How low business tax rates attract MNE activity

municipality-level evidence from Germany

Sascha O. Becker, Peter H. Egger, Valeria Merlo

Research output: Contribution to journalArticleResearchpeer-review

22 Citations (Scopus)

Abstract

Most existing empirical evidences on the impact of profit taxation on multinational firm activity are based on cross-country data. One major drawback of such data is that countries differ not only with regard to taxes but also with other dimensions which might be hard to capture by means of observable characteristics. We compile a database of more than 11,000 municipalities in Germany to analyze the sensitivity of location decisions of foreign MNEs in Germany with respect to business tax rates which are levied directly by the municipalities. We find that higher business tax rates have a negative effect on three alternative measures of MNE activity, after controlling for other determinants of firm location decisions: the number of foreign MNEs, MNE employment, and MNE fixed assets. Our results suggest that tax competition among regional entities for foreign investors is a game of a few. In cross-section instrumental-variable regressions, a one-percent reduction of the municipal business tax rate (equivalent to a decline by about 0.14 percentage points) leads to an increase in the number of legally independent foreign-owned firms by about 0.45. The average municipality would have to reduce its business tax rate by about 2.2 percentage points (or 15%) from its average level to attract one foreign MNE. Hence, municipalities need to be attractive in other dimensions to be able to use tax instruments to attract foreign firms at the margin.

Original languageEnglish
Pages (from-to)698-711
Number of pages14
JournalJournal of Public Economics
Volume96
Issue number9-10
DOIs
Publication statusPublished - Oct 2012
Externally publishedYes

Keywords

  • Count data
  • Multinational firms
  • Profit taxation
  • Regional public finance

Cite this

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abstract = "Most existing empirical evidences on the impact of profit taxation on multinational firm activity are based on cross-country data. One major drawback of such data is that countries differ not only with regard to taxes but also with other dimensions which might be hard to capture by means of observable characteristics. We compile a database of more than 11,000 municipalities in Germany to analyze the sensitivity of location decisions of foreign MNEs in Germany with respect to business tax rates which are levied directly by the municipalities. We find that higher business tax rates have a negative effect on three alternative measures of MNE activity, after controlling for other determinants of firm location decisions: the number of foreign MNEs, MNE employment, and MNE fixed assets. Our results suggest that tax competition among regional entities for foreign investors is a game of a few. In cross-section instrumental-variable regressions, a one-percent reduction of the municipal business tax rate (equivalent to a decline by about 0.14 percentage points) leads to an increase in the number of legally independent foreign-owned firms by about 0.45. The average municipality would have to reduce its business tax rate by about 2.2 percentage points (or 15{\%}) from its average level to attract one foreign MNE. Hence, municipalities need to be attractive in other dimensions to be able to use tax instruments to attract foreign firms at the margin.",
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How low business tax rates attract MNE activity : municipality-level evidence from Germany. / Becker, Sascha O.; Egger, Peter H.; Merlo, Valeria.

In: Journal of Public Economics, Vol. 96, No. 9-10, 10.2012, p. 698-711.

Research output: Contribution to journalArticleResearchpeer-review

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