Trade, FDI and relocation: challenges for the EU 2nd Euroframe Conference on Economic Policy issues in the European Union Trade, FDI and relocation: challenges for the EU Vienna, June 3, 2005 Capital mobility and tax competition in the EU after enlargement MAŁGORZATA JAKUBIAK MAŁGORZATA MARKIEWICZ

Developments in statutory tax rates

Tax competition theory Standard tax competition models identify fiscal externalities. Taxes are set too low resulting in underprovision of public goods and fall in welfare. but: Tax competition may be also efficiency enhancing – models with imperfectly competitive market structures, with government commitment problems and political economy considerations also: Tax competition not always results in low taxation. Inefficently high taxes in case of vertical tax competition (between different levels of governments) or with double taxation conventions.

How different are new member states?

How different are new member states?

Effective tax rates Backward looking measures: micro (financial statements of enterprises) or macro (national accounts) Forward looking measures: EMTR (marginal benefits = marginal costs) or EATR (when project earns more than capital cost)

Two measures – two stories

FDI inflows into EU-8 in millions of ecu/euro 1995-2003 Source: UNCTAD data converted into USD/EUR at average exchange rate

EU-15 FDI outflows to eight new member states, equity investments and loans only, in billions of ecu/euro, 1995-2003 Source: Eurostat

FDI outward stock in EU-8 by largest investing countries, in millions of ecu/euro 1995-2002

Model Tax competition examined indirectly: do FDI flows react on changes in effective taxation (Buettner (2002), Gorter and Parikh (2000) where: σijt – flow of FDI from country i to j tj – effective tax rate in country j Xj – control variables: market size (motivates horizontal FDI flows), labor costs (resource seeking motive), bilateral trade. Unbalanced sample of annual data on six NMS for the period 1996-2003 Fixed-effects and random-effects models Variables in logs

Results for individual countries

Results for individual countries cont.

Conclusions Predominant and only motive of locating FDI from EU-15 in the NMS since the mid 90s has been local market potential Change in effective CIT rates are not significant for the EU-15 investment in EU-8 Labor market and trade proximity also do not seem play any role → horizontal nature of FDI.