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Asymmetric FDI and Tax-Treaty Bargaining: Theory and Evidence

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  • Ron Davies
  • Richard Chisik

Abstract

Tax treaties are often viewed as a mechanism for eliminating tax competition, however, this approach ignores the need for bargaining over the treaty’s terms. This paper makes a first attempt at modeling the conflicting goals in treaty formation by analyzing a cooperative bargaining model of tax determination. In a simple framework, we develop hypotheses about patterns in treaty tax rates. A key determinant for these patterns is the relative size of bilateral foreign direct investment (FDI) activity. In plausible situations, more asymmetric countries will negotiate treaties with higher tax rates. The implications of the model are then tested using 1992 data from bilateral tax treaties with the United States and within the OECD. We find that treaty-specified withholding taxes vary in a systematic way that is consistent with our simple bargaining model. In particular, our results highlight the importance of differences in bilateral FDI activity between the two countries. As the size of this asymmetry grows the scope for cooperation is decreased and negotiated tax rates are higher. We find similar results for relative country size. These findings indicate that it may be difficult for highly asymmetric countries to negotiate a treaty, and in fact, our analysis suggests that countries with highly asymmetric FDI activity are also the least likely to have a treaty.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 Latin American Meetings with number 64.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:latm04:64

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Keywords: Foreign Direct Investment; Tax Treaties; Multinational Corporations; Bargaining; Withholding Taxes;

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  1. Bruce A. Blonigen & Ronald B. Davies, 2004. "The Effects of Bilateral Tax Treaties on U.S. FDI Activity," International Tax and Public Finance, Springer, vol. 11(5), pages 601-622, 09.
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Cited by:
  1. Luca Salvadori & José María Durán-Cabré & Alejandro Esteller-Moré, 2013. "Empirical Evidence On Tax Information Sharing Among Sub-Central Administrations," ERSA conference papers ersa13p461, European Regional Science Association.
  2. Blanchard, Emily J., 2010. "Reevaluating the role of trade agreements: Does investment globalization make the WTO obsolete?," Journal of International Economics, Elsevier, vol. 82(1), pages 63-72, September.
  3. Rixen, Thomas & Rohlfing, Ingo, 2005. "The political economy of bilateralism and multilateralism: Institutional choice in international trade and taxation," TranState Working Papers 31, University of Bremen, Collaborative Research Center 597: Transformations of the State.
  4. Eric Neumayer, 2007. "Do double taxation treaties increase foreign direct investment to developing countries?," Journal of Development Studies, Taylor & Francis Journals, vol. 43(8), pages 1501-1519.
  5. May Elsayyad, 2012. "Bargaining over Tax Information Exchange," Working Papers bargaining_over_tax_infor, Max Planck Institute for Tax Law and Public Finance.
  6. Elsayyad, May & Konrad, Kai A., 2012. "Fighting Multiple Tax Havens," Munich Reprints in Economics 13964, University of Munich, Department of Economics.
  7. Rixen, Thomas, 2008. "The institutional design of international double taxation avoidance," Discussion Papers, Research Unit: Global Governance SP IV 2008-302, Social Science Research Center Berlin (WZB).
  8. Rixen, Thomas & Rohlfing, Ingo, 2005. "The Political Economy of Bilateralism and Multilateralism: Institutional Choice in Trade and Taxation," MPRA Paper 325, University Library of Munich, Germany, revised 2005.
  9. Davies, Ronald B., 2003. "Tax Treaties, Renegotiations, and Foreign Direct Investment," Economic Analysis and Policy (EAP), Queensland University of Technology (QUT), School of Economics and Finance, vol. 33(2), pages 251-273, September.
  10. Bruce A. Blonigen, 2005. "A Review of the Empirical Literature on FDI Determinants," NBER Working Papers 11299, National Bureau of Economic Research, Inc.
  11. Arjan Lejour, 2014. "The Foreign Investment Effects of Tax Treaties," CPB Discussion Paper 265, CPB Netherlands Bureau for Economic Policy Analysis.
  12. Daniel Millimet & Abdullah Kumas, 2007. "Reassessing the Effects of Bilateral Tax Treaties on US FDI Activity," Departmental Working Papers 0704, Southern Methodist University, Department of Economics.
  13. Bruce A. Blonigen & Lindsay Oldenski & Nicholas Sly, 2011. "Separating the Opposing Effects of Bilateral Tax Treaties," NBER Working Papers 17480, National Bureau of Economic Research, Inc.
  14. Bruce A. Blonigen & Lindsay Oldenski & Nicholas Sly, 2014. "The Differential Effects of Bilateral Tax Treaties," American Economic Journal: Economic Policy, American Economic Association, vol. 6(2), pages 1-18, May.

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