Essays on Tax Subcidies and Foreign Direct Investment

Abstract

In my dissertation, I study the cost and benefits of some FDI-preferential policies. I focus on a Foreign Direct Investment (FDI) preferential policy in China that provides a corporate tax reduction for firms with foreign equity shares of no less than 25%. In the first chapter, we investigate the policy under a partial equilibrium and find that a massive number of small firms in China bunch their foreign ownership share at the tax notch. This bunching behavior increases those firms’ average FDI shares by 20.8%, decreases the government’s tax revenue collected from the joint ventures by 19.38%, and leads to a production loss that is about 10% of the firm’s annual sales. In the second chapter, we expand the analysis to a general equilibrium and show that the policy effect depends on the supply elasticity of the foreign partner’s input. We find modest effects indicating that this policy helps China win over other countries in competing for more foreign inputs and bringing them into the Chinese market, which justifies the policy. The third chapter investigates the impact of the policy on technology transfer in China. We investigate firms’ innovation input measured by R&D intensity, the quantity of firms’ invention patent filings, and the value of firms’ invention patents measured by the number of forward citations received by the patent and the patent’s family size. The results suggest that this policy has a limited impact on joint ventures’ technology transfers and does not attract the most innovative firms to participate. In addition, we find evidence suggesting that foreign investors keep those technologies with greater value to themselves while transferring less valuable technologies through joint ventures.