The relationship between effective corporate taxation and FDI across EU countries

Abstract

The European Union is a leader in the provision of foreign direct investment and is also an attractive destination for investment. FDI involves an investor from one country establishing a significant interest and influence in a corporation overseas, most often through ownership of around 10 per cent or more of the voting power. FDI can take numerous forms, such as marketseeking, efficiency-seeking and resource-seeking, through brownfield and greenfield investment methods. The relationship between corporate taxation and the provision of FDI is complex and multifaceted, as it depends on numerous factors. In response to increasing tax competition and issues such as phantom FDI, the EU has adopted initiatives like the Business in Europe: Framework for Income Taxation (BEFIT). The main aim of this research is to determine the extent to which inflows of FDI are influenced by the effective corporate tax rate within the EU. The analysis utilises a panel data approach through the use of a sample of the 27 countries forming part of the EU between 2009 and 2020. Two sets of regressions were carried out, the first with all variables in natural form, and the second with the dependent variable in logarithmic form. Pooled OLS, fixed effects, with both country and year dimensions, and random effects regressions were carried out for both sets of regressions. The preferred model specification follows a fixed effects approach with both year and country dimensions and the dependent variable in logarithmic form. Through analysis, it was found that a one-unit increase in the effective tax rate would cause inflows of FDI to fall by 0.99%.