No 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 focuses on how bargaining can affect the withholding taxes set under the treaty. 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. This theory is then tested using 1997 data from U.S. bilateral tax treaties. Overall, the data supports the prediction that greater asymmetric FDI activity increases the negotiated tax rates. Baker (1994). For additional discussion on some of the primary goals and issues of tax treaties, see Blonigen and Davies (2000). JEL 2Tax treaties are often viewed as a remedy for tax competition. Under bilateral tax treaties, withholding taxes, tax definitions, and relief methods are chosen jointly by the treaty partners.1 In the rubric of game theory, tax treaties move taxation from non-cooperative tax competition to a cooperative setting. Because these policies are now set cooperatively, it is tempting to believe that they eliminate tax competition, however this presumption is misleading since the terms of the treaty (and the distribution of the gains from treaty formation) must be bargained over. If countries differ in their preferred treaties, then there remains unresolved conflict which will be played out through the negotiating process. Thus, rather than eliminating tax competition, tax treaties change the nature of the competition. Recognizing the patterns of this bargaining has important implications for understanding the potential of tax treaties.This paper makes a first attempt at modeling the conflicting goals in treaty formation by presenting a simple bargaining framework. The implications of the model are then tested using 1992 data from bilateral tax treaties with the United States. On the whole, we find that treaty-specified withholding taxes vary in a systematic way which is consistent with our simple bargaining model. In particular, our results highlight the importance of asymmetries in bilateral FDI activity between the two countries. As the size of this asymmetry grows the scope for cooperation is decreased and the negotiated tax rate is higher. We find similar implications for relative country size. These results 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. Since highly asymmetric countries may also engage in the sorts of severe tax competition discussed by Bond and Samuelson (1989), this suggests that in those situations where a cooperative tax treaty may be most beneficial, it may also be the most difficult to agree upon.The difficulties arising from tax competition are well known (see Wil...

Country-of-origin reputations are endogenized in this paper and it is shown that otherwise identical countries can be correctly perceived as differing in their percentage of high-quality producers. These self-fulfilling reputations determine not only the average quality of a country's exports but also the type of products in which a country specializes. Hence, the pattern of international trade can be determined by this "reputational comparative advantage." An inferior country-of-origin reputation leads to lower national welfare, therefore, several trade and industrial policies that can improve country-of-origin reputation are examined.JEL Classification: F12, F13, J71, L15

Bilateral international tax treaties govern the host country taxation for the vast majority of the world's foreign direct investment (FDI). Of particular interest is the fact that the tax rates used under these treaties are gradually falling although the treaties themselves do not specify any such reductions. Since there is no outside governing agency to redress treaty violations, such reductions must be both mutually beneficial and self-enforcing. Furthermore, the optimal tax rates must be less than those initially set, otherwise no reductions would be necessary. To explain such behavior, we model a two-country setting with two-way capital flows. In particular, only part of FDI is immediately reversible. As the extent of irreversibility increases, the likelihood of Pareto optimal tax rates obtaining as a self-enforcing outcome in the initial period is reduced. More modest tax reductions, from the non-treaty levels, are still possible. These limited tax reductions generate an increase in bilateral FDI. As countries increase the stock of capital in one another, further reductions in taxes become self-enforcing. Depending on the extent of irreversibility and asymmetry, Pareto optimal tax rates may be obtainable in the long run. Thus, the amount of inbound investment a country can attract may be related to the commitment to which its outbound investment binds it. This final insight provides an additional rationale for the observed pattern of capital flows in which those countries with the greatest outbound capital flows are also those with the highest inbound flows.JEL Classification: F21, F23, F13, C73.