Tax Burden, Economic Development, Macro-economic Factors and Foreign Direct Investment Inflows Into the East African Community Countries

Abstract

Determinants of foreign direct investment (FDI) inflows are numerous and vary from country to country. To advance research on the determinants of FDI inflows, this study offers conceptualisation of the determinant in the East African Community (EAC) countries as tax burden with the relationship significantly influenced by economic development and macro-economic factors. Individual economic development indicators in the study are market size, human capital, country openness and return on investment while the macro-economic factors are GDP growth rates, inflation rates, exchange rates and interest rates. Specifically, the study determined the effect of the tax burden on FDI inflows into the EAC countries; investigated the influence of economic development on the relationship between the tax burden and FDI inflows into the EAC countries; established the influence of macro-economic factors on the relationship between the tax burden and FDI inflows into the EAC countries; and determined the joint effect of the tax burden, economic development, and macro-economic factors on FDI inflows into the EAC countries. Correlational research design was used on secondary data from 2000 to 2013. The research philosophy was positivism. Data analysis and hypotheses tests (ANOVA and regression analyses) were conducted. The study found that in Objective One, tax burden had insignificant negative coefficients, in Objective Two, market size and return on investments as moderating variables had significant positive coefficients, in Objective Three, exchange rate had significant positive coefficients and in Objective Four, tax burden and human capital had significant negative coefficients while market size, country openness, and exchange rate had significant positive coefficients. The study concluded that in the EAC countries, tax burden had insignificant negative effect on FDI inflows. In addition, market size and return on investments as economic development indicators had significant positive moderating influence on the relationship between tax burden and FDI inflows. Further, exchange rate as a macro-economic factor had significant positive partial mediating influence on the relationship between tax burden and FDI inflows into the EAC countries. Moreover, tax burden and human capital had significant negative joint effect, while market size, country openness, and exchange rate had significant positive joint effect on FDI inflows into the EAC countries. The study has several contributions. For policy contribution, the study has demonstrated that tax burden in presence of economic development and macro-economic factors, has significant negative effect on FDI inflows. Therefore, policies to attract increased and consistent volumes of FDI inflows should be focused on tax burden, economic development and macro-economic stability. For theoretical contribution, the negative relationship between tax burden and FDI inflows confirms that tax competition theory, equity theory and political power theory are applicable in the EAC countries. For knowledge contribution, this is one of the few studies on the subject based in EAC countries; the study forms a base for further research in taxation and international investments. In addition, the study contributes to practice of finance and taxation in that it established the relationship between tax burden and FDI inflows. On policy implications, tax burden based policies such as tax incentives should continue being implemented alongside economic development and macro-economic stability policies to attract increased and consistent volumes of FDI inflows into the EAC. Further studies are recommended: replicating same study after some time, a study using FDI outflows as dependent variable, a study using components of tax burden such as tax types, tax rates, tax bases, tax structures.