The impact of tax incentives on foreign direct investment in China

Abstract

Scholes and Wolfson (1989, 1992) argue that tax rules jointly influence investment decisions and organizational form. The present research uses Chinese data to test these assertions. Specifically, our study investigates whether (1) the creation of special tax incentive zones is an effective tax policy for China to induce new foreign direct investment (FDI) into specific regions, and (2) changes in the tax rules influence the particular form of foreign direct investment selected: equity joint ventures, contractual joint ventures, and wholly foreign-owned enterprises. Our results indicate that tax incentives are effective in attracting FDI to China, and moreover, influence the selection of a particular form of FDI. One limitation of our study is that we were unable to completely control for the correlated-omitted-variable problem.