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Taxation and foreign direct investment (FDI): empirical evidence from a quasi-experiment in China

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Abstract

China’s new Corporate Income Tax Law was passed in March 2007 and took effect on January 1 2008. It terminates the dual corporate income tax regime by removing the preferential tax treatments offered to foreign investment enterprises (FIEs) and unifies the corporate income tax regime for FIEs and Chinese domestic enterprises (DEs). This paper uses a difference-in-differences approach to determine whether FIEs are responding to the law by reducing their investment in China. Employing the Chinese Industrial Enterprises Database (2002∼2008) to implement the analysis, we find that: (1) FIEs are responding to the law by reducing their investment in China; and (2) the magnitude of the response is larger for HongKong-Macau-Taiwan (HMT) investment enterprises than that for other FIEs, which supports the claim that some Chinese investors engaged in “roundtripping” FDI. Our confidence in the conclusions are further boosted by the results of a series of placebo tests and two robustness checks: (1) the results of the placebo tests support the claim that the estimated effect is due to the tax reform rather than to other confounding factors; (2) the results of the first robustness check are consistent with the perception that State-Owned Enterprises (SOEs) might enjoy more favorable treatments from the Chinese government than Private-Owned Enterprises (POEs); and (3) the results of the second robustness check show that incorporating enterprise-specific time trends into the baseline specification of our econometric models does not change the conclusions.

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Notes

  1. Caves (1982) examines many reasons why MNCs invest their resources outside their home country.

  2. See Hines (1997, 1999) for a critical review of most of the papers on the empirical evidence of the effect of taxation on FDI.

  3. In our sample, year t runs from year 2002 to year 2008.

  4. Please see Wooldridge (2002) for how to implement enterprise-specific time trends and see Dharmapala and Khanna (2008) for a nice application that allows not only for enterprise and year fixed effects, but also for enterprise-specific time trends.

  5. Hong Kong and Macau are also on the list of tax havens compiled by Dharmapala and Hines (2009).

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Acknowledgements

The author thanks Alan J. Auerbach, Emmanuel Saez, Feila Zhang, and the anonymous referee for helpful comments. Especially, the author thanks Dhammika Dharmapala, the editor of this journal, for his constructive suggestions and great patience.

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  1. School of Public Economics & Public Administration, Shanghai University of Finance and Economics, Shanghai, 200433, China

    Zhiyong An

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An, Z. Taxation and foreign direct investment (FDI): empirical evidence from a quasi-experiment in China. Int Tax Public Finance 19, 660–676 (2012). https://doi.org/10.1007/s10797-011-9201-0

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