Unobserved Tax Avoidance and the Tax Elasticity of FDI

40 Pages Posted: 21 Aug 2014

See all articles by Peter H. Egger

Peter H. Egger

Ifo Institute for Economic Research - International Trade and Foreign Direct Investment; Ludwig-Maximilians University of Munich; CESifo (Center for Economic Studies and Ifo Institute for Economic Research

Valeria Merlo

University of Tuebingen

Georg Wamser

University of Tuebingen; ETH Zurich

Date Written: July 31, 2014

Abstract

This paper investigates the tax responsiveness of multinational firms’ investment decisions in foreign countries, distinguishing firms that are able to avoid taxes (avoiders) from those that are not (non-avoiders). From a theoretical point of view, the tax responsiveness of firms crucially depends on this distinction. Empirically, however, a firm’s ability to avoid profit taxes is inherently unobservable to the researcher. To address this problem, we use a finite mixture modeling approach which allows us to distinguish avoiders from non-avoiders stochastically from a mixture of distributions of the two types of firms. Using panel data on the universe of foreign affiliates of German multinational firms over the years 1999 to 2010, we find that investments of tax avoiders do not respond to host-country profit taxes at all, while those of non-avoiders do. About 11% of the affiliates are estimated to be able to avoid taxes. These investments account for about 58% of the stock of foreign fixed assets held by German multinational firms abroad. A one-percentage-point increase in the statutory corporate profit tax rate of a host country is found to reduce the fixed assets of non-avoiders in that host country by 0.81%.

Keywords: corporate profit taxation, multinational firms, profit shifting, tax avoidance, tax elasticity, finite-mixture model, firm-level data

JEL Classification: C350, C380, F230, H320

Suggested Citation

Egger, Peter H. and Merlo, Valeria and Wamser, Georg and Wamser, Georg, Unobserved Tax Avoidance and the Tax Elasticity of FDI (July 31, 2014). Available at SSRN: https://ssrn.com/abstract=2483671 or http://dx.doi.org/10.2139/ssrn.2483671

Peter H. Egger

Ifo Institute for Economic Research - International Trade and Foreign Direct Investment ( email )

Poschingerstr. 5
Munich, DE-81679
Germany
+49 0 89 9224 1238 (Phone)
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Ludwig-Maximilians University of Munich

Schackstr. 4
Munich, 80539
Germany

CESifo (Center for Economic Studies and Ifo Institute for Economic Research

Poschinger Str. 5
Munich, DE-81679
Germany

Valeria Merlo (Contact Author)

University of Tuebingen ( email )

Department of Economics
Nauklerstr. 47
Tübingen, 72074
Germany

Georg Wamser

University of Tuebingen ( email )

Wilhelmstr. 19
72074 Tuebingen, Baden Wuerttemberg 72074
Germany

ETH Zurich ( email )

Weinbergstr. 35
Zurich, 8003
Switzerland

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