Legal Uncertainty, Corporate Incoming Taxation, and Foreign Direct Investment

This paper asks whether legal uncertainty surrounding corporate income taxation can defer foreign direct investment (FDI) in developing economies. Legal uncertainty can take many forms. We will focus on uncertainty circling around double tax agreements, differences in the type of legal systems and corruption. We test the effect of legal uncertainty on foreign direct investment econometrically with an international panel where we take explicit account of the spatial dimension. Our unit of observation are country pairs (FDI sender and FDI receiver). We use data from a variety of sources. Bilateral FDI flows come from the OECD, geographical distance from the Haversine formula, and legal information from the IBFD Tax Treaties database, Juriglobe (Ottowa) and Transparency International. We find that an increase in the ratio of the statutory corporate income tax rate of the destination relative to the source country exhibits a negative impact on foreign direct investment. Interacting the statutory corporate income tax rate with measures of legal uncertainty, we observe a negative effect. This implies that legal uncertainty detracts foreign direct investment, and the more so the higher are corporate tax rates.