For many years tax competition models and empirical analysis have been showing taxation as a key variable in FDI location decisions. Countries reduce taxation to attract firms in order to create employment and economic development. Firms locate their investments where the net return on capital is higher due to a lower tax burden. But tax competition is not optimal because the lowering of the tax burden causes an inefficient allocation of capital and provision of public goods. Thus, it requires coordination of tax policies in an economic area such as the European Union (EU).
Despite data not showing a complete “race to the bottom” in tax rates, the predictions of the model are widely believed by businessman and the public opinion. But tax competition has been exclusively based on neoclassical theory where imperfect decisions by managers and certain features of the decision making process such as uncertainty are assumed to be not essential. The same applies when considering incompatibility with FDI theory.
A complementary approach, based on the Heiner model, underlines the central role of uncertainty and the relevance of cognitive characteristics in managers´ FDI decisions. By applying an inductive and qualitative method through questionnaires, interviews with managers and statistical tests, the reliability of the behavioural model is confirmed. Furthermore, location decisions are shown to be significantly explained by heuristics and biases arising from the uncertainty faced by managers.
But the role of taxation in these decisions appears less significant than is usually considered. From a sample of 112 Portuguese FDI operations only 4 are explained by fiscal variables. Then, if managers do not rely on taxation to decide the location of their firms´ investments abroad, countries should not emphasize this variable when implementing policies to attract FDI and the main argument for corporate tax integration in the EU vanishes.
|Date of Award||1 Jun 2008|
|Supervisor||Philip Jones (Supervisor) & John Cullis (Supervisor)|
- Tax competition