Tax Sparing and Direct Investment in Developing Countries

James R. Hines Jr., University of Michigan Law School


Only a small fraction of the world's foreign direct investment (FDI) is located in developing countries. In 1990, countries that were not members of the OECD received roughly 15 percent of the $200 billion of world FDI. Since these developing countries account for 35 percent of world GDP in 1990 (and 80 percent of the world's population), they received a much smaller fraction of total FDI than even their relatively modest economic activity levels appear to warrant. High-income countries are generally eager to promote economic development in low-income parts of the world. With that goal (and others) in mind, they often provide special fiscal incentives for their own firms to do business in developing countries. This chapter examines the effect of the most common of these incentives, the provision of “tax sparing” credits. It evaluates the argument that tax sparing credits are ineffective in encouraging greater investment in developing countries. It compares patterns of FDI by multinational corporations from Japan and the United States over the same time period.