News Release

Higher corporate taxes may attract foreign investment

Peer-Reviewed Publication

University of Nottingham

A team of leading economists has challenged the current political drive to cut corporate taxes — with new research showing that countries with higher taxes and higher social welfare spending are more successful in attracting overseas investment.

Last week, Chancellor Gordon Brown announced that corporation tax for larger companies will be cut to 28% from April 2008. This followed an earlier pledge from the Conservatives to cut corporation tax to 27% on the grounds that the current 30% level is uncompetitive.

But in a new joint research paper, Dr Holger Görg from GEP — the Globalisation and Economic Policy Centre, based at The University of Nottingham — and Professor Hassan Molana and Dr Catia Montagna from the University of Dundee, claimed cutting taxes to become more competitive will not necessarily attract new investment.

After analysing data from 18 OECD countries over a 14 year period, the team found that the countries which attracted the highest levels of foreign investment — a key economic target of most governments — were actually the ones with higher taxes, and higher public social expenditure as a proportion of GDP.

Dr Görg, Associate Professor and Reader in Economics at GEP, said: "The results may be startling and appear to be counterintuitive.

"Most economists have always argued that globalisation leads to a ‘race-to-the-bottom’ as countries compete to cut tax rates in the hope of attracting multinational investment and the jobs that come with it. The traditional theory is that this then leads to a shrinking of tax revenues and undermines the welfare state.

"But our evidence shows that overall effective corporate tax burdens do not appear to have fallen in response to capital and trade liberalisation, that countries aren’t competing to cut taxes and actually, when investing abroad, firms find countries with higher taxes attractive because they associate them with a happy, stable workforce."

The fear that globalisation will force countries to compete in cutting taxes and therefore welfare spending to attract investment is behind much of the recent drive to harmonise tax policies within the EU and OECD.

But the research showed that tax revenues as a percentage of GDP are on the rise in many OECD countries. Whilst many governments have reduced statutory corporate income tax rates, most have simultaneously broadened the tax base and closed various loopholes so total revenue from capital taxation has not declined. And differences in corporate tax treatments between OECD countries remain very large.

Dr Görg said: "This research suggests that commentators and economists have overstated the degree to which international investment decisions are driven by relative tax-treatment considerations."

Among the reasons suggested by the researchers for their lack of sensitivity to taxation is the fact that multinationals have the ability to shift profits to lower-tax locations — for example by transfer pricing or intra-firm debt contracting.

Dr Görg said: "Perceptions about the host country’s economic and social environment are key to the choice of location for many multinationals. It seems that investment decisions depend on the combination of taxation and the provision of public goods and services that host countries can offer because of taxation. So an ‘unfavourable’ tax differential may lead to more and not less investment flowing into a country."

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Notes to editors: The research paper, "Foreign Direct Investment, Tax Competition and Social Expenditure", is written by Görg, Molana and Montagna. Holger Görg is Associate Professor and Reader in Economics at GEP, Hassan Molana is Professor of Economics at the University of Dundee, Catia Montagna is Reader in Economics at the University of Dundee and External Research Fellow at GEP. The research data covered the period 1984-1998 for the following 18 OECD countries: Australia, Belgium, Canada, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, New Zealand, Portugal, Spain, Sweden, Switzerland, UK and USA.

The University of Nottingham is Britain's University of the Year (The Times Higher Awards 2006). It undertakes world-changing research, provides innovative teaching and a student experience of the highest quality. Ranked by Newsweek in the world's Top 75 universities, its academics have won two Nobel Prizes since 2003. The University is an international institution with campuses in the United Kingdom, Malaysia and China.

GEP — the Globalisation and Economic Policy Centre — is based at The University of Nottingham and is the major centre in Europe studying the impacts of globalisation and economic policy. It receives substantial financial support from The Leverhulme Trust.

More information is available from Media Relations Manager Tim Utton in the University’s Media and Public Relations Office on +44 (0)115 846 8092, tim.utton@nottingham.ac.uk


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