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The growing international campaign against tax evasion

The most recent G20 summit led to a multilateral agreement to facilitate information sharing between tax agencies, with the US currently negotiating bilateral tax treaties with the tax havens of Switzerland and Luxembourg. But before celebrations begin, this column points out that cracking down on tax evasion comes at a cost. International investment may well suffer.

One of the few solid agreements that came out of the latest G20 summit in Cannes was that governments will increase their cooperative efforts to curb tax evasion. The agreement, called the Convention on Mutual Administrative Assistance in Tax Matters, allows national tax agencies to request greater amounts of information from foreign governments on the activity of multinational enterprises and private citizens that are otherwise outside their authority to monitor. Under the new agreement, countries can choose voluntarily to transmit tax information about foreign parties in bulk to their resident country’s tax agency. There are also provisions of the convention that will require nations to assist in the recovery of foreign tax claims if a business or individual is in noncompliance.

Several leaders of G20 nations cited reports from the OECD that recent efforts to reduce tax evasion have resulted in more than $14 billion of additional tax revenue being collected, with hints that there are much greater amounts of offshore tax liabilities yet to be collected. With mounting government debt in most nations, the incentives for them to reduce tax evasion are clear.  But if we take a closer look, this may be just the next step in the ongoing efforts of developed countries to recapture lost revenues by multinational firms.  In particular, most bilateral tax treaties include similar requirements for cooperation in sharing of tax information between the two governments. The signing and renegotiation of tax treaties has proliferated in recent decades and Easson (2000) reports that there are nearly 2,500 treaties in force worldwide. The current US activity on tax treaties is also telling.  The US Senate has pending agreements with Switzerland and Luxembourg, two countries that are typically on lists of tax havens, and in June of this year the US Treasury Department announced a plan to renegotiate its tax treaty with Japan, where provisions for information sharing are relatively weak. Deterring tax evasion has long been a priority for governments in coordinating the international tax system.

Despite the recent attention, information-sharing provisions of tax treaties are typically not the first attributes touted. The stated goal of the OECD and UN model for tax treaties is to limit the incidence of double taxation and promote efficient flows of capital in the world economy through the coordination of tax rules and definitions.  For this reason, prior studies of the effect of tax treaties on the FDI activity of multinational enterprises have expected to find positive impacts. 

Yet finding systematic evidence of such positive effects has proven elusive.  Di Giovanni (2005) fails to observe any significant impact of tax treaties on cross-border mergers and acquisitions, while Louie and Rousslang (2008) find no evidence that tax treaties affect US firms’ required rates of return from their foreign affiliates. Likewise, Blonigen and Davies (2004, 2005) do not find any discernable effect of tax treaties on US and OECD FDI activity. There is some evidence provided by Davies et al (2009) that the number of firms entering a foreign country grows once a new treaty is signed. But many more studies support the conclusion that foreign investment flows do not appear to take advantage of the double-taxation relief afforded by tax treaties.

The lack of evidence that tax treaties impact foreign investment flows between treaty partners is surprising because there is a clear relationship between foreign capital flows and tax rates. Papke (2000) finds that the elasticity of reported foreign earnings to differences in withholding taxes rates is near -1, indicating a tight relationship between the location of reported income and the tax liabilities across countries. Furthermore, Hines and Rice (1994) find that real aspects of multinational firm operations, such as the location of production, employment, and equipment purchases, also respond to differences in tax rates across countries.

In recent work (Blonigen et al 2011) we provide an answer to the puzzling insignificant effects of tax treaties and find it is rooted in the tax-sharing provisions of tax treaties, which are intended to reduce tax evasion and, thus, can have a negative influence on FDI activity. Our premise is that firms in industries which use relatively homogeneous inputs will be most affected by the information-sharing provisions of tax treaties, since arms-length prices for intermediate goods are easily verified in these industries once tax authorities share information and can verify activity across MNEs’ affiliates.  In contrast, firms that use fairly differentiated and specialised inputs will retain a much greater ability to mitigate their tax liabilities across countries by engaging in strategic transfer pricing.  

We look across more than two decades of investment activity by US multinational firms, spanning 73 different industries and more than 150 countries. During the time span of our sample, 1987–2007, the US signed several new tax treaties, and renegotiated agreements to increase the degree of information sharing with several existing treaty partners.

The evidence strongly supports that provisions for tax-information sharing, such as those included in recent G20 convention, can alter the pattern of international investment activities. For a firm with average use of homogeneous inputs, increased cooperation between national tax agencies when a tax treaty is put into place is associated with a gross reduction in the firm’s foreign affiliate sales by $26 million per year.  Looking at the US economy as a whole, this equates to an estimated reduction of outbound investment activity of $2.29 billion annually. We also find that tax-sharing provisions of tax treaties lead to gross reductions in the number of firms that choose to invest in countries for the average industry as well. 

We do estimate a positive impact of the other features of the tax-treaty agreements, which counterbalances the negative effects from the information-sharing provisions. For the average firm in our sample the average net impact of tax treaties on FDI activity is positive.  Yet, it is clear from our analysis that the negative effects of the information-sharing provisions of tax treaties are large and a main reason why prior studies have puzzlingly found little evidence for any effect of tax treaties on FDI.

Final thoughts

International policy can obviously pursue many different goals.  Our research suggests that governments may be pursuing tax treaties just as much to reduce tax evasion as to promote more efficient international capital allocation.  The recent economic troubles seems to have focussed governments even more on the short-run goal of capturing tax revenues, apparent from the G20’s recent signing of the multilateral Convention on Mutual Administrative Assistance in Tax Matters. However, agreements that allow for greater information sharing between governments deter multinational enterprises from engaging in foreign investment in the first place.  It seems that the longer-run policy goal of facilitating international investment has taken a back seat in recent accords.


Blonigen, Bruce A and Ronald B Davies (2004), “The Effects of Bilateral Tax Treaties on US FDI Activity", International Tax and Public Finance, 11(5):601-622.

Blonigen, Bruce A and Ronald B Davies (2005), “Do Bilateral Tax Treaties Promote Foreign Direct Investment?”, in J Hartigan (ed.), Handbook of International Trade, Volume II: Economic and Legal Analysis of Laws and Institutions, Blackwell Publishers, 526-546.

Blonigen, Bruce A, Lindsay Oldenski, Nicholas Sly (2011), “Separating the Opposing Effect of Bilateral Tax Treaties”, NBER Working Paper No 17480.

Davies, Ronald B, Pehr-Johan Norback, and Ayca Tekin-Koru (2009), The Effect of Tax Treaties on Multinational Firms: New Evidence From Micro-Data", The World Economy, 32(1):77-110.

di Giovanni, Julian (2005), “What Drives Capital Flows? The Case of Cross-Border M&A Activity and Financial Deepening", Journal of International Economics, 65(1):127-149.

Easson, Alex (2000), “Do we still need tax treaties?”, Bulletin for International Fiscal Documentation, 54:619-625

Hines, JR Jr. and EM Rice (1994), “Fiscal Paradise: Foreign Tax Havens and American Business”, Quarterly Journal of Economics,109:149-182.

Louie, Henry J and Donald J Rousslang (2008), “Host-Country Governance, Tax Treaties and US Direct Investment Abroad", International Tax and Public Finance, 15(3):256-273.

Papke, Leslie E (2000), “One-Way Treaty with the World: The US Withholding Tax and the Netherlands Antilles”, International Tax and Public Finance, 7(3): 295-313.

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