Tax-rate differentials and sector-specific foreign direct investment

This paper analyzes the tax responsiveness of bilateral foreign direct investment flows in the EU. Differentiating between investments in the three main economic sectors and using effective tax rates to measure tax incentives, we show that the tax sensitivity of foreign direct investment depends crucially on the sector the transaction takes place in. While investment in the primary sector is driven by other than tax incentives, investment in the secondary and the tertiary sector is deterred by high tax rates. The response in the tertiary sector is substantially higher than that in the secondary sector.