Fiscal benefits and environmental costs of the corporate tax race to the bottom

• Thesis title in Czech: Fiskální přínosy a environmentální náklady závodu na dno v korporátní dani z příjmu
• Thesis title in English: Fiscal benefits and environmental costs of the corporate tax race to the bottom
• Key words: Korporátní zdanění, emise skleníkových plynů, společenské náklady uhlíku, přímé zahraniční investice, daňové ráje
• English key words: Corporate taxation, greenhouse gas emissions, social costs of carbon, foreign direct investment, tax havens
• Academic year of topic announcement: 2019/2020
• Thesis type: diploma thesis
• Thesis language: angličtina
• Department: Institute of Economic Studies (23-IES)
• Supervisor: PhDr. Miroslav Palanský, Ph.D.
• Author: hidden - assigned by the advisor
• Date of registration: 23.07.2020
• Date of assignment: 23.07.2020
• Date and time of defence: 14.09.2022 09:00
• Venue of defence: Opletalova - Opletalova 26, O105, Opletalova - místn. č. 105
• Date of electronic submission: 31.07.2022
• Date of proceeded defence: 14.09.2022
• Opponents: prof. Petr Janský, Ph.D.

References

Esty, D. C., & Porter, M. E. (2001). Ranking national environmental regulation and performance: a leading indicator of future competitiveness?. The global competitiveness report, 2002, 78-100.

Brunel, C., & Levinson, A. (2016). Measuring the stringency of environmental regulations. Review of Environmental Economics and Policy, 10(1), 47-67.

Lall, S. (2001). Competitiveness indices and developing countries: an economic evaluation of the global competitiveness report. World development, 29(9), 1501-1525.

Cole, M. A., & Elliott, R. J. (2003). Determining the trade–environment composition effect: the role of capital, labor and environmental regulations. Journal of Environmental Economics and Management, 46(3), 363-383.

Chung, S. (2014). Environmental regulation and foreign direct investment: Evidence from South Korea. Journal of Development Economics, 108, 222-236.

Cai, X., Lu, Y., Wu, M., & Yu, L. (2016). Does environmental regulation drive away inbound foreign direct investment? Evidence from a quasi-natural experiment in China. Journal of Development Economics, 123, 73-85.

Neequaye, N. A., & Oladi, R. (2015). Environment, growth, and FDI revisited. International Review of Economics & Finance, 39, 47-56.

Greaney, T. M., Li, Y., & Tu, D. (2017). Pollution control and foreign firms’ exit behavior in China. Journal of Asian Economics, 48, 148-159.

Cole, M. A., Elliott, R. J., & Fredriksson, P. G. (2006). Endogenous pollution havens: Does FDI influence environmental regulations?. Scandinavian Journal of Economics, 108(1), 157-178.

Jones, C., & Temouri, Y. (2016). The determinants of tax haven FDI. Journal of world Business, 51(2), 237-250.

Haberly, D., & Wójcik, D. (2015). Tax havens and the production of offshore FDI: an empirical analysis. Journal of Economic Geography, 15(1), 75-101.

Preliminary scope of work

Motivation:
The topic of corporate tax avoidance has been a topic of economic research for a moderate amount of time now and is generally high on the political agenda due to the increasing pressures in recent years on state budgets to become more frugal and efficient. Offshore tax havens allow corporate subjects to transfer some of their profits from countries applying comparatively large corporation income taxation into countries known for a high degree of secrecy and low (zero, at times) rates of tax.

On the other hand, the pollution haven hypothesis states that corporations from developed nations usually seek the cheapest option when setting up new factories abroad. This, however, often comes hand in hand with producing at lower environmental standards than it would in its home, developed country. Therefore, companies seek new locations in countries with low strictness of environmental regulations or weak enforcement of those. In practice, however, it is more difficult to classify a country as a pollution haven compared to a tax haven, due to the discrepancy said country can have between the environmental laws for different industrial sectors.

This thesis aims to connect these two issues. This is to be done through observation of the effects each of these two phenomena have on the Foreign Direct Investment (FDI) the country receives. The link between artificially inflated FDI and tax havens (so-called “phantom investments“ has been investigated and proved by numerous studies (Jones & Temouri (2016), Hines (2010)), however, the link between FDI and pollution havens lacks such robust research to fully prove it, with a smaller number of authors focusing on the issue. Therefore, investigating this relationship will be the first objective of this study.

The second objective is to measure the interaction of both tax and pollution havens. We want to investigate, whether, if a country in question is a tax haven while at the same being a pollution haven, the FDI increases linearly or whether it experiences diminishing returns. This will be made harder mainly by the fact, that, as “pollution haven” is a rather loosely defined term and few useful indexes that would measure the strength of environmental regulation exist (for OECD countries, there exists the Environmental Policy Stringency Index, and for all countries there is data from the Global Competitiveness Report, which touches on environmental issues, but not as directly as would be necessary for the purposes of this study).

The third main objective will then be to investigate whether firms from sectors of industry, which can generally be considered as having a more negative effect on the environment, such as mining or heavy industry, are drawn towards countries with weak environmental regulations or enforcement thereof.

Hypotheses:
1. Hypothesis #1: There is positive causal relation between incoming FDI and weak environmental regulation
2. Hypothesis #2: Diminishing returns exist in the effect on FDI in case a country is both a tax and pollution haven
3. Hypothesis #3: More polluting industries experience the effects of pollution haven hypothesis to a significantly greater degree than their more environmentally friendly counterparts

Methodology:
The data on FDI of different countries and regions is widely available, for example on the web page of the United Nations Conference on Trade and Development. Data on FDI by industry sector is also freely available on the web of OECD and so combining it with the country data should pose little difficulty. The database of EXIOBASE that contains the data on environmentally extended multiregional input‐output for a number of countries, which can be used to analyze the effects of the global economy on the enviroment. The data there is also ordered by industrial sectors, which will help us in testing Hypothesis #3.

Collection of data on the state of environmental regulations could prove a bigger challenge, however, even here there exist some useful indexes that aid us in the classification of countries as pollution havens. First, as already mentioned, we can use the Global Competitiveness Report and the Environmental Policy Stringency Index. Alternatively, Esty & Porter (2001) and Brunel & Levinson (2016) explore this issue indepth and offer their own environmental laws stringency measures. Data on the tax leniency of countries are, on the other hand, readily available, as well as there are universally accepted lists of tax haven countries, such as lists by the EU or the OECD.

To test all three of the hypotheses, it is expected that simple cross-sectional data analysis methods such as Least Squares estimation will be sufficient, as long all assumptions of OLS are fulfilled. Should that not be the case, we can either remedy this by data transformation or use a different method completely, one that would be appropriate to the situation and which assumptions would be fulfilled.


Expected contribution:
As the topic itself is not thoroughly investigated by the academic literature, the findings of this thesis can bring several benefits, mainly to country authorities who set national policies in the area of both environmental and tax laws. The findings themselves might not be impactful enough to warrant authorities to actually set the policies based on them, however, they will provide useful insight into the behaviour of multinational corporations, more precisely on the direction of their foreign investments. This information can be used to optimise the polices in the country in order to minimize the outflow of phantom investments, which can make a dent in the tax revenue of the country.

Outline:
I. Introduction: I will explain core concepts here in short
II. Motivation: In light of other studies, I will highlight the contribution the thesis will bring
III. Theoretical part: I will go into detail on all concepts involved and do a literature review as well
IV. Methodology: Methods used are explained here
V. Data: The sources of data are investigated here, as well as possible problems with data
VI. Results: Discussing the results and drawing conclusions from them, as well as the possible implications for the concerned authorities
VII. Conclusion: I will summarize the findings of the thesis here