Taxes, Leverage and the National Return on Outbound Foreign Direct Investment

The effect of outbound foreign direct investment (FDI) on the national income of the parent firm's country depends on the relative importance of two countervailing factors: the loss of tax revenue to the foreign government and the increased use of foreign debt. The present paper develops an explicit analysis of these two factors in the context of the segmented international capital market in which most national saving remains in the country in which the saving is done. The analysis is applied with realistic parameter values for U.S. outbound foreign direct investment. The calculations imply that an increase in outbound FDI raises the present value of U.S. national income by a rather substantial amount. Traditional analyses that conclude that the foreign tax credit causes excess outbound FDI fail to take into account the fact that firms that invest abroad increase their use of foreign debt as they increase the extent of their FDI.