Corporate tax, R&D and export decisions: Evidence from European firms

The paper presents a unified framework for analyzing the impact of corporate taxation on R&D and exporting, con- sidering firm productivity heterogeneity and sunk costs. We empirically examine three hypotheses using data from 7819 European firms spanning 2001–2014. We propose that: (a) an increase in corporate tax reduces the likelihood of inno- vation, (b) an increase in corporate tax reduces the like- lihood of exporting, and (c) firms that innovate are more likely to enter foreign markets. On average, a high Effec- tive Average Tax Rate (EATR) lowers the probability of investing in R&D and exporting by 2.3% and 1.41%, respec- tively. For firms with low Total Factor Productivity (TFP), the adverse effect of taxation on R&D investment ranges from 3.71% in our baseline analysis to 12.9% in our sensitiv- ity analysis. Interestingly, while EATR positively influences the export decisions of high-TFP firms, a higher EATR can reduce the export probability by up to 25.5% for firms at the lower end of the TFP distribution. Our findings demon- strate a causal relationship between firm heterogeneity and their capacity to mitigate the distortions caused by higher taxes. From a policy perspective, our results suggest that fostering innovation is essential for firms aiming to expand into international markets.