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Corporate taxation and FDI within the EU25

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. What do we know?. Traditional tax competition literature Increasing integration  pressure on tax policies

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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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