The evidence presented in this paper supports the claim that a U.S. tax hike can cause foreign direct investment (FDI) in the United States to increase by affecting the relative tax advantage of certain foreign firms and domestic firms. If a foreign f...
The evidence presented in this paper supports the claim that a U.S. tax hike can cause foreign direct investment (FDI) in the United States to increase by affecting the relative tax advantage of certain foreign firms and domestic firms. If a foreign firm can credit all U.S. taxes paid against its home tax liability on the income earned in the U.S., an increase in the U.S. tax rate may not affect the total tax burden on this firm’s investment in the United States. This firm may rather benefit from an increase in the pretax rate of return on U.S. assets caused by reduced investments by domestic firms.
Our empirical analysis draws on the experience of fluctuating tax incentives and FDI in the United States during the 1980s. The estimated equations, which relate industry-level variations in the effective tax rate and net capital expenditures and control for the effects of exchange rates and U.S. business conditions, indicate a robust and significantly positive tax effect on FDI across various specifications. This result provides a more convincing support to the Scholes-Wolfson type of argument since the role of tax-induced FDI in U.S. capital accumulation can be more adequately investigated using the comparable measures of investments by foreign and domestic firms.