Tax Treaties Spread Because Countries Compete, Even When They Lose Revenue

Why This Question Matters

Fabian Barthel and Eric Neumayer examine why so many countries sign bilateral double taxation treaties (DTTs) even when some states—particularly net capital importers—stand to lose tax revenue under the residence-based rules typical of these agreements. DTTs are important because they shape cross-border investment incentives and national tax bases, so understanding why they spread speaks directly to debates on tax competition and the political economy of foreign direct investment (FDI).

What the Authors Argue

The authors contend that DTT diffusion is driven by strategic interdependence among states: countries face a prisoners’ dilemma. While a collective refusal to sign would protect tax revenues for net capital importers, each country has a unilateral incentive to sign a DTT to attract or retain FDI and gain a competitive edge. As a result, governments look to the treaty choices of other countries and follow suit.

Data and Empirical Approach

• The analysis uses a global dyadic dataset covering the period 1969–2005 and models the likelihood that two countries conclude a DTT.
• The empirical strategy explicitly tests for spatial dependence in treaty adoption, assessing whether prior DTT activity by (a) regional peers and (b) competing countries—defined by similarity in export product structure—raises the probability that a given dyad will sign a treaty.

Key Findings

• There is clear evidence of spatial dependence in DTT diffusion: dyads are more likely to sign DTTs the more their regional peers have already concluded such treaties.
• Competition matters: prior DTTs among countries that compete with at least one dyad member in terms of export product structure also increase the likelihood of a new treaty.
• These patterns support the prisoners’-dilemma logic: states copy treaty behavior to avoid competitive disadvantage, even when individual treaties can be fiscally costly for net capital importers.

What This Means for Policy and Research

The findings illuminate how international tax agreements can proliferate through emulation and competitive pressures rather than through unilateral welfare-improving choices. This helps explain the growing density of the global DTT network and highlights a structural tension between attracting FDI and protecting domestic tax bases—an issue that matters for tax policy, international economic governance, and research on policy diffusion.