How do tax increases affect investment allocation within multinationals?

Abstract

This paper studies how tax increases transmit across countries through multinationals’ internal networks of subsidiaries. Using a large subsidiary-level dataset of European firms and several exogenous tax hikes, we find that local business units cut capital investment in response to foreign tax increases. We document two channels that propagate these shocks through firms’ internal networks: production linkages among subsidiaries and financial constraints. In the aggregate, domestic investment and employment decline with higher exposure to foreign tax increases, suggesting that tax increases in one country can spill over to other foreign countries.

Keywords: Tax hike, investment, internal networks, spillover effects

JEL Classification: D25, G11, H32, L14