How Does FDI React to Corporate Taxation?

Using a panel of bilateral FDI flows for 11 OECD countries over 1984-2000, we show that, although agglomeration-related factors are strong determinants of FDI, tax differentials also play a significant role in understanding foreign location decisions. We further investigate non-linearities in the impact of tax differentials, and explore the role of tax schemes. We show that the reaction of FDI inflows to tax differentials is non-linear: it depends on the magnitude of the tax gap, on the sign of this gap, and on the nature of bilateral tax schemes in operation (credit vs. exemption). Our results are consistent with the imperfect competition literature which underscores the possibility of tax differentials across countries in equilibrium