The effect of Foreign Direct Investment on tax revenue in developing countries

The objective of this research paper is to study the effect of foreign direct investment (FDI) on tax revenue in developing countries. FDI net inflow, greenfield, and brownfield FDI are selected as the independent variable, and tax revenue and its types are chosen as the dependent variable. Using panel data analysis, this research finds that FDI net inflow has a positive correlation and statistically significant on total tax revenue, corporate tax revenue, individual tax revenue, and VAT revenue. However, the effect of FDI net inflow on property tax revenue is not statistically significant. The regression result from greenfield and brownfield FDI shows that the greenfield FDI has a beneficial effect and statistically significant on total tax revenue and individual tax revenue, while brownfield FDI brings a negative impact on individual tax revenue. Using interaction variable between FDI and GDP per-capita, this research also finds that in developing countries, the effect of greenfield FDI depends on the level of GDP per-capita. Where, the effect of greenfield FDI on tax revenue is increasing, but this effect is decreasing (increasing at decreasing rate) along with the increase of GDP per-capita or FDI. To deal with endogeneity problems, this research uses “political stability and absence of violence” index as an instrumental variable and conducts a two-stage least square (2SLS) regression to estimate the parameter. The result shows that FDI has a positive correlation on total tax revenue, but not significant. However, the endogeneity test shows that the endogeneity problem is less likely to exist. Therefore, FDI and tax revenue tend to only have one direction effect from FDI to tax revenue.