Corporate taxation and foreign direct investment : the case of Malta

Abstract

Foreign Direct Investment (FDI) has always been a topic of debate, particularly due to the increasing role of multinational firms in the world economy. Measured in relative terms, Malta is one of the greatest beneficiaries of FDI. The primary aim of this research is to analyse whether this increase is partly attributable to the beneficial corporate tax rate offered by the Maltese Government. The research seeks to determine whether the amount of FDI inflows is related to the difference in the corporate tax rate between the multinational firms’ home countries and that of Malta. The analysis uses an augmented gravity model approach based on a cross-sectional dataset for Maltese FDI stock, that emanates from a sample of 31 European countries. Based on different model specification, the results show that FDI inflows increase between 6% to 15% for every 1 percentage point difference in the effective corporate tax rate. In part, this reflects multinationals’ exploitation of Malta’s advantageous tax rate through profit shifting. In fact, a more elaborate version of the initial econometric model, which includes a dummy variable for tax havens as one of the explanatory variables, shows a statistically significant relationship. When this is combined with the statistical insignificance of the variable measuring geographic distance between countries, it confirms that there are high bilateral flows between Malta and known European tax havens.