Two Essays on Corporate Income Tax Rates and Foreign Direct Investment in the United States

This dissertation investigates the relationship between corporate income tax rates and inbound foreign direct investment in the United States. In the two essays presented, the first estimates the effect of the corporate income tax rate on FDI inflows, while controlling for other non-tax variables. The study uses time series data over the period 1957-2002 and employs cointegration techniques and error correction models to estimate the long run and the short run tax responses. The corporate income tax rate is found to exert a significant negative effect on total FDI inflows in the long run. A one percent decrease in the tax rate will increase total FDI by 2.4 percent. The tax rate is also found to exert significant negative effect on transfer funds in the long and short run. Tax rate elasticities are larger in absolute value terms for the transfer funds than for total FDI. In the long run reinvested component of FDI is not responsive to the U.S. corporate income tax rate.

The second essay investigates whether the corporate income tax rate is an important determinant of inbound FDI by incorporating both host country and home country tax rates into the analysis. We find that inbound FDI shares a significantly negative relationship with the host country corporate income tax rate, and a positive relationship with the home country tax rates. This essay also examines whether investors’ decisions are affected differently by the various corporate taxation systems of the investing countries. Findings suggest that investors from exemption countries are more responsive to the U.S. corporate income tax rate than are those from tax credit countries. However, the groups are not systematically different in their response to home country corporate income tax rates.