- Taxes, Institutions and Foreign Diversification Opportunities
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- by Desai, Mihir A.; Dharmapala, Dhammika
- Investors can access foreign diversification opportunities through either foreign portfolio
investment (FPI) or foreign direct investment (FDI). By combining data on US outbound FPI and
FDI, this paper analyzes whether the composition of US outbound capital flows reflect efforts to
bypass home country tax regimes and weak host country investor protections. The cross-country
analysis indicates that a 10% decrease in a foreign country’s corporate tax rate increases US
investors’ equity FPI holdings by 21%, controlling for effects on FDI. This suggests that the
residual tax on foreign multinational firm earnings biases capital flows to low corporate tax
countries toward FPI. A one standard deviation increase in a foreign country’s investor
protections is shown to be associated with a 24% increase in US investors’ equity FPI holdings.
These results are robust to various controls, are not evident for debt capital flows, and are
confirmed using an instrumental variables analysis. The use of FPI to bypass home country
taxation of multinational firms is also apparent using only portfolio investment responses to
within-country corporate tax rate changes in a panel from 1994 to 2005. Investors appear to alter
their portfolio choices to circumvent home and host country institutional regimes.
- Publication Type: WCFIA Working Paper
- Published Date: May 2007
- Field of Interest: Comparative Politics
- Desai, Mihir, and D. Dharmapala. "Taxes, Institutions and Foreign Diversification Opportunities." Working Paper 2008-0022, Weatherhead Center for International Affairs, Harvard University, May 2007.
- Also NBER Working Paper No. 13132.