F2013: Linking Infrastructure and Taxes as Determinants of Multinational Activity: An Empirical Study of Foreign Direct Investment in Central and Eastern European Countries

FWF

The investment location decisions of Multinational Enterprises depend inter alia on a country’s level of the corporate income tax burden and its endowment with production-related infrastructure. Both factors might have an effect on the profitability of an investment, high corporate income taxes should have a negative and a favorable infrastructure endowment a positive impact. As corporate income taxes and production-related infrastructure have opposing effects on Foreign Direct Investment, one might ask whether a favorable infrastructure endowment compensates a firm for relatively high taxes. In this case high corporate income taxes do not deter Foreign Direct Investment.

The aim of the project is to test the hypothesis that the tax-rate sensitivity of Foreign Direct Investment decreases with an increase in a country’s infrastructure endowment.

To empirically test this hypothesis, appropriate measures for production-related (tangible) infrastructure and for the (effective) corporate income tax burden are used in a panel econometric analysis, based on a gravity-model-framework.

We expect that both, corporate income taxes and production-related infrastructure are economically and statistically significant determinants of Foreign Direct Investment. Moreover, we expect that accounting for production-related infrastructure as a determinant of Foreign Direct Investment indeed leads to a reduced tax-rate sensitivity of Foreign Direct Investment.

Such results should have consequences for the type, the speed and the degree of tax coordination and harmonization in the European Union which is needed to battle negative effects of tax competition for Foreign Direct Investment.