Impact of Taxation on Foreign Direct Investment: Empirical Evidence from Pakistan

Abstract

Foreign direct investment plays a vital role in promoting economic growth, especially for developing economies. It causes improvement in the different sectors such as education, healthcare, manufacturing industries, and creates more jobs. The speed of FDI inflows has been increasing in Pakistan each year. In order to attract more FDI, many countries try to reframe their tax policies by introducing different tax incentives such as tax holidays, investment allowances, exemptions, deductions etc. The purpose of the present paper is to find the implication of taxation in the decision of FDI inflows in Pakistan. Time series data is used spanning over 1985 to 2020. The data was obtained from two sources: the “World Development Indicator” (WDI) and “Economic Survey of Pakistan”. “Auto-Regressive Distributed Lag” (ARDL) and “Error Correction Model” (ECM) techniques are used for empirical analysis. The study concludes that low taxes motivate foreign investors' investment contribution and the long-run relationship between taxes and FDI in Pakistan. Other control variables, including GDP growth, trade openness and exchange rate, positively impact FDI. It is suggested that decision-makers should direct policies to reduce the taxes to welcome FDI in Pakistan. In this regard, the government needs to reconsider its priorities while making policies favouring FDI.