Published 13 October 2014

How taxation influences business location and investment decisions

Taxes play an important role when companies decide where they should locate their production and their investments. Trying to retain and attract businesses in multinational companies is something many countries aspire. What impact has the corporate tax on foreign direct investment, FDI, and where the corporate profits are reported? How is the FDI affected by the taxes on labour income and taxes on capital income at the shareholder level?

Jobs and economic growth are created where businesses are located and investments made. A number of factors affect where firms choose to locate and where and how much that is invested. Many of these factors are hard to influence in the short run while others are governed by politicians and can be designed in order to stimulate desirable business and investment behaviour. One such factor is taxation.

This report summarises the economic literature on the impact of taxation on business location and investment decisions. Even if the focus is on the impact the corporate income tax rate has on businesses’ localisation and investment decisions, other taxes, such as taxation of labour income and personal capital income, are also discussed.

The results of the report suggest that taxes play an important role for enterprises’ localisation and investment decisions. The corporate tax rate impacts where enterprises locate, where foreign direct investments take place, and where profits are reported. The corporate tax rate is an important policy instrument for especially new EU member states as they lack many of the other important factors, such as agglomeration effects, and can by having attractive corporate tax rates gain investments. Hence, the corporate tax rate should be lower in the new member states than in the old. Labour taxation is also an important factor influencing the amount of foreign direct investment that are invested in a country, but more so in the old member states.

While the corporate tax rate is important for already established and profit making enterprises, the personal capital income tax is relatively more important for the creation of new and innovative enterprises.

For Sweden – a small country located in the periphery – the implication of the results suggests that the corporate tax rate should be below the rate in the big countries located in the European core. In addition, it may be worthwhile to investigate whether the, in an international perspective, high tax rate on personal capital income hinders enterprise creation and should be lowered.

Title
How taxation influences business location and investment decisions

Serial number
PM 2014:18

Reference number
2013/324

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