Tax Policy and the Location Choices of
Multinational Firms
Martina Lawless, Daire McCoy,
Edgar Morgenroth and Conor O’Toole
21st October 2014
www.esri.ie
Funded by the Department of Finance
Introduction
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International activity involves multiple decisions by a
firm – export or locate abroad? Locate where? At what
scale?
Many costs and benefits to be weighed up.
Tax rates and structure likely to play a role at each stage.
Corporate tax increasingly focus of attention in
competing for investment.
How much does it matter for location choice of
multinationals?
What We Do
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Examine effects of corporate tax on location decisions of
multinational firms (Amadeus database).
 Focuses on one stage of multinational decision
process.
Entry decision of newly established multinational
subsidiaries across 26 European countries, 2005-2012.
Model location decision for each firm across countries.
Control for country characteristics, including tax rate.
Allow for non-linear response to changes in the tax rate.
Estimate effects for different sectors, firm size groups.
Simulate effects of change in Irish tax rate.
Literature
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Devereux and Griffith (1998; 2002; 2003)
Barrios, Huizinga, Laeven, and Nicodème (2012)
Basile, Castellani and Zanfei (2009)
Chen and Moore (2010)
Davies, Norbäck and Tekin-Koru (2009)
Head and Mayer (2005)
Siedschlag, Smith, Turcu and Zhang (2013)
Measures of Corporate Tax
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Policy Rate - KPMG, EY
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Mean Effective Average Tax Rate (EATR) – EC
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Calculated by comparing the cash-flows from a hypothetical, forwardlooking investment project in the presence and absence of taxation. It is
a weighted average of the effective marginal tax rate and the policy rate.
Total Tax Rate - WDI
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The statutory rate charged by the host country government on corporate
profits earned by the subsidiary.
Includes all taxes and mandatory contributions payable by businesses
after accounting for allowable deductions and exemptions.
EATR Cross-border – EC
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Similar calculation to mean EATR but includes taxes levied by both host
and home country governments.
Tax Variation Across Europe
Country Coverage
Country
No of Firms
Country
No of Firms
Austria
101
Hungary
14
Belgium
27
Ireland
130
Bulgaria
121
Italy
421
Czech Republic
214
Lithuania
36
Germany
316
Latvia
42
Denmark
30
Netherlands
249
Estonia
66
Norway
104
Spain
320
Poland
142
Finland
40
Portugal
109
France
213
Sweden
34
Greece
6
Slovenia
23
Croatia
90
Slovakia
48
Hungary
14
United Kingdom
342
Firm Sector Coverage
Number of Firms by Sector Type & Skill
Sector Skill
Number
Percentage
High tech manufacturing
176
5%
Low tech manufacturing
224
7%
High tech Services
720
22%
Low tech Services
1,300
40%
Financial
639
20%
Other
179
6%
New Firms Over Time
Year of Entry
No of Firms
2005
389
2006
444
2007
423
2008
439
2009
217
2010
634
2011
486
2012
206
Other Explanatory Variables
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Market potential – Size of location and surrounding markets
GDP growth
Labour education - % population with 3rd level education
Relative Labour cost – Compensation/employees
Historic stock of FDI
Distance – from home to host country
Infrastructure – motorway density / broadband coverage
Common language
Share border
Former colony
Natural resources - Total natural resources rents as %of GDP
EU 15 membership
Relative Population – comparing home and host country sizes
Relative GDP per capita – comparing home and host country income levels
Methodology
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The profits earned from locating in a particular country,
are:
  X  
i ,c
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i ,c
i ,c
Firm faces a choice across destinations which yield
different potential returns. Chose c where:
i ,c  i , j  j  1,..., J , j  c
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 i,c yields the highest profit across all groups.
Conditional logit model:
1 if  ic   ij   c 
Y 

otherwise 
0
Effect of Non-Tax Variables
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Higher levels of GDP and GDP growth increase
probability location choice.
Market potential also positively linked with location
attractiveness (not always statistically significant).
 Suggests peripheral economies at a relative
disadvantage.
Infrastructure has a positive and significant effect on the
probability of location choice.
Labour cost and quality measures not robust, but are
perhaps overly broad indicators – refinement needed.
Tax Results for Location Choice
Marginal Effects – Baseline and Extended Models
Policy rate
Mean EATR
Total Tax Rate
Baseline (Linear)
Marginal Effect
-0.07
Baseline (Quadratic)
Marginal Effect
-0.80
-1.26
-0.53
Extended Main Model
Marginal Effect
-0.68
-1.15
-0.56
Notes: Marginal effects are calculated as Davies et al. (2001).
Effects by Sector
Marginal Effects - Main Model – By Sector
Mean
Total Tax
Policy rate
EATR
Rate
Manufacturing
-0.63
-0.94
-0.48
Services
-0.31
-0.75
-0.45
Financial sector
-1.36
-2.58
-0.67
Other
-0.73
Effects by Firm Asset Size
Marginal Effects by Size
Policy rate
Small
Mean EATR Total Tax Rate Number
-0.74
-0.42
24,056
Medium
-0.50
-1.06
-0.52
20,350
Large
-0.99
-1.35
-0.46
21,714
Small
Total Assets less than €250k
Medium Total Assets greater than €250k and less than €3m
Large
Total Assets greater than €3m
Policy Experiment
Changes in Irish Statutory Tax Rate and Location Probability
Remain at Change
Change Change
Change
12.5%
to 15% to 17.5% to 20% to 22.5%
Probability of
locating in Ireland
3.12%
2.44%
1.98%
1.65%
1.43%
Change in percent
of new affiliates
opened in Ireland
0%
-22%
-37%
-47%
-54%
Conclusions
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We find a consistent negative effect of the corporate tax
rate choice probability.
Small but significant non-linearity in the tax effect – i.e.
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.
1 percent increase in the policy rate reduces the
likelihood of choosing a destination by 0.68 percent.
1 percent increase in EATR reduces likelihood of
choosing a destination by 1.15 percent.
Large variations in the sensitivity to tax rates across
sectors.
Policy Simulation Result
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Simulate the possible effect of a number of changes in
Irish corporate tax rate on the entry of new multinational
subsidiaries.
 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.