The Sovereign Bond Issuance and Tax Competition for Portfolio Investment

This study examines interjurisdictional tax competition aimed at attracting portfolio investments by foreign creditors in sovereign bonds and corporate loans. In each of two jurisdictions, one with lower and the other with higher capital, governments maximize workers’ utility by choosing the volume of sovereign bond issuance to finance public inputs, the tax rate on creditors’ interest income, and the degree of compliance with bilateral treaty provisions concerning information exchange on creditors’ income. Under a bilateral treaty mandating only information exchange, the jurisdiction with initially lower capital tends to set a lower tax rate and exert less compliance effort, effectively functioning as a tax haven. In contrast, the jurisdiction with higher capital imposes a higher tax rate and demonstrates greater compliance, benefiting from the residence principle due to its substantial global interest income. Alternatively, under a bilateral treaty that combines information exchange with a withholding tax at source on foreign creditors, the two jurisdictions set the same tax rate on domestic creditors. This inadvertently weakens the incentives for the jurisdiction with higher capital to exchange information. These findings suggest that the specific design of international tax cooperation agreements critically shapes jurisdictions’ fiscal behavior, leading to divergent outcomes despite their shared objective of implementing residence-based taxation.