Bilateral Tax Competition and Regional Spillovers in Tax Treaty Formation

This paper investigates tax competition in withholding tax rates signed under double tax treaties between developed and developing countries. We document a decline in average withholding tax rates since 1990 and attribute this trend to tax competition. As opposed to traditional tax competition, where every foreign investor benefits from lower tax rates, tax treaties allow countries to compete bilaterally, cutting tax rates for investors from a specific country and leaving taxes for everyone else unaffected. We test our predictions empirically for the four different types of withholding tax rates on passive income in more than 900 double tax treaties. We find strong support for a positive relationship in withholding tax rates in tax treaties signed by developing countries in relation to the same origin country of investment, supporting the notion of tax competition.