The Impact of Tax Treaties on Foreign Direct Investment: the Evidence Reconsidered

Abstract

The existing empirical literature often reports a non-significant or even negative impact of tax treaties on foreign direct investment. Such mixed evidence stokes controversy over the validity of tax treaties. This paper reconsiders the empirical evidence for the relationship between tax treaties and FDI, using U.S. outbound FDI to 78 countries over the period 2007–2018. Unlike previous studies, this one explicitly controls for differences in the tax environments of recipient economies, including tax haven status, transfer pricing rules, CFC rules, anti-avoidance regulations and corporate income tax rates, in the estimation. Our results confirm the importance of controlling for country-specific tax environments, especially tax haven status and transfer pricing rules, to avoid omitted variable bias. We find that tax treaties positively contribute to FDI inflow in developing countries, while they have no statistically significant impacts to OECD countries. Recently-signed tax treaties still foster FDI but less than older ones do. Finally, our results indicate that, other things being equal, the weaker the transfer pricing regulations, the greater the amount of U.S direct investment into a recipient country.