How Low Business Tax Rates Attract Multinational Headquarters: Municipality-Level Evidence from Germany

CESifo Working Paper No. 2517

How Low Business Tax Rates Attract
Multinational Headquarters:
Municipality-Level Evidence from Germany

Abstract

Most existing empirical evidence on the impact of profit taxation on multinational firm
activity is based on cross-country data. One major drawback of such data is that countries
differ not only with regard to taxes but along other dimensions which might be hard to capture
by means of observable characteristics. We compile a database of more than 11,000
municipalities in Germany to analyze the sensitivity of the location decisions of foreign
MNEs with respect to business tax rates which are levied directly by the municipalities. Using
count data models suited for cross-sectional and panel data, we find that higher business tax
rates have a negative effect on the number of foreign MNE headquarters, after controlling for
other determinants of firm location decisions. On average, a one-percent reduction of the
municipal business tax rate (equivalent to a decline by about 0.14 percentage points) leads to
an increase in the number of headquarters of foreign MNEs by about 0.05. Hence, the average
municipality needs to reduce its business tax rate by 20% to attract one foreign MNE.

JEL Code: F23, H25, H32, R10.

Keywords: multinational firms, profit taxation, regional public finance, count data.

Sascha O. Becker

Department of Economics
University of Stirling
UK - Stirling FK9 4LA
[email protected]

Peter H. Egger                             Valeria Merlo

Ifo Institute for Economic Research at Ifo Institute for Economic Research at
the University of Munich                    the University of Munich

Poschingerstrasse 5                        Poschingerstrasse 5

Germany - 81679 Munich                 Germany - 81679 Munich

[email protected]                             [email protected]

December 18, 2008

We thank Thiess Büttner and participants at the Deutsche Bundesbank FDI Workshop, and at
the MGSE and CES seminars at LMU Munich for useful comments and discussions. We
thank Elisabetta Fiorentino, Heinz Herrmann, and Alexander Lipponer for support at the
Deutsche Bundesbank. Merlo thanks the German Science Foundation for funding.

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