Introduction to International Taxation and Multinational Activity

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


The ability of modern multinational firms to adjust the scale, character, and location of their worldwide operations creates serious challenges for governments that seek to collect tax revenue from the profits generated by these operations. One of the most important issues that policy makers confront in setting tax policies is to evaluate the extent to which taxation influences the activities of multinational firms. Taxation clearly has the potential to affect the volume of foreign direct investment (FDI), since higher tax rates depress after-tax returns, thereby reducing incentives to commit investment funds. Of course, other considerations are seldom equal: Countries differ in their commercial and regulatory policies, the characteristics of their labor markets, the nature of competition in product markets, the cost and local availability of intermediate supplies, proximity to final markets, and a host of other variables that influence the desirability of an investment location. Until somewhat recently, the obvious relevance of these nontax factors served to convince many observers of the likely unimportance of tax policy in determining the location and character of foreign direct investment.