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



income collected from the foreign MNE.

In comparison to work at the aggregated (country-pair) level, the esti-
mated business tax elasticities on foreign investments are very high (see de
Mooij and Ederveen, 2003, 2006, 2009, for an overview). However, it is well
documented that elasticities estimated from sub-national data are higher
than those obtained at the aggregate level (see Slemrod, 1990; Hines, 1996,
for examples and de Mooij and Ederveen, 2003, for pointing to this fact).
One fundamental difference between most of the work on profit taxes on
foreign direct investment and ours is that we focus entirely on the exten-
sive margin in terms of numbers of regional MNE headquarters. Work on
the tax responsiveness of foreign direct investment at the aggregate (coun-
try or country-pair) level in general tends to mix effects on the extensive
margin (i.e., on lumpy investment) and the intensive margin. And, finally,
even though the elasticities are high, the average German municipality needs
to change its business tax rate quite dramatically to become attractive to
foreign investors at all.

6 Concluding remarks

This paper provides evidence on the impact of profit taxation for the location
of regional headquarters of foreign MNEs using data for more than 11, 000
German municipalities. We link data on local public finance and other mu-
nicipality characteristics available from the German Statistical Office and the
Federal Employment Agency with firm-level data from the German Central
Bank about inbound foreign direct investments in Germany for the years
2001-2005.

One advantage of this data-set is that institutional characteristics and the
taxation of other factors are much more homogeneous across municipalities
within a country than in cross-country studies. Moreover, the number of
municipalities foreign MNEs may locate in is larger by more than one order
of magnitude than the number of countries for which profit taxes are typically
available. So, the impact of profit taxes on MNE headquarters location may
be identified much more precisely than in an international context.

Overall, we find that the business tax rate levied by a municipality nega-
tively affects the number of MNEs it can attract. This impact is found after
controlling for other important determinants of a foreign MNE’s location
decision. Irrespective of whether we assume that business tax rates are en-
20



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