The Impact of State Corporate Taxes on FDI Location

Abstract

This paper examines the effects of state corporate income taxes on the location of foreign direct investment in the U.S., taking into account the endogeneity of taxes and the outside options of investors. States have a set of characteristics that influence investors' decisions, some of them are not observable by a researcher but states take them into account when they set taxes. States can also act strategically with respect to other states when setting taxes. The former behavior bias the estimated tax effects because it creates correlation between the error term and the tax rate. The latter behavior directly implies an endogenous tax rate. I adapt a discrete choice model of differentiated products to estimate the tax effects. This approach allows me at the same time to control for the outside options of investors and to use instrumental variables to solve the problem of tax endogeneity. I find the tax elasticity to be consistently around -1.Foreign Direct Investment, State Corporate Income Taxes, Tax Endogeneity.