Labor Taxes and FDI Decisions in the European Union

This paper uses panel data on bilateral FDI flows in the European Union to empirically analyze the impact of labor and corporate taxations on FDI decisions. While the effect of corporate taxes on FDI is well documented, the impact of labor taxes on FDI has been neglected. This is surprising since labor taxation may influence FDI as well. The reason for this is that taxation of labor affects the production cost and the ability to attract and retain productive labor and ultimately the investment return. By employing a Heckman two-step estimation model, which controls for possible sample selection bias due to many zero bilateral observations, it is found that labor taxes do influence FDI decisions. The effect is significant both statistically and economically, although the magnitude is smaller than for corporate tax.