Foreign Direct Investment and Tax Competition in Southeast Asia

Abstract

Foreign direct investment (FDI) is a unique form of international capital movement because it finances the construction of plant and equipment and also transfers technology and management skills from one country to another. Most developing countries use a variety of tax policies in an attempt to encourage investment and to Channel this investment into areas that are considered national priorities. The study of the impact of tax policy on FDI can have significant policy relevance. If FDI is not responsive to tax advantages offered by the host country, the foregone tax revenues represent a windfall loss that have to be made up by raising other, likely distortionary, taxes in the host country. If inward FDI is sensitive to the host country’s tax policies then policy design should attempt to strike a balance between foregone revenues and the benefits derived from capital technology and know-how transfers and future increases in tax base and revenues. Whether or not FDI is responsive to host country tax inducements also depends on the tax policies of home countries and may also depend on the tax policies of competing host countries.1 Therefore, the host country’s design of tax policy also has to take into account home country tax policies and may have to take into account the tax policies of competing host countries.