Internationalization and business tax revenue—evidence from Germany

The ongoing internationalization of business activity fuels concerns that governments may lose their ability to tax business income. By using data on sixteen German states from 1970 to 2005, we estimate the impact of internationalization, measured by trade volumes and stocks of foreign direct investment, on business tax revenues. We control for the impact of internationalization on business profits. Surprisingly, we find strong and robust evidence for a positive impact of internationalization on tax revenue. An increase in the internationalization indicator of ten percent increases tax revenue by over three percent. This counterintuitive result may be explained by higher tax avoidance activity of purely national firms or by legal provisions in the tax law which can be used as tax loopholes in the case of domestic transactions as opposed to cross-border transactions.