Corporate Taxation and Multinational Activity



pean economies corporate tax rates have been reduced in response to the much
lower tax rates in Central and Eastern Europe.

Empirical evidence tends to confirm the presumption that taxation is de-
cisive for production and location decisions of MNEs. The bulk of results is
available for the U.S. (see Hines, 1997, for an excellent overview). Three strands
of the literature can be distinguished here. One of them analyzes the impact
of U.S. corporate tax rates on inbound FDI (see, e.g., Hartman, 1984; Bar-
tik, 1985; Coughlin, Terza, and Arromdee, 1991; Head, Ries, and Swenson,
1999). A second line of research studies the effects of host country taxes on
U.S. outbound FDI (see Grubert and Mutti, 1991, 2000; Hines and Rice, 1994;
Devereux and Griffith, 1998; Grubert and Slemrod, 1998; Altshuler, Grubert,
and Newlon, 2001; Mutti and Grubert, 2004; Desai, Foley, and Hines, 2005).
A third strand of work considers both parent and host country taxation by
additionally accounting for the role of the underlying method of double taxa-
tion relief, i.e., whether (repatriated) profits of foreign affiliates are taxed on
a territorial or a worldwide basis in the country where the headquarters are
located (see Slemrod, 1990; Shah and Slemrod, 1991; Cummins and Hubbard,
1995; Swenson, 1994, 2001; Hines, 1996). In general, the U.S. evidence reveals
that inbound FDI is negatively affected by the U.S. tax burden,
2 and U.S. out-
bound FDI is positively (negatively) associated with domestic (host country)
tax rates. Although one would expect that the impact of tax rates differs be-
tween countries applying the credit and exemption method (see, e.g., Slemrod,
1990),
3 there is no clear-cut empirical support for this view.

Only a few studies consider a broader set of country-pairs. Devereux and
Freeman (1995), using bilateral FDI flows between seven countries (including
the U.S.) from 1984 to 1989 and referring to a cost-of-capital concept of taxa-
tion, find that a firm’s choice between domestic and foreign investment as such
is not influenced by taxation. However, given that a firm has decided to invest
abroad, taxation is decisive for where the investment takes place. The results of
Benassy-Quere, Fontagne, and Lahreche-Revil (2005), relying on bilateral FDI
flows among 11 OECD countries over the period 1984-2000 and using statutory
corporate tax rates as well as (forward-looking) effective marginal (
EMT R)

2One notable exception is Swenson (1994), who finds that the increased after-tax cost
of capital after the Tax Reform Act 1986 induced an increase in U.S. inbound FDI. The
underlying reason is that the broadening of the tax base raised the attractiveness of U.S.
assets for foreign investors whose parent countries allowed a tax credit against taxes abroad
(see Scholes and Wolfson, 1990, for a theoretical foundation of this argument).

3Under the credit method, foreign-earned profits are taxed both in the parent and the
host country, but the foreign taxes are deductible from the domestic tax liability. Under the
exemption method, by way of contrast, foreign-earned profits are only taxed abroad.



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