Tax Cost: Does It Deter Foreign Direct Investment (FDI)?

Abstract

Yes, it does. My study investigates the question, ‘does tax cost deter FDI?’ by employing a rich dataset of bilateral FDI between the OECD developed countries and developing countries. The argument posed in the study is – ‘tax cost deters FDI as it straightway reduces the profitability of multinational firms’. The contribution of the study to the empirical literature of international economics is noteworthy. It adds to the literature by estimating the partial effect of tax cost on FDI while drawing on the gravity framework as its analytical approach. By utilizing the empirical exercise, the study draws the inference that the tax cost indeed substantially deters FDI. Furthermore, the study explores – ‘how does parent’s tax system – the worldwide tax system and the territorial tax system affect the sensitivity of FDI to tax cost?’ The study affirms that FDI reacts differently depending on the parents’ tax system. The study also examines the effect of host-country differences on the responsiveness of FDI to tax cost. Additionally, the study also empirically validates the ‘regionalists’ argument’.

KEYWORDS:

• FDI
• Tax cost
• Gravity framework
• Developing countries
• Multinationals

JEL CODES:

• F21
• F23
• H25

Acknowledgements

I extend my sincere gratitude to the anonymous referees for their invaluable feedback.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data Availability Statement

The dataset is generated during and/or analyzed during the current study are available from the corresponding author on reasonable request.

Notes

1 OECD (2016). The information is retrieved from www.oecd.org.

2 The paper uses FDI and international production interchangeably.

3 FDI statistics in this study are estimated in accordance with the OECD Benchmark Definition of the 3rd Edition (BMD3). As per OECD's guidelines, these statistics are calculated by considering the market value of assets at their current prices. This methodology aligns with the recommended standards for FDI measurement and reporting. Information is retrieved from www.oecd.org.

4 Information is retrieved from www.worldbank.org.

5 The reason of the negative value of OFDI stock is that the value of disinvestment by foreign investors was more than the value of capital newly invested in the reporting economy. The OECD’s OFDI stocks by partner country measure the total level of direct investment from the reporting economy at the end of the year, by destination countries. It is the value of the resident investors' equity in and net loans to enterprises in the foreign destination country.

Additional information

Notes on contributors

Munmi Saikia

Munmi Saikia, an Assistant Professor in Economics at Alliance University, Bengaluru, earned a Ph.D. from Indian Institute of Technology Guwahati. With a two-year post-doctoral research background in Economic Science at Indian Institute of Science Education and Research Bhopal, the author specializes in FDI, international business, taxation, cross-border capital flow, and emerging multinationals.