Taxation Policies, Interest Rates and Foreign Direct Investments: Evidence from East Africa Community Member Countries

Abstract

This article examines how interest rates shape the relationship between taxation policies and foreign direct investment in East African Community member countries from 2014 to 2023. Using a random effects generalized least squares panel framework, the analysis proceeds in the standard three step sequence. First, corporate income tax, capital gains tax, withholding tax, and value added tax each show clear negative associations with foreign direct investment when considered together, establishing a strong baseline. Second, introducing the interest rate alongside the four tax instruments improves model fit and reveals a distinct negative association between higher borrowing costs and investment inflows, indicating that monetary conditions add meaningful explanatory power beyond tax variables alone. Third, interaction terms between the interest rate and each tax instrument are negative and significant, demonstrating that interest rates systematically amplify the adverse association between taxes and foreign direct investment. In practical terms, tighter credit conditions deepen the penalty investors perceive from higher profit, exit, remittance, and consumption related taxes by compressing after tax returns and heightening working capital pressures. The findings show that investment outcomes reflect a combined fiscal and monetary environment, and they underscore that tax reforms aimed at competitiveness will be most effective when coordinated with policies that stabilize financing costs.

Keywords:       Foreign direct investment, taxation policies, corporate income tax, capital gains tax, withholding tax, value added tax and interest rate