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Economic Policy Towards Foreign Direct Investment in the CEECs

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The corporate tax system has an obvious theoretical relation with inward FDI: higher tax rates increase the cost of doing business in a country, thereby reducing the attractiveness of such location (Besile et al. 2005, p. 9). In fact, the tax treatment of FDI, according to Mintz and Tsiopoulos (1992, p. v), is a potentially important part of the policy framework in Central and Eastern European countries. In their study on how their sample CEE countries can consider for the development of their corporate income tax policies, Mintz and Tsiopoulos suggested that if tax holidays were eliminated, thereby reducing the corporate tax to around 20 per cent, or allowing investment tax allowances of around 20 percent, would preserve the tax competitiveness of regimes in the countries analyzed.

Moreover, they also noted that investment tax allowances or credits would probably be more cost-effective than tax holidays for attracting foreign direct investment without undue revenue losses to the treasuries of the CEE countries (Mintz and Tsiopoulos 1992, p. vii). Corrupt behavior among government officials is an informal institution that can arise when market economy institutions are underdeveloped, and produce high transaction costs that increase the multinational enterprises (MNE)’ s costs of doing business in the host country.

Such extra-costs decrease the expected profitability of an MNE direct investment and tend to deter foreign investors from starting production in the host country (Besile et al. 2005, p. 9). Broadman et al. (2004, p. 252) recommends policy measures that will deepen the separation between politicians and firms as they found out in their analysis that in the case of the South Eastern European countries, the lingering involvement of the state can interfere with the value-producing function of productive enterprises [e. g.

managers of partially state-owned firms complaining of the amount of time they have to spend dealing with state officials rather than pursuing the creation of value, state-owned firms performed consistently worse than privately owned firms, either foreign or domestic].

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