Tuesday, October 21, 2014

The Importance of Corporation Tax Policy in the Location Choices of Multinational Firms

The Irish Department of Finance released this report yesterday in connection with its 2015 budget. The report considers data on newly established multinational subsidiaries across 26 European countries from 2005 to 2012. Here are a few key points from the executive summary:
  • We find a consistent negative effect of the corporate tax rate on the probability of a country being chosen as a location by multinationals. 
  • We find a highly significant, albeit modest sized, effect of allowing for non-linearity in the effect of the tax structure. In other words, a change in the tax rate will have a larger effect if the starting point is a low rate of tax compared to if the same size change is applied to a higher tax rate.
  • We find large variations in the sensitivity to tax rates across sectors. For manufacturing firms, the effect is similar to the baseline but for service firms the effect is noticeably smaller. Services firms may be more likely to make location decisions based on the need to be close to their identified customer base and this reduces their sensitivity to tax rates. 
  • When comparing the effect of taxation to other important factors, we find that taxation is the largest single determinant of the location decision. 
  • Financial sector firms are most sensitive to changes in corporation tax rates, with an estimated marginal effect more than double those of the other sectors. This is likely to be a reflection of the more footloose nature of these firms, and has important implications for the potential effect of a tax change in Ireland, given the weight of the financial sector in foreign investment in this country. Firms with higher assets sizes appear more responsive to corporation taxation in their location decision. 
  • Combining all effects of tax and country characteristics, Ireland had a 3.1% probability of being chosen as a location for the newly established subsidiaries over the period investigated. For context, Irish GDP is 1.4% of the EU-26 total, so this demonstrates the attractiveness of the country as a destination for foreign investment well in excess of its size. 
  • If the Irish tax rate had been 15% over the period in our sample, the number of new foreign affiliates entering the country would have been 22 % lower. 
  • If the tax rate had been 22.5% (the sample average), the number of new foreign affiliates would have been 50 % lower. 
The idea that Ireland will really give up its favorable tax regimes under external pressure just seems implausible as a result. I know, Ireland is going to repeal the residence rule that gave rise to the double Irish. But there's always the double dutch not to mention an alarming proliferating of patent boxes so that means Ireland will have to come up with something else. If the US, the UK, the Netherlands, etc. aren't going to give up their goodie bags, it is difficult to see Ireland doing so.


  1. I would make a few comments here. First, should we really trust the Irish government, of all governments to produce unbiased research on corporate taxes, given the rough treatment meted out to 'tax dissidents' in Ireland who dare to question the tax haven model? Second, Ireland isn't at all what it seems here - as this blog notes. http://www.taxjustice.net/2014/10/15/bono-tax-haven-salesman-celtic-paper-tiger/ Third, studies that measure "investment" responses to tax polities seem to be rather beside the point: academic curiosities, really. These, to the extent we can believe Irish corporate tax hype, are GROSS benefits to Ireland. But it's the NET benefits that matter. Corporate tax cuts and so on bring costs, alongside the benefits. It's the NET benefits that are of interest. I'd say you need to look at economy-wide measures to say anything of real interest - otherwise you are falling for the old fallacy of composition.

  2. "should we really trust the Irish government, of all governments'--> I can't see why we should trust them any more or less than any other government, which is to say, we shouldn't trust any government too much when it talks about how to think about tax policy. Where governments have an advantage is in analyzing actual tax data. They never seem to want to share that kind of insight, more's the pity. I agree with you, it's the net benefits that matter. If it is true that all tax incentives are mechanisms that merely shift rather than create wealth in a zero-sum game, then the only conversation that is relevant is whether and under what circumstances it is normatively justifiable to try to capture greater market share in order to benefit your own state and subjects at the expense of another state and their subjects. Until we have a normative theory of tax competition (which I don't think we have yet) I can't see why we should mistrust, or scold, Ireland any more or less than any other country including the US, the UK, etc etc.