Coordination vs. Competitiveness of Effective Average Tax Rates in Relation to FDI: The Case of Emerging EU Economies

Abstract

Due to the single market within the European Union (EU), capital mobility has created many challenges in the field of tax policy, especially whether taxes should be coordinated or governments should retain fiscal sovereignty for the sake of tax competitiveness. In order to attract foreign direct investment (FDI), emerging EU economies most often choose the policy of tax reduction and particularly lowering the effective average tax rates (EATR). The purpose of this paper is to empirically assess the impact of changes in the EATR on the decision to localize FDI in emerging EU economies in the period 1998–2021, in the framework of cross-sectional dependent, non-stationary, heterogeneous panels. Using the (Pooled) Mean Group estimator, the long-run relationship between the EATR and the FDI is revealed. The error-correction parameters are significant and heterogeneous, showing that the speed of adjustments towards equilibrium is different, but the highest in Estonia. Accession to the EU contributed faster adjustments to the long-run relationship in the majority of the emerging EU economies, while a broader set of potential determinants of FDI localization is taken into consideration and estimated using the Panel-corrected standard error method. Results showed de facto tax competitiveness in the group of emerging EU economies, instead of de jure tax coordination in the EU.