Foreign Direct Investment and Tax: OECD Gravity Modelling in a World with International Financial Institutions

Abstract

In this paper, bilateral OECD FDI flow data from 1985 to 2017 is evaluated and compiled to create a new dataset in order to clarify the controversial role (in the literature) of corporate tax levels on the decisions of firms regarding whether or not, and where, to undertake investments. In the course of our research we find the need to control for interaction with international financial institutions: Membership in BIS, EBRD, ADB and MIGA. Quantitative analyses via gravity models firstly provide findings which are consistent with previous studies and, secondly, expand the knowledge about FDI and tax by providing new results relevant for policymakers in the context of globalization and international institutions. It is shown that falling corporate tax rate levels lead to increasing FDI inflows, the effect is, however, smaller than expected; if deviation from international cooperation is chosen as a national strategy (i.e. unilateralism), the tax rate, however, gains in importance. On the other hand, unilateralism triggers various effects decreasing FDI inflows, as trade openness is likely to decrease, the opportunity costs for other nations to deviate decrease, and therefore bilateral tax differences are likely to decrease as well; which will further reduce the effect of low tax levels. Evidence for the phenomenon of implementing low corporate tax levels in order to keep domestic firms within the country and reduce their incentives to invest abroad is not found.

Keywords

• foreign direct investment
• corporate taxation
• international financial institutions
• gravity equation
• oecd countries