The analysis presented in this paper shows that u.s. tax
policy can have significant effects on u.s. direct investment
outflows through various channels. It is stressed that a
sensible choice of specification and data in an empirical model
entails a rigorous examination of the theoretical underpinnings
behind the model. In particular, we emphasize the difference
between foreign fixed investment undertaken by the foreign
subsidiary and direct investment of the entire international
firm, and the need to use different theoretical frameworks in
We present estimated equations relating the balance of
payments direct investment outflows -- distinguishing between
retained SUbsidiary earnings and parent transfers -- to various
measures of the u.s. net rate of return and the cost of funds.
The evidence shows that u.s. tax policy toward domestic
investment has an important effect on direct investment outflows
by influencing the relative net rate of return between the u.s.
and abroad. We estimate that a 16 cent reduction in transfers
made by U.S. parents firms occurs for every dollar increase in
u.s. domestic investment. In contrast to previous studies,
transfers equations fit much better than retained earnings
equations for every net return variable used in our estimation.
Of the various specifications tested, the transfers equation
containing a marginal, forward-looking and corporate-investor net
return variable fits best, a result which is consistent with the
predictions of our theoretical framework.
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