How does corporation tax affect the quality and quantity of FDI?

Corporate taxation can affect the quality, as well as the quantity, of foreign direct investment (FDI). The quality of FDI may be affected if taxes reduce the extent to which investment contributes to the corporate tax base and to the capital intensity of production. Depending on the sign of the quality effects, the detrimental welfare effects though the quantity of FDI are either mitigated or aggravated. This research project considers a number of hypotheses regarding how corporate tax changes may affect quality. We test the hypotheses using data from a large sample of European multinationals. We find that quality effects account for up to 40% of the total effect. We find that the quality effects mitigate the negative impact of the tax on labour by nearly 60%, as corporate taxes increase the labour intensity of production.

Clemens Fuest and Nadine Riedel