Reassessing the Effects of Bilateral Tax Treaties on US FDI Activity

Despite substantial evidence that foreign direct investment (FDI) is influenced by taxation, the impact of bilateral tax treaties on FDI is surprisingly unclear. We provide a simple theoretical framework illustrating why the impact of tax treaties may be heterogeneous across the distribution of FDI, and thus why focusing on the average effect of tax treaties may be misleading. We then assess the empirical relevance of such heterogeneity by estimating the quantile treatment effects of tax treaties on US inbound and outbound FDI using panel data from 1980-1999. Our results are striking, and consistent with our expectations. We obtain positive effects of tax treaties at lower quantiles of the distribution of FDI, but negative effects in the upper quantiles. Moreover, while the negative effects are substantially larger in absolute terms relative to the positive effects, the two effects are roughly equivalent in percentage terms.