How Low Business Tax Rates Attract Multinational Headquarters: Municipality-Level Evidence from Germany

Most existing empirical evidence on the impact of profit taxationon multinational firm activity is based on cross-country data. One majordrawback of such data is that countries differ not only with regardto taxes but along other dimensions which might be hard to captureby means of observable characteristics. We compile a database of morethan 11,000 municipalities in Germany to analyze the sensitivity ofthe location decisions of foreign MNEs with respect to business taxrates which are levied directly by the municipalities. Using count datamodels suited for cross-sectional and panel data, we find that higherbusiness tax rates have a negative effect on the number of foreign MNEheadquarters, after controlling for other determinants of firm locationdecisions. On average, a one-percent reduction of the municipal businesstax rate (equivalent to a decline by about 0.14 percentage points)leads to an increase in the number of headquarters of foreign MNEsby about 0.05. Hence, the average municipality needs to reduce itsbusiness tax rate by 20% to attract one foreign MNE.