Corporate Tax Effects on the Quantity and Quality of FDI

This paper measures quantity and quality effects of corporate taxation on foreign direct investments (FDI). While corporate taxes are well known to reduce the equilibrium stock of foreign capital in a given country, they may also change the quality of investment projects. Our analysis focuses on two quality dimensions: the profitability of asset investments and their labor intensity. We build a model with heterogeneous investment projects in order to analyze the interdependent effects of taxes on investment quantity and quality. The model predictions are tested using data from a large sample of European multinationals.We find that corporate taxes reduce the profitability of investment projects and enhance their labor intensity. Both quality effects are found to be sizable and relevant when compared to the quantity effect. An important implication is that governments should not only care about the size of inbound FDI flows but also about its specific characteristics.