Fiscal federalism and foreign direct investment – An empirical analysis

Abstract

Previous empirical studies suggest that fiscal decentralisation, measured by the number of government layers, is associated with less foreign direct investment (FDI). With an improved dataset on the tax autonomy of sub‐federal government tiers, we present evidence that fiscal decentralisation (de facto) does not reduce FDI. If local governments can set their tax rates and bases autonomously, they attract more FDI. Analysing 128,425 corporate cross‐border acquisitions (CBA), between 194 source and 215 host jurisdictions from 1997 to 2021, we find that full taxation autonomy by subnational governments can double the number of CBAs in a given year. These results apply to high‐income hosts and do not depend on specific periods.