Corporate Tax Cuts and Foreign Direct Investment

Accurate policy evaluation is central to optimal policymaking, but difficult to achieve. Most often, analysts have to work with observational data and cannot directly observe the counterfactual of a policy to assess its effect accurately. In this paper, we craft a quasi-experimental design and apply two relatively new methods—the differencein-differences estimation and the synthetic controls method—to the policy debate on whether corporate tax cuts increase foreign direct investment (FDI). The taxation– FDI relationship has attracted wide attention because of mixed findings. We exploit a quasi-experimental design for Russian regions, which were granted autonomy to reduce corporate profit tax in 2003, enabling them to simultaneously experiment with different tax policies. We estimate both the average and local treatment effects of two types of tax cuts on FDI inflows. We find that, on average, relative to the absence of tax cuts, nondiscriminatory tax cuts on direct investment profit increase FDI, but discriminatory tax cuts on selected government-sanctioned investment projects do not. Yet for both types of tax cuts, local treatment effects vary dramatically from region to region. Our research has important implications for the design of tax policy and fiscal incentive, and the assessment of fiscal policy reforms. C © 2014 by the Association for Public Policy Analysis and Management.