Does taxation influence the foreign direct investment in developing economies? (India and Bangladesh)
The hypothesis formed based on literature review is as follows:
For simplicity of analysis the taxes considered are consumption tax, income tax, import tariff, business taxes (like property taxes, etc). The idea here is to study the impact of all these variables on FDI in respective countries.
Further scope of this research will be to explore how FDI influences GDP and other associated economic parameters of these developing economies. This will give an idea on how the tax policy changes can affect the overall growth of economies.
Taxes on income (both wages and profit) can affect return on work effort. Labour supply could be inelastic and therefore incidence of tax will fall on workers in short run. In long run, supply elasticity is higher. When wage costs are high, companies will be less likely to invest in these economies. This is because with higher incidence of taxes companies will be left with lower profit and burden of higher overhead expenses. Again, with higher import tariff other economies will be keener to produce the good in the target economy itself in order to capture market share.
Research topic
Governments of both developed and developing countries are always eager to bring in foreign direct investment in their respective countries. The need for FDI is of more importance in case of developing countries as they most often suffer from capital deficiency in their economy. FDI not only brings in capital but also technological progress, better managerial techniques and blueprints in the developing countries. FDI investment generates employment and income together with development of market, establishment of economic institutions in these counties whose spill over effect spreads across the economy in the form of positive externality (Jones and Wren 2016).
However, FDI in any country is subject to several conditions. The carriers of FDI are multinational corporations (MNC) who will invest only when they foresee encouraging return from the same. For this they take a few factors into their consideration to assess the investment environment of the country with investment potential. One such factor is taxation system of the country. How the government taxes the business is a factor that is believed to be impacting the investment decision (Said and Marimuthu 2012).
Knowing the underlying psychology of the MNCs governments of developing countries cut tax rate on investment and offer other tax benefits to these companies to lure them. However, most developing countries likely to have a weak and cumbersome tax design wrapped in stringent and non-transparent administrative rules (Molle 2017). These make tax compliance a time consuming and inconvenient task. MNCs, therefore, find such tax incentives unattractive and do not consider it as a major factor while deciding on FDI in a developing country (Morisset and Pirnia n.d).
The question that this research seeks to answer is: “How taxation influences the FDI decisions in India and Bangladesh?”. The reason behind choosing Bangladesh along with India are manifolds. First, both are democratic countries. Second, they are neighbours, and hence, a comparison can be made easily with ample availability of data and primary research. Third, India is a large country while Bangladesh is a small country in terms GDP, population, foreign trade and foreign investment. It would be interesting to study whether there is any effect of taxation on a large country vis-à-vis a small country.
The study requires secondary data analysis. However, quantitative and qualitative analysis may be used. A secondary study will help gather data on various developing countries’ FDI inflow, tax-GDP ratio, HDI rank needed to ascertain the level of development of the country (Johnston, 2014). Moreover, there is no other option but to use secondary data for a study that involves collection and comparison of data across countries. The specific objectives behind this research are:
For the purpose of conducting the research a period of last ten years is being taken up that is the time period from 2005-2015. The reason for the same is that the period for which the research is to be conducted must be sufficient enough to accommodate the changes that come with the change in the leadership of the country, the time that is taken up by the reforms to actually yield quantifiable results and the time required for the purpose of reliably measuring the same (Deresky 2017). If the period is taken too long then the weightage of the irrelevant past actions and the decisions of the government of the country will be reflected and if the period is too small the substantial changes taken place in the country won’t be reflected properly.
For the purpose of identification of the relevant dataset it is necessary to track down the latest changes that have occurred in the economy of the countries chosen for the research. The reason for the same is that the main purpose of the research is to not only establish the current situation existing in the country but also the implications of the various decisions taken up by the government in the last few years that have significantly impacted the economy of the country. In this scenario for India, the data has been taken from 2005-2015 from “DIRECT AND INDIRECT TAXES – Statistical Year Book India 2017” and for checking the trend of taxation of India and Bangladesh; it has been taken from “World bank Data” under the heads of Percentage of Tax GDP and FDI.
Also, the data taken will help in understanding the execution of principles and reforms taken in the countries over the years (Low 2016).
For the purpose of the evaluation of the data set that is being chosen and the results that are being obtained an effort is being made to ensure that the questions and the parameters of the research are kept objective in n nature. the reason for that is that if the questions are kept objective with further clarifications being required on the part of the body to whom the question are being asked, then the analysis carried out based upon it will be very accurate and objective in nature (Deresky 2017). The reason for that is that if the scope of subjectivity is eradicated all the relevant points that are influencing the economy and the Foreign Direct Investment within the country will come to light.
For the purpose of collection of the data an effort will be made towards ensuring that the right method is being used up for the same purpose. The reason for this is that in case the method that would be used is secondary data collection method because to acknowledge the taxation and FDI environment, it is important to address years based on which changes had led to implications.
For the purpose of conducting the following research the method of primary method of data collection will also be beneficial as the primary data would be done based on respondents of taxation official personnel that can give us an overview of on a macro level.
Based on the results that are obtained from the interview and the analysis of data using secondary data sets over the years that will lead to analysis of effective and efficient approach adopted for the purpose of ensuring that the results that have been obtained from the questionnaire are utilised for the purpose effective communication of the results.
Taxation: A system where the government collects revenue from business and household for making its expenditure is called taxation. The governments can encourage or discourage economic decisions by altering levels of taxes.
The taxation system of developing country like India is broadly classified in to Direct Tax and Indirect Tax. Direct taxes are those whose burden falls directly on the entity being taxed. They include Income tax, Corporation tax, Capital gain tax, Wealth tax. Indirect taxes are those which are paid by someone, but its burden can be partially or wholly shifted to other person through business transactions. They include Excise duties, Sales tax, Goods and Services tax (Chakraborty 2016). In 2013-14 the tax-GDP ratio of India stood at 17.4 percent. The same ratio in sub-Saharan Africa in 2010 was 20 per cent (EPS 2013).
Taxes impact economic growth in developing countries in many ways. Studies by Aleena (2014) to determine the effect of tax incentives on economic growth of Kenya showed that there was a negative relation between GDP growth rate and tax incentives. Another study in 2016 by Eugene Abigail which examined the impact of tax incentives on economic growth of Nigeria, demonstrated that taxes have a significant effect on Nigeria’s economic growth. Especially it was the indirect taxes that had the robust positive effect on the economic growth of the country while the direct tax had weak impact on growth (Thaçi 2018).
Foreign Direct Investment (FDI): Investment by one country into another mostly through private agents like companies, individuals instead of government is known as foreign direct investment or FDI. Foreign direct investment is the source of employment, growth and income along with exposure to foreign capital, technological progress, improved managerial practices.
India post 1991 pursued a policy of liberalization and welcomed foreign direct investments. These investments have been key to drive growth economic activities through technology transfer, creation of employment, and improved access to managerial expertise (Pradhan 2017). The exposure to global capital, product markets and distribution network restructured the Indian market. FDI in India has helped the country to achieve some degree of financial stability, growth and development. Even in the wake of financial crisis 2008 and its subsequent global recession India was able to retain its FDIs and attracted more capital flow compared to many developed countries (Marimuthu 2012).
Developing Countries: Development is a concept which is difficult to define. There are no universally accepted criteria for classifying countries according to their level of development. International agencies like UNDP, IMF and World Bank use their separate criteria to make distinctions and group countries according to their level of prosperity (Aharoni 2015). The term “Developing Countries” is used mostly by UNDP to indicate those countries which are below the 75 percentiles of the Human Development Index distribution. The world Bank defines developing countries as those countries which have per capita income level of $4, 035 or less (A4ID 2018). The primary characteristics of developing nations include low level of industrialization together with low level of income, lower life expectancy, lower educational attainment, and high rates of fertility. Most of the countries in Africa, Asia, South America, Central Europe, and East Europe exhibit these features and hence are considered as developing.
Studies have investigated the role of foreign direct investment in growth of developing countries. It has been found that FDI is not driven by a single factor but is a function of multiple factors including market size, market growth, human capital, trade openness, taxation, physical infrastructure (San, Cheng and Heng 2012). In their study San, Cheng and Heng (2012) delved deep into the relationship between corporate tax and US outward FDI in developing countries. They found that there exists a negative relation between the two in host developing countries.
OECD (2008) report on effects of tax on FDI stated that FDI falls by 3.7% with a 1 percentage point increase in the tax rate on FDI. However, other studies reflect decrease in the range of 0% to 5%. This variation is partly due to differences between the industries and the examined countries, or the time periods considered (OECD 2008). In the same report it has been further mentioned that some studies have shown increasing sensitivity of FDI against taxation. This is due to the enhanced mobility of capital resulting from removal of non-tax FDI barriers. In his discussion (Margalioth, (n.d)) emphasised on the negative impact that taxation has in attracting FDI. In fact, international institutions like World Bank, OECD, IMF consider it a “Bad policy” to use tax incentives for luring FDI. The strongest argument against the tax incentives are that it distorts behaviour and brings in inefficiency and they are not effective rather are harmful and have very little impact of FDI decision (Penrose 2017).
A study by (Economou et.al, 2016) revealed that in developing countries the taxation does not play a significant role in decision drawing FDI in those counties. The determining factors included market size, labour cost, and institutional variables. (Maria et al., 2017) in their book titled Corporate tax incentives and FDI in developing countries elaborate the reason behind insignificant impact of taxation on FDI inflow in developing countries. They are of the view that in most developing countries the tax design is clumsy, weak, lacks transparency, and is full of administratively cumbersome paraphernalia. These make the tax incentive less attractive and inefficient.
Previous researches focused on capital income taxes mainly. Also, they did not exclusively consider developing economies. So, in this paper the idea is to explore what kind of tax policies developing economies should undertake in order to boost their growth through FDI. These developing economies depend a lot on inflow of foreign investments for their all-round economic growth (Paramati et al. 2015). Therefore, the paper will throw light on the possibilities of adjustment in taxes and tariffs in order to promote these foreign investments.
In addition to that an effort will be given to ensure that the relevant results that are obtained from the analysis and the research are objective in nature. The reason for that is that the usefulness of the information that is received in a subjective manner is very less compared to the usefulness of the information that is objective in nature (Kim et al. 2015). If the objectivity of the information that is gathered is being focussed upon the implications of the various decisions taken up by the government in respect of the tax deductions given out to the companies. The importance of the study of the result is immense, the reason being that if the reasons or the factors that are affecting the FDI within the country are found out it will enable the government of the countries to form the decisions and undertaking steps that will guarantee the increase in the flow of the FDI within the country (Sinclair-Maragh and Gursoy 2015). it is seen that it is not only the matter of the deductions that are being given out by the company but also the extent of the compliance procedures that are to be followed by the entity to ensure that the required actions and the decisions are being taken up by them.
It is seen that both the countries are agreeing that the complexities that are present in the system taxation within the country are a significant reason by which the FDI of the country is affected. India is more agreeable on the fact that the deductions that are being given to the companies affect the FDI in a significant way. Bangladesh on the other hand is of the belief that the deductions that are being given to the companies do not influence the FDI in a significant manner.
Conclusion
It can be concluded that the Bangladesh is of the view that the impact of the deductions on the FDI of the country is not so significant. On the other hand India is of the opinion that the deductions given out to the companies play a huge rule in ensuring that the FDI is coming into the country in adequate amounts.
Confidentiality and Consent:
Since secondary research method involves existing research data to find an answer to the research question, ethical concerns about them include data confidentiality and security (Triparty, 2013). The data that will be used for this research are freely available in the internet, books or other public forums. That is why their use for further analysis is implied. There is no need to take usage permission separately. However, the ownership of the original data will be acknowledged (Grinder 2009).
Evaluation of data:
Another point that will be taken care of is the evaluation of the data. Since the data used for this study was not collected to answer this research question, its adequacy and relevance must be ascertained. This will be done by scrutinizing the methodology of data collection, accuracy of the data, data collection period, purpose of data collection and the content of the data.
Access to data:
The access of the data will be restricted to ensure that there is no unauthorized use of the data, accidental loss or destruction.
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