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Parent Country Taxes and FDI

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Presentation to Fiscal.ie seminar on US Corporate Income Tax Reform: Consequences for Ireland (May 3rd 2017)

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Parent Country Taxes and FDI

  1. 1. Parent Country Taxes and FDI Ronald B. Davies University College Dublin @ron b davies April 30, 2017 Parent Country Taxes and FDI 1/10
  2. 2. Taxes and FDI with Fixed Investment Stock Suppose the US cuts its tax rate to 15%. What happens to US outbound FDI? Most people assume that it would fall. This is based on the after-tax-rate of return model of investment decisions with a fixed investment stock The US investor has K to invest somewhere on the planet Ship Z of that overseas (FDI) (1 − t)Fk (K − Z) = (1 − t∗ )F∗ k (Z) In this setting, as the US tax falls, so does FDI How much depends on the marginal productivity of investment in the US and abroad Parent Country Taxes and FDI 2/10
  3. 3. Taxes and FDI with Endogenous Investment Stock But where did K come from? Equity (23%) Debt (50%) Retained Earnings (27%) So lower taxes means higher after-tax profits which makes more investment possible Effect may be even larger for credit-constrained firms Now, suppose the US cuts its tax rate. Two changes occur: Relative tax change reduces FDI Absolute tax change increases FDI The cut in taxes leaves more money in firms’ hands, so they invest it, here and abroad What’s the net effect? Ask the data. Parent Country Taxes and FDI 3/10
  4. 4. Parent Taxes and FDI There a hundreds of studies that make it very clear that higher host taxes lower inbound FDI Average elasticity of profits 3.3 (de Mooij and Edverdeen, 2008) Not much analysis of the role of parent taxes, but that’s changing Barrios, Huizinga, Laeven, Nicodeme (2012): FDI into EU 1999-2003 Davies, Desbordes, and Ray (2017): Worldwide FDI 2003-2010 Davies, Siedsclag, and Studnicka (2016): FDI between EU 2004-2013 All of these find that the higher parent taxes, the less FDI Endogenous investment is a major force in FDI patterns Parent Country Taxes and FDI 4/10
  5. 5. Parent Taxes and FDI Barrios, Huizinga, Laeven, Nicodeme (2012): FDI into EU 1999-2003 Looks at location of greenfield investments Uses parent taxation of foreign-source income; host effective tax Finds that higher parent taxes reduce probability of investment even with deferral Deterrent effect of parent taxes as large as for host taxes Davies, Siedschlag, and Studnicka (2016): FDI between EU 2004-2013 Looks at location and size of greenfield investments Uses parent and host effective tax (both country and firm-specific) Higher parent/host taxes affect both location choice (extensive margin) and investment size Parent tax: 64% of aggregate changes at extensive margin Host tax: 84% of aggregate changes at extensive margin Parent Country Taxes and FDI 5/10
  6. 6. Parent Taxes and FDI Davies, Desbordes, and Ray (2017): Worldwide FDI 2003-2010 Looks at the number of M&A and greenfield FDI projects Uses statutory corporate tax rate Finds that taxes only impact greenfield investment (Becker and Fuest, 2010) Parent tax elasticity is -.4; host tax elasticity is -1.08 So the data indicates that with a long-run cut in US taxes, outbound US FDI will most likely rise Parent Country Taxes and FDI 6/10
  7. 7. Tax Amnesties and FDI US tax amnesty of 2005 Irish inbound FDI fell 10%, largely because of US repatriations Irish employment went up 3% at the same time Some suggestion that US multinationals temporarily lowered repatriations in expectation But don’t forget, taxes aren’t all that matter Productivity matters equally What gets shed first will be the least productive Herger and McCorriston (2013) show that half of FDI is “conglomerate” without any clear industrial linkage Industrial linkages are key for spillover effects (especially when locals supply to foreigners) There’s a lot of fat that can be trimmed Parent Country Taxes and FDI 7/10
  8. 8. Non-US Owned Investment This has focused on the US as a parent, what about them as a potential host? How likely is an investor to now pick a low-tax US over Ireland? I don’t expect much change because taxes aren’t the only consideration There are other solid economies with lower taxes than Ireland Even for shadow banks, GDP, language, and proximity to markets The US is a lousy base to serve the EU market The stated intents of the Trump administration are unlikely to improve that (non-tariff barriers especially) I would be far more worried about what is likely to happen to trade agreements and global value chains than taxes Parent Country Taxes and FDI 8/10
  9. 9. Conclusion A US tax cut can lead to less outbound US investment but doesn’t have to The data indicates that leaving more in firms’ hands will on average increase their FDI What does fall is likely the least productive, mitigating impacts on the real economy Parent Country Taxes and FDI 9/10
  10. 10. . “Nobody knew international taxation could be so complicated.” Parent Country Taxes and FDI 10/10

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