The relevance of supply side taxation for attracting foreign direct investment to developing countries: evidence from Egypt

Abstract

Many developing countries commonly use tax incentives as a key instrument for attracting foreign direct investment (FDI). Empirical studies have identified a causal relationship between FDI and a number of determinants including tax incentives, because they lower multinational enterprises' (MNEs) tax burden and consequently maximise their after-tax returns. Egypt is an example of a developing country that employed tax incentives through granting tax holidays to MNEs, in order to attract FDI, during the period 1974 to 2004. However, in 2005 the supply side tax policy was introduced through broadening the tax base and abolishing the bulk of tax incentives including tax exemptions. Nevertheless, in 2017 a new investment law was ratified which re-introduced tax incentives. This policy reversal raises a question about the relevance or otherwise of supply side tax policy in attracting FDI. To answer this question, we employ an econometric model to test the causal relationship between FDI and its determinants during the period 1975 to 2017. We assume that abolishing tax incentives would have a positive impact on inflow FDI. Using data from 1975 to 2017 for estimating the regression model, it is shown that there is a significant relationship between inflow FDI and implementation of supply side tax policy, while tax incentives have an insignificant effect on FDI. The result indicates that MNEs are looking for simplified tax provisions and lower tax rates, which are provided under supply side taxation. Further, the majority of MNEs are often taxed on their worldwide income in their residence countries, which indicates that they do not benefit from tax exemption. Accordingly, it is recommended that developing countries should consider broadening the income tax base and lowering income tax rates as an effective means of attracting FDI. 2021. All Rights Reserved.