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Corporate Tax Cuts and Foreign Direct Investment

December 11, 2014 10:30 AM

Accurate policy evaluation is central to optimal policymaking, but difficult to achieve. Most often, analysts have to work with observational data and cannot directly observe the counterfactual of a policy to assess its effect accurately.

In Corporate Tax Cuts and Foreign Direct Investment, published in the latest issue of the Journal of Policy Analysis and Management, Leonardo Baccini, Quan Li, and Irina Mirkina craft a quasi-experimental design and apply two relatively new methods—the difference-in-differences estimation and the synthetic controls method—to the policy debate on whether corporate tax cuts increase foreign direct investment (FDI). The taxation–FDI relationship has attracted wide attention because of mixed findings. The authors exploit a quasi-experimental design for Russian regions, which were granted autonomy to reduce corporate profit tax in 2003, enabling them to simultaneously experiment with different tax policies.

The authors estimate both the average and local treatment effects of two types of tax cuts on FDI inflows and find that, on average, relative to the absence of tax cuts, nondiscriminatory tax cuts on direct investment profit increase FDI, but discriminatory tax cuts on selected government-sanctioned investment projects do not. Yet for both types of tax cuts, local treatment effects vary dramatically from region to region. This research has important implications for the design of tax policy and fiscal incentive, and the assessment of fiscal policy reforms.

Read the full paper in the Fall 2014 issue of JPAM.

 

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