Competing for Scarce Foreign Capital: Spatial Dependence in the Diffusion of Double Taxation Treaties

Abstract

Recent research suggests that double taxation treaties (DTTs) increase bilateral foreign direct investment (FDI). However, entering such a tax treaty is not unambiguously favorable for both partners if their bilateral FDI positions are asymmetric. Due to the usual bias toward residence-based taxation in DTTs, net capital importers can face a considerable loss of tax revenues when entering these treaties. Nevertheless, there is an ever denser and growing global network of such treaties. This article argues that net capital–importing countries are caught in a prisoners’ dilemma: Collectively, they would be better off refusing to sign DTTs, but each one has an incentive to sign DTTs to gain a competitive advantage. Countries will look toward and be influenced by the policy choices of other focal countries and will follow their DTT activity. We find evidence for such spatial dependence in our analysis of DTT diffusion in a global sample over the period 1969–2005. Dyads are more likely to sign a DTT the more DTTs have previously been concluded by the regional peers of the dyad members as well as by other countries who compete with at least one of the dyad members in terms of export product structure.