the NEM

  16. Taxation only impacts FDI in the EU15...

  17. … but things are not so simple 1 Higher taxes in the recipient divert FDI

  18. … but things are not so simple 2 Higher taxes the NEM divert FDI   Incentive for lowering taxes

  19. Further problems: competitors’ taxes 1

  20. Competitors’ taxes 2 FDI is diverted by higher taxes in the recipient, but attracted by lower taxes in the recipient, compared to its (distance-weighted) competitors

  21. Conclusion 1 • Orders of magnitude: tax competition and geography • 1% point change in competitors tax differential must be compensated for by a 1.4 % point change in the opposite direction in the recipient country  sizeable • a 1 sd increase in the market potential can be compensated for by a 3.1% points increase in the apparent tax differential in the recipient country  even more sizeable

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