Do low corporate income tax rates attract FDI? – Evidence from Central- and East European Countries

Abstract

Fifty six bilateral country relationships combining 7 home countries from the EU and the US, and 8 Central and East European host countries (CEECs) of foreign direct investment (FDI) from 1995-2003 are used in a panel gravity-model setting to estimate the role of taxation as a determinant of FDI. While gravity variables explain most of the variation of FDI inflows, the bilateral effective average tax rate (beatr) is roughly equally important to other cost-related factors. The semi-elasticity of FDI with respect to taxation is about -4.3. This is above those of earlier studies in absolute terms and can partly be attributed to using the beatr instead of the statutory tax rate. Our results indicate that tax-lowering strategies of CEEC governments seem to have an important impact on foreign firms’ location decisions.