Taxes, Institutions and Foreign Diversification Opportunities

Mihir A. Desai and Dhammika Dharmapala

No 13132, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: F21 F23 G11 G30 H25 (search for similar items in EconPapers)
Date: 2007-05
New Economics Papers: this item is included in nep-acc and nep-pbe
Note: CF IFM ITI PE
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Citations: View citations in EconPapers (8)

Published as Desai, Mihir A. & Dharmapala, Dhammika, 2009. "Taxes, institutions and foreign diversification opportunities," Journal of Public Economics, Elsevier, vol. 93(5-6), pages 703-714, June.

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Journal Article: Taxes, institutions and foreign diversification opportunities (2009)
Working Paper: Taxes, Institutions and Foreign Diversification Opportunities (2008)
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