Fatica, Serena (2009): Taxation and the quality of institutions: asymmetric effects on FDI.
Download (405Kb) | Preview
Economic integration has intensified international competition to attract productive capital. This paper analyzes, both theoretically and empirically, the effect of tax policies and institutional quality on the allocation of FDI -- two aspects that the economic literature has extensively investigated, though only in isolation. I build a simple two-country partial equilibrium model to study competition among governments vying for potential investors whose location choices are driven by both the quality of institutions and the corporate tax rate. Modeling good governance as a public good, it is shown that the jurisdiction providing better institutions is able to levy a higher tax on capital. Moreover, provided firms are sensitive enough to institutional quality, it attracts a larger share of investment than the low-quality/low-tax location. The main predictions of the model are tested on FDI stocks to 63 economies using a "simple difference gravity" equation derived from discrete choice theory of firms' location. Using a pair of destination countries as the unit of analysis eliminates the need to control for multilateral interdependence among receiving countries, a source of possible bias in the traditional gravity specification in the levels. The empirical evidence corroborates the claim that the sensitivity of foreign investment to the tax rate varies significantly between host countries characterized by different levels of institutional quality. The findings are robust to a number of sensitivity checks and to the use of instrumental variables to tackle endogeneity of both tax rates and institutional quality.
|Item Type:||MPRA Paper|
|Original Title:||Taxation and the quality of institutions: asymmetric effects on FDI|
|Keywords:||foreign direct investment; fiscal competition; institutions; public goods|
|Subjects:||F - International Economics > F2 - International Factor Movements and International Business > F23 - Multinational Firms; International Business
H - Public Economics > H7 - State and Local Government; Intergovernmental Relations
K - Law and Economics > K0 - General > K00 - General
F - International Economics > F2 - International Factor Movements and International Business > F21 - International Investment; Long-Term Capital Movements
|Depositing User:||Serena Fatica|
|Date Deposited:||31. Jul 2010 22:39|
|Last Modified:||18. Feb 2013 20:54|
Acemoglu, D. and S. Johnson, 2005. Unbundling institutions. Journal of Political Economy, 113(5), 949-995.
Acemoglu, D., S. Johnson and J. A. Robinson, 2001. The colonial prigins of comparative development: an empirical investigation. American Economic Review,91(5), 1369--1401.
Aghion, P., A. Alesina and F. Trebbi, 2004. Endogenous political institutions. Quarterly Journal of Economics, 119(2), 565-613.
Albouy, D., 2010. The colonial origins of comparative development: an investigation of the settler mortality data, mimeo, University of Michigan.
Alfaro, L., S. Kalemli-Ozcan and V. Volosovych, 2008. Why doesn't capital flow from rich to poor countries? An empirical investigation. Review of Economics and Statistics 90 (2), 347-368.
Anderson, J.E., 1979. A Theoretical Foundation for the Gravity Equation. American Economic Review 69, 106-116.
Anderson, J.E. and D. Marcoullier, 2002. Insecurity and the pattern of trade: an empirical investigation. Review of Economics and Statistics 84, 342-352.
Anderson, J.E. and E. Van Wincoop, 2003. Gravity with gravitas: a solution to the border puzzle. American Economic Review 93 (1), 170--192.
Anderson S.P., A. De Palma and J.-F. Thisse, 1992, Discrete Choice Theory of Product Differentiation, MIT Press, Cambridge.
Angrist, J.D. and J.-S. Pischke, 2009. Mostly harmless econometrics: an empiricist's companion. Princeton University Press.
Barro R.J. and J.W. Lee, 2000. International data on educational attainment: updates and implications. Harvard University CID, Working Paper n. 42.
Berkowitz, D., J. Moenius and K. Pistor, 2006. Trade, law, and product complexity. Review of Economics and Statistics 88, 363-373.
Besley, T. and T. Persson, 2009. The origins of state capacity: property rights, taxation, and politics. American Economic Review 99(4), 1218-44.
Bénassy-Quéré, A., M. Coupet and T. Mayer, 2007. Institutional determinants of foreign direct investment. World Economy, 764-782.
Bénassy-Quéré, A., L. Fontagne and A. Lahreche-Revil, 2005. How does FDI react to corporate taxation? International Tax and Public Finance 12, 583-603.
Borck, R. and M. Pfügler, 2006. Agglomeration and tax competition. European Economic Review, 50, 647--668.
Braconier, H., P.-J. Norbäck and D. Urban, 2005. Multinational enterprises and wage costs: vertical FDI revisited. Journal of International Economics 67 (2), 446-470.
Brülhart, M., M. Jametti and K. Schmidheiny (2008). Do agglomeration economies reduce the sensitivity of firm location to tax differentials? CEPR Discussion Paper n. 6606.
Caplin, A. and B. Nalebuff, 2001. Aggregation and imperfect competition: on the existence of equilibrium. Econometrica, 59, 25-59.
Coeurdacier, N., R. A. De Santis and A. Aviat, 2009. Cross-border mergers and acquisitions: financial and institutional forces. ECB Working Paper n. 1018, March.
Coughlin, C.C., J. V. Terza and V. Arromdee, 1991. State characteristics and the location of foreign direct investment within the United States. Review of Economics and Statistics 73, 675-683.
Da Rin, M., M. Di Giacomo and A. Sembenelli, 2010. Corporate taxation and the size of new firms: evidence from Europe. Journal of the European Economic Association Papers & Proceedings, 8(23), 606-616.
Daude, C. and M. Fratzscher, 2008. The pecking order of cross-border investment. Journal of International Economics 74 (1), 94--119.
Daude, C. and E. Stein, 2007. The quality of institutions and foreign direct investment. Economics and Politics 19, 317-344.
De Mooij, R. and S. Ederveen, 2003. Taxation and foreign direct investment: A synthesis of empirical research. International Tax and Public Finance 10, 673--93.
Desai, M. and D. Dharmapala, 2008. Taxes, Institutions and Foreign Diversification Opportunities. Journal of Public Economics 93, 703-14.
Devereux, M. P., R. Griffith and A. Klemm, 2002. Corporate income tax reforms and international tax competition. Economic Policy 17, 449-495.
Djankov, S., C. Freund and C.S. Pham, 2009. Trading on time, Review of Economics and Statistics, forthcoming.
Djankov, S., T. Ganser, C. McLiesh, R. Ramalho and A. Shleifer, 2008. The effect of corporate taxes on investment and entrepreneurship. American Economic Journal: Macroeconomics, forthcoming.
Eaton, J. and A. Tamura, 1994. Bilateralism and regionalism in Japanese and U.S. trade and foreign direct investment patterns. Journal of the Japanese and International Economies, 8, 478--510.
Ernst & Young, 2009. European Attractiveness Survey 2008. An open world.
Ekholm, K., R. Forslid and J.R. Markusen, 2007. Export-platform foreign direct investment. Journal of the European Economic Association 5, 776-795. EC : European Communities, 1998. Conclusions of the ECOFIN Council Meeting on 1 December 1997 concerning taxation policy. Official Journal, 98/C 2/01.
Guimaraes, P., O. Fuigueirdo and D.Woodward, 2003. A tractable approach to the firm location decision problem. Review of Economics and Statistics 85, 201-204.
Guiso, L., P. Sapienza and L. Zingales, 2009. Cultural biases in economic exchange? Quarterly Journal of Economics, 1095-1131.
Hakkala, K., P.-J. Norbäck and H. Svaleryd, 2008. Asymmetric effects of corruption on FDI: Evidence from Swedish multinational firms. Review of Economics and Statistics 90(4), 627-642.
Head, K., Gravity for beginners, University of British Columbia, mimeo.
Head, K. and T. Mayer, 2004. Market potential and the location of Japanese investment in the European Union. Review of Economics and Statistics 86(4), 959-972.
Head, K and J. Ries, 2007. FDI as an outcome of the market for corporate control: Theory and evidence. Journal of International Economics 74, 2-20.
Hines, R.J., 2005. Corporate taxation and international competition. Ross School of Business Paper No. 1026.
Hines, R.J., 1996. Altered States: taxes and the location of foreign direct investment in America. American Economic Review 86 (5), 1076-1094.
International Monetary Fund, Growth and Institutions, Chapter 3 in Economic Outlook 2003.
Kaufmann, D., A. Kraay, M. Mastruzzi, Governance Matters VII: Aggregate and Individual Governance Indicators, 1996-2007(2008). World Bank Policy Research Working Paper No. 4654.
Konrad, K. A and D. Kovenock, 2008. Competition for FDI with Vintage Investment and Agglomeration Advantages, CEPR Discussion Papers 6740.
La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, 1999. The quality of government. Journal of Law, Economics and Organization 15 - 1, 222--279.
La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, 1998. Law and finance. Journal of Political Economy 101, 678--709.
Levchenko, A., 2007. Institutional quality and international trade. Review of Economic Studies 74, 791-819.
Mac Fadden, D. 1974. Conditional logit analysis of qualitative choice behavior, in P. Zarembka (ed.), Frontiers in Econometrics, Academic Press: New York, pp. 105-142.
Mutti J. and H. Grubert, 2004. Empirical asymmetries in foreign direct investment and taxation. Journal of International Economics 62, 337-- 358.
North, D., 1990. Institutions. Journal of Economic Perspectives 5, 97-112.
Nicodème, G., 2001. Computing effective corporate tax rates: comparisons and results. Economic Papers, 153.
Nunn, N., 2007. Relationshio-specificity, incomplete contracts and the pattern of trade. Quarterly Journal of Economics, 569-600.
Oates, W. E., 1972. Fiscal Federalism. New York: Harcourt Brace Jovanovich.
OECD, 1998. Harmful tax competition: An emerging global issue. Paris.
Papaioannou, E., 2009. What drives international financial flows? Politics, institutions and other determinants. Journal of Development Economics 88, 269-281.
Persson, T. and G. Tabellini, 2004. Constitutional rules and fiscal policy outcomes. American Economic Review, 94 (1), 25-45.
Razin, A. and E. Sadka, Foreign Direct Investment - Analysis of Aggregate Flows. Princeton University Press.
Schmidheiny, K. and M. Brülhart, 2009. On the Equivalence of Location Choice Models: Conditional Logit, Nested Logit and Poisson. CESifo Working Paper 2726.
Tiebout, C.M., 1956. A pure theory of local expenditures. Journal of Political Economy 64, 416-424.
Train, K. 2003. Discrete choice models with simulation. Cambridge University Press.
UNCTAD, 2002. Investment Policy Review. The Republic of Tanzania. Geneva.
Wei, S.-J., 2000. How taxing is corruption on international investors? Review of Economics and Statistics 82 (1), 1--11.
Wooldridge, J.M., 2001. Econometric Analysis of Cross Section and Panel Data. MIT Press, Cambridge.
Zissimos, B. and M. Wooders, 2008. Public good differentiation and the intensity of tax competition. Journal of Public Economics 92, 1105-1121.
Available Versions of this Item
- Taxation and the quality of institutions: asymmetric effects on FDI. (deposited 31. Jul 2010 22:39) [Currently Displayed]