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Studies Confirm Tax Plays Crucial Role In Investment Decisions

by Robert Lee,, London

01 May 2006

Taxes play an important role in the location and investment decisions of multinationals, according to two new research papers.

The papers, published by the European Tax Policy Forum (ETPF), were presented at a joint conference of the ETPF and the Institute for Fiscal Studies on Monday.

According to one study based on data from a number of OECD countries, conducted by Michael Devereux and Ben Lockwood of the University of Warwick, taxation has a substantial impact on the investment behaviour of US multinationals.

Specifically, they found that a ten percentage point fall in the effective average corporation tax rate in a host country (such as the UK) would increase inward investment by US multinationals by 60% in the short-term, and would increase the capital stock owned by US multinationals in the host country by 15%.

The study distinguishes two types of decisions made by multinationals: where to locate new activity, and, having chosen the location, how much to invest. The results suggest that it is the location decision which is affected by corporation tax; conditional on the location, the size of investment is not responsive to corporation tax.

A second study, by Thiess Buettner and Georg Wamser of the University of Munich, examined whether other taxes affect foreign direct investment. Examining confidential data from the Bundesbank on German multinational companies, they confirmed that corporation tax affected the location decisions. However, surprisingly, they also found that sales taxes and VAT had a significant effect on investment outside Germany.

The study concluded that on average, countries which reduced their tax revenue from sales taxes and VAT by 1 percent of GDP would see an increase in investment by German multinationals of 12%.

They also found that R&D tax credits have a significant impact, and that increasing income taxes on skilled labour tended to deter investment.

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