The true art of the tax deal: Evidence on aid flows and bilateral double tax agreements

Of a total of 2,976 double tax agreements (DTAs), some 60% are signed between a developing and a developed economy. As DTAs shift taxing rights from capital-importing to capital-exporting countries, the latter inherently benefit more from the agreements. In this paper, we argue that capital exporters use foreign aid to incite capital importers into signing DTAs. We demonstrate in a theoretical model that in a deal, one country does not trump the other, but that the deal must be mutually beneficial. In the case of an asymmetric DTA, this requires compensation from the capital-exporting country to the capital-importing country. Examining DTAs that are signed between donor and recipient countries between 1991 and 2012, and using a fixed effects Poisson model, we find that bilateral foreign aid commitments increase by 22% in the year of the signature of a DTA. Evaluated at the sample mean, this translates into around US six million additional aid commitments in a DTA signatory year.