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Tax Wedges and FDI Decisions in the EU15

Roussos, Alexander LU (2015) NEKH01 20151
Department of Economics
Abstract
Free movement of labour and open borders are one of the main principles of the European Union. Workers can relatively easy relocate in the search for new job opportunities and firms compete internationally for productive labour. Corporate taxes affect firms’ profits, and also their investment decisions. The costs associated with employment on the other hand have not been studied to the same extent. They do however affect the returns to the investment by impacting production costs and the ability to attract and retain productive labour. In theory therefore, expensive labour (i.e. high tax wedges) should lead more restrictive FDI inflows.
This paper uses bilateral panel data on FDI flows in the EU-15 to analyse the impact of tax wedges on... (More)
Free movement of labour and open borders are one of the main principles of the European Union. Workers can relatively easy relocate in the search for new job opportunities and firms compete internationally for productive labour. Corporate taxes affect firms’ profits, and also their investment decisions. The costs associated with employment on the other hand have not been studied to the same extent. They do however affect the returns to the investment by impacting production costs and the ability to attract and retain productive labour. In theory therefore, expensive labour (i.e. high tax wedges) should lead more restrictive FDI inflows.
This paper uses bilateral panel data on FDI flows in the EU-15 to analyse the impact of tax wedges on labour on foreign direct investment decisions. The tax wedge is the ratio between the labour cost and the net salary of that labourer. By using this indicator I try to capture the effects of total expensiveness of labour on firms’ decisions of investing abroad. I use data for the EU-15 countries in order to control for unobserved heterogeneity and due to the relative mobility of labour in those countries. I employ a gravity equation in my efforts to derive the determinants of FDI-flows and I find that tax wedges in general and employee social security contributions in particular do affect the investment decision of intra-EU15 FDI in a negative way. Due to many zero bilateral observations I use a Heckman two-step estimation model, which controls for sample selection bias and effectively controls for non-existing and negative flows from the regression. For robustment checks I also employ a tobit estimation and a fixed effect estimation. The purpose of this paper is to analyze whether cross-country differences in the tax wedge affects investment decisions. (Less)
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author
Roussos, Alexander LU
supervisor
organization
course
NEKH01 20151
year
type
M2 - Bachelor Degree
subject
keywords
FDI, tax wedges, labour cost, social security contributions
language
English
id
7373533
date added to LUP
2015-06-30 15:24:59
date last changed
2015-06-30 15:24:59
@misc{7373533,
  abstract     = {Free movement of labour and open borders are one of the main principles of the European Union. Workers can relatively easy relocate in the search for new job opportunities and firms compete internationally for productive labour. Corporate taxes affect firms’ profits, and also their investment decisions. The costs associated with employment on the other hand have not been studied to the same extent. They do however affect the returns to the investment by impacting production costs and the ability to attract and retain productive labour. In theory therefore, expensive labour (i.e. high tax wedges) should lead more restrictive FDI inflows.
This paper uses bilateral panel data on FDI flows in the EU-15 to analyse the impact of tax wedges on labour on foreign direct investment decisions. The tax wedge is the ratio between the labour cost and the net salary of that labourer. By using this indicator I try to capture the effects of total expensiveness of labour on firms’ decisions of investing abroad. I use data for the EU-15 countries in order to control for unobserved heterogeneity and due to the relative mobility of labour in those countries. I employ a gravity equation in my efforts to derive the determinants of FDI-flows and I find that tax wedges in general and employee social security contributions in particular do affect the investment decision of intra-EU15 FDI in a negative way. Due to many zero bilateral observations I use a Heckman two-step estimation model, which controls for sample selection bias and effectively controls for non-existing and negative flows from the regression. For robustment checks I also employ a tobit estimation and a fixed effect estimation. The purpose of this paper is to analyze whether cross-country differences in the tax wedge affects investment decisions.},
  author       = {Roussos, Alexander},
  keyword      = {FDI,tax wedges,labour cost,social security contributions},
  language     = {eng},
  note         = {Student Paper},
  title        = {Tax Wedges and FDI Decisions in the EU15},
  year         = {2015},
}