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Asymmetric FDI and Tax-Treaty Bargaining: Theory and Evidence

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Author Info
Ron Davies
Richard Chisik

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

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Find related papers by JEL classification:
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
K34 - Law and Economics - - Other Substantive Areas of Law - - - Tax Law

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

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    Other versions:
  4. Ronald B. Davies, 2003. "The OECD Model Tax Treaty: Tax Competition And Two-Way Capital Flows," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(2), pages 725-753, 05. [Downloadable!] (restricted)
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bruce Blonigen & Ronald Davies, 2004. "The Effects of Bilateral Tax Treaties on U.S. FDI Activity," Asia-Pacific Financial Markets, Springer, vol. 11(5), pages 601-622, September. [Downloadable!] (restricted)
    Other versions:
  2. 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. [Downloadable!]
  3. Ronald Davies, 2004. "Tax Treaties and Foreign Direct Investment: Potential versus Performance," Asia-Pacific Financial Markets, Springer, vol. 11(6), pages 775-802, November. [Downloadable!] (restricted)
    Other versions:
  4. 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. [Downloadable!]
    Other versions:
  5. 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. [Downloadable!]
  6. Bruce Blonigen, 2005. "A Review of the Empirical Literature on FDI Determinants," Atlantic Economic Journal, International Atlantic Economic Society, vol. 33(4), pages 383-403, December. [Downloadable!] (restricted)
  7. Bruce A. Blonigen, 2005. "A Review of the Empirical Literature on FDI Determinants," NBER Working Papers 11299, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Rixen, Thomas, 2008. "The institutional Design of international double Taxation Avoidance," MPRA Paper 8322, University Library of Munich, Germany. [Downloadable!]
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