Economic Modelling 122 (2023) 106244

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Economic Modelling
journal homepage: www.journals.elsevier.com/economic-modelling

Trade, investment and size inequalities between countries and the

asymmetry in double taxation agreements
Janusz Kudła a, *, Katarzyna Kopczewska a, Monika Stachowiak-Kudła b
a
University of Warsaw, Faculty of Economic Sciences, Długa 44/50, 00-241, Warsaw, Poland
b
Warsaw School of Economics, Madalińskiego 6/8, 02-513, Warsaw, Poland

A R T I C L E I N F O A B S T R A C T

Handling Editor: Sushanta Mallick The inequalities among countries and their bilateral relationship affect the asymmetry of rules in double taxation
agreements. The asymmetry in rules appears when one country prefers tax credit while another country
JEL classification: exemption, for the same type of income. According to the literature, the inequalities involve trade, investment
H25 relations, economy size and tax competition. However, the relative importance of these factors for the design and
H87
asymmetry of tax treaties is not recognised well. To address this problem we use ANOVA, Hierarchical Linear
K33
Model and Ordered Logistic Regression with spatial lags on the sample of tax treaties from large European
K34
countries. The most important factor for low asymmetry is the intensity of bilateral trade. The differences in
Keywords:
countries’ wealth and taxation increase asymmetry but they are of less importance. These findings help to
Double taxation agreements
Tax competition improve the negotiation of tax treaties and spur bilateral cooperation, especially when differences among
Economic asymmetry countries are substantial.
Tax credit
Tax exemption
Tax treaties

1. Introduction
The paper strives to investigate the application of asymmetric rules
in double taxation agreements (DTAs) to balance the inequalities in
foreign investment, trade, size of economies and harmful tax competi­
tion. The double taxation agreements are aimed at the prevention of
cross-border discrimination of investments and supporting bilateral in­
vestments through the alleviation of international double taxation. In­
ternational double taxation occurs when two countries impose taxation
on the same income or assets. There are also opinions that signing a DTA
facilitates access to information about the foreign investment of do­
mestic entities (Keen and Ligthart, 2006) and counteracts international
tax avoidance. In this last view, the avoidance of excessive (double)
taxation or effective allocation of capital are a secondary matter (Chisik
and Davies, 2004b; Davies, 2004). The agreement is the most effective
when bilateral investments are high because it lowers the possibility of
withdrawal from the agreement, as the second party can ‘punish’
tax-related investments made by the first party (Chisik and Davies,
2004a). DTAs allow for a more restrictive policy of taxing multinationals
as they involve the setting of common rules by two countries.1 For
example, Hearson (2018b) showed that British officials used tax treaties
to disseminate the common Organization for Economic Co-operation
and Development (OECD) standards to constrain other countries’ abil­
ity to tax inward investment. It required the abolishment of rules that
were better fitted to benefit British enterprises. Finally, the network of
tax agreements decreases the cost of channelling corporate income from
one country to another, making foreign direct investment (FDI) more
profitable (Petkova et al., 2020). The reasons listed above indicate that
bilateral relations have to be sufficiently intensive to justify the
assignment of a treaty. The signed treaties are relatively hard to be
terminated because they provide at least some informational value to
involved parties. Therefore, even strong but transitory events inducing
an increase in protectionism (e.g., Covid 2019 pandemic) should not
affect them substantially.
If countries decide to sign a DTA, they must negotiate the double
taxation avoidance methods which are applied to different types of

* Corresponding author.
E-mail addresses: jkudla@wne.uw.edu.pl (J. Kudła), kkopczewska@wne.uw.edu.pl (K. Kopczewska), mstachowiak@poczta.fm (M. Stachowiak-Kudła).
1
Haufler et al. (2018) postulate a similar effect for cooperative settlement of thin capitalization and controlled foreign company rules that should be higher than
set in a non-cooperative way.

https://doi.org/10.1016/j.econmod.2023.106244
Received 3 March 2022; Received in revised form 19 February 2023; Accepted 20 February 2023
Available online 1 March 2023
0264-9993/© 2023 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/).
J. Kudła et al.
assets and income. In general, they can choose between tax credits and
tax exemptions but the particular rule can be different for different types
of income or assets. Tax exemption means that income from foreign
investments is not taxed while tax credit assumes that foreign income is
taxed like domestic income but allows for the subtraction of tax paid
abroad. The subtraction cannot be larger than the tax due in the country
of investment origin. The tax exemption fosters an increase in capital
outflow. Thus, every difference in taxation between the two countries
should affect the decision to invest abroad. In countries favouring tax
credit, the capital outflow should be smaller because owners of capital
sometimes have to pay additional tax, if the domestic tax rate is higher
than the tax rate in the host country. As long as taxation in the host
country is lower than the domestic tax, the latter does not affect the
decision to invest abroad. Therefore, widespread tax credits can be
treated as a means to protect against excessive capital export (Becker
and Fuest, 2011) and harmful tax competition. Therefore, any increase
in protectionism should lead to more frequent use of the tax credit rule at
the expense of the tax exemption rule. Conversely, using an exemption
instead of tax credits may be desirable from a political point of view if
governments strive to intensify capital flows. The tax credit is more
demanding for tax administration but potentially offers higher tax rev­
enues and better information about the international operations of do­
mestic entities. The exemption is cheaper for tax administration but
implies lower revenues and worse information about foreign in­
vestments. This trade-off permits a choice of different general double
taxation avoidance rules by different countries.
The chosen rules can be symmetric (the same rule applied to income
or assets in both countries) or asymmetric (different rules in both
countries). Asymmetry can be triggered by the application of the method
preferred by one country with a partner preferring the alternative
method, or it can be set strategically for other deliberate reasons. The
symmetric rules should be preferred as it treats income and assets in
both countries equally, not discriminating against the investments of
either party of the treaty. The asymmetric rules are reasonable if poli­
cymakers would like to limit the perceived advantage of the other party
or to equalise the business conditions for inflowing or outflowing
investments.
The reasons behind the use of asymmetric rules are not explicit and
they are also not well-recognised in the literature on DTAs. Therefore,
we propose a new and original quantitative approach to model this
issue. The results of the modelling shed some light on the reasons for the
diversification of tax provisions and their relative importance. This
further contributes to the understanding of the reasons driving the
policies in international relations. The relationships between countries
are rarely equal as countries differ in size, economic development,
preferred policies and attractiveness for foreign investment. The DTA’s
regulations can mitigate these inequalities by providing some provision
for the tax treatment of income or assets coming from another country.
Such compensation is not unique, for example, Sanz-Córdoba (2020) has
noticed that infrastructure investment and productivity-enhancing pol­
icies are used as strategic substitutes for capital taxation. Moreover,
attractive infrastructure increases the effectiveness of policy preventing
tax-motivated profit shifting (Pieretti and Pulina, 2020). A similar effect
can be obtained through the deliberate shaping of the rules included in
DTAs, limiting of competitive advantages of other countries. This role is
particularly important when other political tools (like tariffs and
non-tariff barriers) are not available. Particularly, the latter situation
applies to countries forming an economic union with a free flow of
capital and trade.
This motivated us to investigate the bilateral double taxation
agreements of six relatively large countries (France, Germany, Italy,
Poland, Spain, and the United Kingdom) with other members of the
European Union. We analyse only countries from one region of the world
(Europe) because it ensures intensive investment and trade relationships
between countries, due to low transportation costs and similar institu­
tional conditions. It is important because the need for signing a DTA and
2
Economic Modelling 122 (2023) 106244
detailed tax provisions depend on the intensity of bilateral relations. It
excludes countries located further away because their economic re­
lationships are small (especially with the smaller nations of Europe)
which affects both the existence and the content of tax treaties.2 If re­
lationships are not intensive, then the need for signing a DTA is low or
countries prefer the use of general rules without detailed provisions.3
We decided to investigate countries belonging to the European Union
in2017.4 It was the last year before the implementation of the OECD
Multilateral Convention to Implement Tax Treaty Related Measures to
Prevent Base Erosion and Profit Shifting (Multilateral Instrument, MLI).
We decided to not consider provisions of MLI, which entered into force
on July 1, 2018. The MLI modifies existing tax treaties by adding new
regulations and replacing the existing ones (Kleist, 2016). There are two
reasons for excluding MLI: 1) the multilateral convention is general and
not country-specific, and 2) there is no evidence of its implementation
yet because only a fraction of countries has ratified it.
The choice of members of the EU is important because the Com­
munity Law harmonised regulation on investment and trade but did not
affect DTAs signed among countries. It increases the importance of the
DTAs as a tool for compensating inequalities in investment and taxation,
particularly for cases not regulated by Community Law. It was also
important for our study to include countries with diversified economies.
The diversification of an economy increases the need for detailed rules in
DTA, providing higher differentiation of applied rules. It inspires us to
consider highly populated countries because their economies are more
diversified compared to countries with smaller populations. Finally,
because we also investigate tax avoidance, it is important to omit
countries perceived as tax havens. For example, the Netherlands was
excluded from the sample because of the special tax treatment of
multinational holdings (Weyzig and van Dijk, 2009) which classifies this
country as a “conduit country”. A conduit country facilitates the transfer
of income to other law regimes with low taxation through the beneficial
treatment of incoming transfers and the network of tax treaties with
other countries. It affects not only the policy of the Netherlands but also
the policy of their tax treaty partners, making the Netherlands’ a special
case.
Based on the existing literature, we can formulate three hypotheses
referring to the three groups of factors affecting the shape of double
taxation agreements: intensiveness of relations, differences in econo­
mies and investments and tax competition.
Intuitively, one can expect that intensive tax competition and higher
differences in economies and bilateral investments favour the asym­
metry of rules. This is because the asymmetry is introduced to mitigate
the benefits resulting from comparative advantages or tax preferences
offered by one party of the DTA. However, the relative strength and
cause of these factors are unknown. Moreover, these factors are modi­
fied by the insensitivity of bilateral relations. We formulate the
following three hypotheses:
Hypothesis 1. If the relations between the home and host country are
weak, then the concord choice of rules is of minor importance and each
country can choose the preferred method of tax avoidance (tax exemp­
tion or tax credits). The asymmetry in such a case should be undeter­
mined (it can be high or low).
If the international relations between countries are not intensive,
then the diversification of tax rules is redundant. A country can choose
2
For example, Japan has no tax treaty with Cyprus, Greece, and Malta and
only recently (2017) signed tax agreement with Estonia.
3
The general rule means the rule (tax credit or exemption) applied to income
or assets received or possessed by residents of one country in another country if
the given income or assets are not on the list of detailed provisions. The detailed
provision includes items for which the opposite rule should be applied. The
general rules also can be discordant, if one country applies a tax credit and the
other - an exemption.
4
The United Kingdom exited the European Union in 2021.
J. Kudła et al.
the preferred method of tax avoidance or agree to the same method as
preferred by the second country. This is because we are close to the
situation when a DTA is not necessary because of rare bilateral relations.
Contrary to this, the intensification of international cooperation (deep­
ening globalisation) increases the number and type of relations,
affecting the complexity of tax treaties positively. This is because the
need for investment protection becomes more important, and the need
for regulatory autonomy is less important (Montal et al., 2020). Insen­
sitivity of relations can also affect the structure of taxation, for example,
the taxation of dividends can depend on the share of a foreign investor’s
ownership (Petkova, 2021).
Hypothesis 2. If relations between countries are asymmetric (e.g., one
country’s economy is large and the second is small) or the benefits of the
agreement are asymmetric (one country’s benefits from the investment
are larger than the other), then the rules should be asymmetric.
Several scenarios can be considered here. For example, tax credits
capture some tax benefits of international investment flows. This is more
important for large or more affluent countries for which relations with
small countries are not so important. For a small country, a relationship
with a large country is more important, so the exemption should be
chosen more eagerly. Similarly, small countries should prefer exemp­
tions in relations with other small countries (Dickescheid, 2004). These
different choices should yield higher asymmetry in tax agreements,
where less developed countries agree to reduce the withholding tax rates
on outgoing dividends and interest payments to promote foreign in­
vestment (Janský and Šedivý, 2019), trade (Pham et al., 2019) or
financial aid (Braun and Zagler, 2018). There is evidence that the switch
from fully equal investments between countries to only
one-side-investment raises the withholding tax by five percentage points
in German double taxation agreements and affects the definition of
permanent establishment (Rixen and Schwarz, 2009). However, similar
research on a sample of tax treaties between developed and developing
countries reveals that these effects are moderated by the size of the
government’s revenue base and its reliance on corporate tax (Hearson,
2018a). Some non-economic factors can also affect the asymmetry of
rules, e.g., the differences in a country’s power or knowledge and the
bargaining skills of negotiators involved in signing a tax treaty (Allee
and Peinhardt, 2014; Kangave, 2009).
Hypothesis 3. If tax competition intensifies (diversification of tax
burden on corporate income or assets in both countries is substantial)
then asymmetry increases because countries negatively affected by tax
competition choose tax credits over exemptions and countries with low
taxation still prefer exemption.
Some types of incomes are especially liable to switch (like dividends,
royalties or interests) when differences between countries in taxation
rates increase. Countries negatively affected by tax competition should
prefer tax credits to control the income of their residents investing
abroad (Gordon, 1992). The exemption is not resistant to tax competi­
tion, so the symmetry obtained by tax exemptions should be more
frequent when tax competition is low. Exemption of income is particu­
larly preferred by small countries, according to the theory of asymmetric
tax competition (Bucovetsky, 1991; Peralta and van Ypersele, 2005;
Rixen, 2011; Haufler and Stähler, 2013), to attract income and invest­
ment from large countries. As Mongrain and Wilson (2018) showed,
small countries are inclined to choose the preferential tax regime and
when the distribution of moving costs of firms is non-uniform, the
preferential regime may dominate. This can enhance a larger country to
increase the asymmetry of rules in tax treaties to minimize the harm
caused by the tax competition of a smaller country. (The general idea is
shown in Fig. 1).
To test the hypotheses, we applied a statistical approach with
ANOVA, Hierarchical Linear Model (HLM) and an econometric
approach with ordered logistic regression models (OLR). The ANOVA is
used to examine whether double taxation avoidance rules can be used to
group the countries according to their economic performance – this is to
3
Economic Modelling 122 (2023) 106244
Fig. 1. The factors affecting the asymmetry of rules in double taxation agree­
ments and their expected impact.
check whether there are visible differences between countries with
different DTAs provisions. HLM works similarly to ANOVA but allows
for a hierarchy of explanatory variables and their inter-dependence (in
ANOVA they are assumed independent). The ordered logistic regressions
are used to indicate variables affecting the probability of higher asym­
metry in tax treaties. Auxiliary, only to identify whether the relation­
ships can be non-linear, we use box plots. Statistics allows for detailed
insight into relations between data, while econometrics generalises
these relationships. In selected regression models we included spatially
lagged variables to capture spatial effects. The use of spatial methods is
becoming more popular in the study of double taxation agreements. For
example, Barthel and Neumayer (2012) and Neumayer and Plümper
(2010) focused on the decision of signing a tax treaty as an effect of
mimicking the behaviour of a country’s neighbour. Hearson (2018a)
investigated the probability of signing a treaty between developed and
developing countries and other spatial studies concentrated on the
impact of tax treaty rules on FDI (Azémar and Dharmapala, 2019).
However, according to our knowledge, spatial models have not yet been
used to investigate asymmetry in tax treaties.
The contribution that this paper provides to the literature also in­
cludes a quantitative identification of the reasons affecting the content
of Double Taxation Agreements and the assessment of their importance
(see Fig. 1). The main results of our research indicate that the intensity of
bilateral relations (and especially the intensity of bilateral trade) is
crucial for the asymmetry of rules in DTA. In general, based on the
regression results, the higher bilateral FDI and trade stimulate higher
symmetry of rules. The imbalance of FDI spurs higher asymmetry in DTA
when inward investments are larger than outward investments. In other
words when the larger (first) country is more attractive to investment
than the smaller (second) country. The differences in size measured by
the Gross Domestic Product (GDP) are less important and work in the
opposite direction than differences in the average affluence of countries
measured by PPS per capita. A large difference in GDP size decreases
asymmetry, while a large difference in affluence increases it. One can
guess that a small country is more willing to approve the proposition of a
large country if differences are limited to country size and conversely, a
large country can approve any rules with a small country because it is
not affecting its economy much. The differences in affluence affect the
benefits from bilateral investments so a poorer country can agree to the
preferred treatment of investments from a wealthier country. Evidence
on the impact of tax competition on asymmetry is limited. Only when
J. Kudła et al.
the diversification of tax rates among countries is substantial, can one
observe higher asymmetry; but the number of observations is too small
to conclude unambiguously. Nevertheless, this observation is in line
with the theory of asymmetric tax competition. In a small country, the
benefits of a preferential tax regime can be so high that the government
of this country is not able to withdraw tax preferences even if other
countries respond with retaliation.5
The paper is structured as follows: in the first section, we discuss the
economic purposes of signing double taxation agreements. The next
section describes the data and variables used in the ANOVA, a Hierar­
chical Linear Model and Ordered Logistic Regression. In the fourth
section, we model the differences in tax treaties. Finally, we present the
results of the analysis. The paper ends with a brief discussion of the
implications of the study for policymakers.
2. The economic purposes of signing double taxation
agreements
Investigation of double taxation agreements (DTAs) requires un­
derstanding the reasons for signing this type of international treaty. This
is not trivial because DTAs generate at least some contradictions with
their declared purposes.
For the first time, an economic analysis of double taxation rules was
presented formally by Koichi Hamada (1966). He showed that double
taxation treaties could improve the situation of countries competing in
equilibrium. However, market conditions usually mean that capital ex­
porters lose on this. The use of DTAs makes sense only for large coun­
tries, which can thus share the benefits of the impact on the price of
global capital. However, in small countries (i.e., countries that do not
affect the global rate of return on capital), DTAs do not bring benefits for
effective capital allocation. These arguments indicate that we can expect
less diversified DTAs when at least one small country is involved in the
agreement. In such a case the main source of asymmetry can be the
preference for one of the double taxation avoidance rules.
The unilateral exemption is worse than a lack of exemption if
countries maximise their domestic welfare and do not want to share tax
revenues with foreign countries (Whalley, 2011). Therefore, agreements
with asymmetric rules should be rare but as one can see from the study
sample, about 41% of treaties apply different general rules (see details in
the Appendix). Attempts to explain this phenomenon usually relate to:
maximising global welfare instead of national, the differences in the
monitoring costs of domestic and foreign incomes (to the detriment of
the latter), or the limited possibilities of withdrawal from the agreement
because of fear of retaliation by the other party. Moreover, the use of tax
credits at similar tax rates in both contracting countries does not lead to
welfare improvement and is unreasonable from an economic point of
view. For example, if a country of origin would like to promote in­
vestments of its entities abroad, it can apply an exemption of foreign
income from taxation without any international agreement
(Davies, 2004). In small countries, taxation does not change the profit­
ability of capital, while the presence of foreign investments stimulates
excessive taxation. Therefore, in a non-cooperative equilibrium of two
small economies applying source taxation, the maximisation of national
welfare requires exemption as a rule (Dickescheid, 2004). This result is
different from that obtained by Davies (2003) for large countries. A
country is large if taxation does affect the profitability of capital. Tax
credits should be preferred in large countries as it affects the global rate
of return on capital. The tax credit choice is also supported by compe­
tition from many countries offering lower taxation of capital
(Scharf, 2001) and by the maximisation of national income when
compensatory payments (between countries) or harmonisation of tax
rates are not available (Janeba, 1995).
5
Some evidence of such a resistant’s strategies of small countries provides
Crasnic (2020).
4
Economic Modelling 122 (2023) 106244
The referred arguments indicate that DTAs are unnecessary, inef­
fective for FDI, or even harmful to domestic welfare. This paper proposes
a broader view of the reasons for signing DTAs as a tool not only for
attracting FDI but also for reducing tax and size inequalities6 that affect
bilateral relationships.
There are several empirical studies on the rules used in tax treaties.
Loretz (2007) uses data on effective taxation between OECD countries to
confirm the preference for tax credits by countries with a high GDP and
relatively high taxation of capital. He showed that countries prefer tax
exemption over tax credits because the latter does not require interna­
tional negotiations. Based on probit analysis, the probability of signing a
double taxation treaty depends on the average distance between coun­
tries and the sum of their GDPs. Both factors transpire to be essential but
they are only responsible for around 5% of the change in the likelihood
of establishing a DTA. Contrary to this research, our analysis does not
concern the probability of signing a DTA.
Chisik and Davies (2004b) investigated the impact of asymmetry
between countries signing double taxation agreements on the level of
tax rates on the data of US affiliates’ sales and FDI stocks. A greater
asymmetry between countries favours higher taxation at source,
regardless of the type of regulated payments (dividends, royalties, in­
terest, etc.). The taxation in a country can be set high if the response of
the other country would not be very harmful to the investment abroad.
This is possible when the investments of both countries are asymmetric.
Formally, it stems from the occurrence of two effects of a DTA. The first
effect is the reduction of withholding tax levied by the other party,
which makes it easier to invest abroad, but at the expense of tax reve­
nues obtained by a foreign country. The second effect is related to the
reduction of administrative and tax control costs, and it is always pos­
itive for both parties. The level of tax rates is also dependent on tax
exemption for foreign income, and tax exemption by one of the countries
fostering a decline in withholding tax rates. Contrary to the described
paper, our study treats tax rates as determinants of the rules included in
a DTA and we left aside sales of affiliates focusing analysis on macro­
economic data.
Several other empirical studies have checked the impact of tax credit
or tax exemption rules on the size of foreign direct investments and their
localisation (Nguyen, 2019; Egger et al., 2009; Bénassy-Quéré et al.,
2005; Mills and Newberry, 2004; Gorter and Parikh, 2003). The syn­
thesis of this stream of research is a meta-analysis conducted by Mooij
and Ederveen (2003). However, this part of the literature is not related
to the asymmetry in tax treaties.
3. Asymmetry and the variables used for analysis
Our sample consists of 147 DTAs and one case without a double
taxation agreement (France- Denmark) in the form valid for 2017, be­
tween six highly populated countries (Germany, Poland, France, Italy,
Spain, and the United Kingdom) and 27 European countries - members
of the European Union at the time. We analyse the consistency of the
general rule and nine detailed rules which affects the asymmetry. The
dataset is a complex system of information. The dependent phenomenon
– asymmetry of DTAs - is a set of variables. It includes in total 10 dummy
variables for 9 individual detailed rules and general rule (0-the same
rule, 1-different rules), while the asymmetry variable is a total of 9
dummies for individual rules (asymmetry = 0 means all individual rules
between two countries are the same). The same value of asymmetry can
6
For example, Canada benefited from the United States tax credit rule due to
the inflow of US investments and the possibility of applying relatively high
national taxation (without outflow of investors to the US). At the same time,
Canada lost revenues on taxes imposed on passive income of various types, as
they were taxable to the recipient in the United States. The associated income
flows were larger in the direction to the United States than to Canada because of
the different sizes in the economies (Davies, 2004).
J. Kudła et al.
result from differently defined DTAs (e.g. asymmetry = 4 can result from
dissimilarities in 4 different rules, theoretically 4 rules can be selected
out of 9 rules on more than 1.5 thousands ways).
The preliminary analysis of DTAs in the sample reveals some inter­
esting asymmetries. Germany and Poland prefer exemption, while
France, Italy, Spain, and the United Kingdom prefer tax credit as a
general rule (see Tables A.1-A.6 in Appendix). Tax exemption, as a
general rule, was applied in 16 treaties from Poland, 15 from Germany,
11 from France, nine from Italy, seven from Spain and six from the UK.7
If we consider the nine types of income, namely business profits, divi­
dends, interest, royalties, alienation of property, independent personal
services, pensions, director’s fees and entertainers, the variable Asym­
metry is defined as the number of inconsonant detailed rules in each DTA
(see the final columns in Tables A.1-A.6 in Appendix). This number can
vary from 0 to 9. The value 0 means no difference in rules, and this is the
most common situation covering 41 cases in the sample. The value 9,
representing the full difference, appears only once when there is no DTA
(Denmark-France).
The lowest discrepancies involve dividends (8 inconsistent cases out
of 121), royalties (16 cases) and interest (19 cases), while discrepancies
in other income categories exceed, on average, 50 cases. The most
common rules in these three types of income are tax credit, if the
ownership share is small, and exemption, if the ownership share tres­
passes a threshold limit. The rules of taxation applying to these types of
income are important for investments, so it is in line with the expecta­
tion that they should not be differentiated to foster higher bilateral
investments.
The fundamental question in this study is the relation between the
economic and institutional performance of countries and legal differ­
ences in DTAs between countries. The set of variables used in the study is
extensive and represents the relations between country characteristics.
The variables are chosen to illustrate the country’s performance and
relations – in investment and import/export, GDP, affluence, and tax
competition (described below). We set the first country as one of the six
large countries (Germany, France, Italy, Spain, Poland and the United
Kingdom) and the second country as a partner in the EU or the UK. In
some pairs, the second country is a country from the first group (e.g.,
Germany with France where Germany is the first country and France the
second country). The most appropriate would be the use of variables
that were valid at the time of signing an agreement. Unfortunately, it is
not possible because there is no such data on international investment
and trade relations that are consistent and complete. For example,
complete data on FDI from OECD are available since 2013, the data
about trade since the beginning of the 1990’s and data from Eurostat
since 1995; while most European DTAs were signed before 1990.
Moreover, treaties are sometimes modified, so there is a problem
whether the data from the year of the last change or the year of a DTA
signing should be chosen. However, the factors potentially affecting the
content of the treaties are changing slowly, and similarly, the changes in
the latter are not frequent. Therefore, we built our analysis on the
assumption that, in the long run, treaties are adjusting to the economic
factors, and represent a compromise, balancing the interests of countries
even if they possess different bargaining power. It allows the comparison
between the rules and economic factors at one time to find some asso­
ciations or interdependences.
We strive to capture the relative validity of the relations, so some
variables are related to the GDP of the first or second country. All the
variables are divided into four groups:
a) Variables illustrating the intensity of bilateral relations between
countries: absolute incoming foreign direct investments (FDIinward)
7
Each country can have 26 treaties with other members of the EU or the
United Kingdom, for example, 20 treaties of the United Kingdom use tax credits,
as a general rule.
5
Economic Modelling 122 (2023) 106244
in the first country and absolute outgoing foreign direct investments
(FDIoutward) in the first country. These variables indicate the
importance of bilateral FDI. The sum of export and import (Expimp)
captures the insensitivity of trade. The values of these variables are
calculated on the reports of the first country. Another variable, the
distance between the capitals of countries (Distance), is a proxy of the
potential intensity of other relations – generally, a higher distance
means higher transportation cost which limits the number of actual
bilateral connections.
b) Variables determining the inequalities between countries include
the net difference of FDI to the GDP of the second country (FDI.net­
diff.relative), a net difference of FDI to the GDP of the first country
(FDI.netdiff.in.first.GDP), the absolute value of trade balance related
to the GDP of the first country (Tradebalanceabstogdpfirst), the dif­
ference in purchasing power standard per capita measured as an
absolute value of the difference between GDP in Purchasing Power
Standard per capita (PPSdiffabs), and the relative size of GDP
calculated as the maximum relation of nominal GDP between two
countries in market prices (Sizerelation). These variables refer to the
differences in size and affluence affecting the economic relations (e.
g., the capital flows are more likely to be from the richer partner to
the poorer one, and from larger to smaller rather than vice versa).
c) Variables capturing the tax competition calculated as an absolute
value of differences in tax rates between countries for personal in­
come tax (PITdiffabs) and effective average tax rate (EATRdiffabs).
The first measure captures the differences in personal taxation, while
the second covers the intensity of tax competition and the possible
profitability of avoidance strategies by entrepreneurs. The tax dif­
ferences are proxies for the tax competition and profit-shifting
(Nerudova et al., 2023). Effective Average Tax Rate (EATR) pro­
vides the measure of the tax burden for a hypothetical investment
considering not only tax rates but also a definition of the tax base and
rules of amortisation in a country (Devereux and Griffith, 2003). It is
valid for the assumed form of investment financing (e.g. own capital
or debt). The EATR values are provided by ZEW (Leibniz-Zentrum für
Europäische Wirtschaftsforschung in Mannheim) and frequently used in
the analysis of taxation (e.g., Hristu-Varsakelis et al., 2011). We
decided to omit the corporate income tax variable because it is less
informative than EATR and the absolute value of tax wedge differ­
ence as the latter depends on the marital status and the demographic
structure of a society.
d) Variables describing the differentiation of double taxation
avoidance rules in individual categories of income or property.
These are dummy variables for country pairs, where 0 means the
same double taxation avoidance rule and 1 means different rules.
The following items were collected: General_rule, Business_profits,
Dividends, Interest, Royalties, Alienation_of_property, Inde­
pendent_personal_services, Pensions, Director’s_fees, and Entertainers.
The General rule measures the concordance of the main rules used in
the DTAs, while the next nine variables compare the rules for
different types of income or property. The General rule affects the
asymmetry measure because the rules which are not determined in
other ways reveal the same concordance as the General rule. The
General rule increases Asymmetry when inconsistent (equals 1) and
decreases it when consistent (equals 0). The differences in the impact
of economic variables on Asymmetry and General rule are presented in
the two last columns of Table 1, where common variance is analysed.
In the regressions, the General rule is used as a control variable. It
captures the asymmetry in rules stemming from general preferences
for the exemption or the tax credit. If all economic factors are irrel­
evant, then the whole asymmetry is caused by the discordance of the
General rule. There are also differences not determined by the general
rules and we tried to explain them in regressions using economic
factors.
e) We also constructed spatially lagged explanatory variables, which
are used in some statistical analyses. They include information from
J. Kudła et al. Economic Modelling 122 (2023) 106244

geographical neighbourhood to capture the distance-dependence

Asymmetry
and over-border relations. They involve all variables from the: a, b,

Model 3
and c groups above, but without, the variable Distance. These vari­
ables are identified by the ‘lag’ at the end of their names. In some

*
*
.
graphical analyses, the application of variables of different sizes is
not convenient, so we present the results on normalised variables
Model 2

General
rule
(these variables are transformed by subtraction of mean and division
by standard deviation). These variables are identified by the ‘norm’

.
at the end of their names.
Entertainers

It is worth underlining that this study refers much more to associa­

tions than causal relations. First, DTAs are stable legal contracts and are
.
rarely renegotiated (even if this is possible). Secondly, one cannot expect
.
that a particular DTA may change significantly the properties of the
economy of a given country. Thus, we are to explain the existing
Director’s

asymmetry in DTAs, while conclusions may be used to fine-tune existing

fees

contracts or design new ones.

The trade data was collected from the World Integrated Trade Solution
Pensions

Database. The trade data can reveal the true importance of bilateral
relations because FDI is less dependent on current international relations
**
*

and less sensitive to transaction costs. It should be noted that trade

.

variables are counted for 2017, and in most cases, they do not refer to
Independent_personal_services

the time when a DTA was signed. Moreover, exports and imports
declared by a given country are not the same as reported by the coun­
terpart due to errors, omissions and different definitions of exports and
imports.8 We assume that the relative importance of countries in trade is
relatively stable over time (despite the increasing volume of trans­
actions). The data about FDI is taken from the OECD database and re­
flects the investment between countries in 2017. Dispersion of FDI is
higher than that of trade because making a direct investment in a
*

country located far away is easier than trade due to the transportation
Alienation_of_property

cost. This cost is negligible for long-term investments.

FDI data describes the relations which are partially subsidiary and
partially complementary to the trade, but unfortunately, it includes
many gaps. The geographic distances between capitals are calculated
Significance of factors in ANOVA – Sum of Squares of type III in three models for normalised variables.

using flight (orthodromic) distances, from online calculators and the

economic data is taken from the Eurostat database. To avoid operating
**

*
.

on too many variables, we decided to work on selected variables

Royalties

extracted from a broader group of variables measuring the differences in

economies, the intensity of bilateral relations and tax competition
***
***
***

**
*

measures. For example, this broader group includes the relation to the
second country’s GDP instead of the first, variables presenting the di­
Interest

rection of asymmetry, and the absolute values of measures or their

***

relative values. Most of these omitted variables are highly correlated

with the final variables subsequently used in the analysis. We dropped
Dividends

them because they do not provide more valuable insight into the
problem.
*

Below we present the statistical analysis of dependent (Fig. 2a) and

explanatory (Fig. 2b) variables. The variables concerning double taxa­
Business_profits

tion avoidance rules generally show a significant positive correlation

(Fig. 2a), only for a dividend is this correlation negative (but insignifi­
cant). This means the countries predictably construct their DTAs. High
correlations in Fig. 2a mean that if countries A and B agree on rule 1 then
Significance: *** 0.001; ** 0.01; * 0.05;. 0.1.

they agree on rule 2. Asymmetry is generated by all rules except for

Dividends, Interest and Royalties DTAs Our question is how this regu­
Model 1

General

larity can be explained. In a group of explanatory variables, one observes

rule

***
*

varying correlations, both positive and negative, weak and strong

(Fig. 2b). Stronger correlations are visible in groups referring to the
FDI.netdiff.in.first.GDP.norm

same economic factors (like bilateral investments or trade).

Tradebalanseabstogdpfirst.

FDI.netdiff.relative.norm
Explanatory variables:

Dependent variable:

4. Modelling the differences in tax treaties

FDI.outward.norm

EATRdiffabs.norm

Sizerelation.norm
FDI.inward.norm

PPSdiffabs.norm
PITdiffabs.norm
Distance.norm
Expimp.norm

We have used several statistical and econometric techniques to

norm
Table 1

8
E.g., sometimes re-export is treated as an export from a given country.

6
J. Kudła et al. Economic Modelling 122 (2023) 106244

Fig. 2. A. Correlation of variables for the tax treaty rules. Fig. 2B. Correlation of variables for explanatory variables and their spatially lagged values.

7
J. Kudła et al.
determine which variables are interrelated with double taxation
avoidance rules, especially with asymmetry. This a complex problem as
the dependent phenomenon is not a single variable but a set of variables.
Therefore, we search for associations rather than for causality. We apply
multidimensional methods to possibly best capture the non-obvious
regularities. The statistical approach, including analysis of vari­
ance (ANOVA) and hierarchical linear model (HLM), is to find the
factors (here the tax rules) that separate different groups within the
target variable (here the economic performance of countries). If sub­
groups with diversified distributions exist (e.g. subgroups of low/high
values), then the factors should distinguish them. ANOVA and HLM are
interpreted in terms of associations: if e.g. GDP distribution (of all
countries) can be divided by some factor into two different GDP distri­
butions (in subgroups of countries), then we say that GDP level matters
for the factor value. Both methods allow for more than one grouping
factor. There are two major differences between ANOVA and HLM: the
first one lies in the independence of grouping factors, while the second
one in the hierarchy (multilevel) of factors, by introducing fixed and
random effects. ANOVA assumes that the grouping variables are inde­
pendent and on the same hierarchical level. HLM allows for interde­
pendence among grouping factors and for the mixture of fixed and
random effects. Both are used to identify the relations between double
taxation avoidance rules and theirasymmetry, and economic variables.
This statistical analysis is augmented by an econometric approach,
including linear regression, a spatial lag model (SLM) and two or­
dered logistic models, ordinary and with spatially lagged variables.
The ordered logistic regression fits the investigated problem because the
dependent variable Asymmetry is categorical and can take 10 values
representing all levels of possible asymmetry. OLS is used here as a
benchmark. Spatial lags are to control a geographical neighbourhood of
countries.
The purpose of the modelling in the first stage (with ANOVA and
HLM) is to determine the differences between countries related to
double taxation avoidance rules. From a modelling point of view, this is
a complex system of interdependence between rules of avoidance and
economic factors. Precisely, we would like to determine to what extent a
particular double taxation avoidance rule’s concordance is related to the
level of economic factors and whether separate groups can be distin­
guished by economic variables. What is more, one may expect non-
linearity in taxation rules, which should be detected with in-depth sta­
tistical analysis. We decided to use:
− y1 ∼ x1 …xn – the ANOVA model investigating the association be­
tween tax avoidance concordance rules x1 … xn (considered jointly)
on the chosen economic processes represented by variable y1.
ANOVA (Analysis Of Variance) examines the extent to which it is
possible to distinguish coherent groups concentrated around the
mean value of a variable. The homogeneity of these groups is tested
by evaluating the variance of the data around the mean – if mean
values in subgroups differ (and this difference is more than the
standard deviation), then we consider the difference as significant.
The result of ANOVA is a sum of squares (SS) (deviations) within and
between groups. The high (between) intergroup SS (understood as
between-group heterogeneity) and the low (within) intragroup SS
(within-group homogeneity) demonstrate the existence of distinct
groups. When the sums of intragroup and intergroup squares are
equal, we treat the data as belonging to one group. The F-test for
variance determines the significance of these differences. In multi-
factor ANOVA, the most convenient to interpret are marginal
squared sums of type III as they are independent of the order of
variables and take into account interactions between variables
(Kuznetsova et al., 2017). The interactions refer to tax avoidance
concordance rules as the other economic variables are not present in
this approach. The analysis (Table 1) is provided on normalised data
and includes three models (detailed rules concordance and asym­
metry and General rule concordance).
8
Economic Modelling 122 (2023) 106244
− y1 ∼ 1| x1 …xn – the hierarchical linear model (HLM) measures the
association between tax avoidance concordance rules x1 … xn
(considered jointly) on chosen economic process yn (for each y1, ….,
yn we calculate a separate model). HLM is an extension of ANOVA.
Contrary to ANOVA, the HLM models the fixed effects resulting from
explanatory variables (economic variables) and random effects as
controls (tax avoidance concordance rules) and allows for a nesting
hierarchy of variables. HLM allows for inter-relatedness (correlation)
of explanatory factors (McNeish et al., 2017). The results of HLM are
interpreted by the shares of variance explained by a given variable.
The final stage includes ordered logistic regression to explain the
drivers of the asymmetry of rules in DTAs. Regression is used to identify
the direction and significance of impact triggered by economic variables
on the asymmetry of double taxation avoidance rules. Ordered logistic
regression provides information about the increasing or decreasing
probability of asymmetry. As a robustness check, we apply Ordinary
Least Squares (OLS) regression. The ordered logit is applied because the
dependent variable Asymmetry is multilevel and discrete – the model
explains the probability of a given (from 0 to 9) level of asymmetry
considering the economic performance of two countries. Additionally,
we present box plots to disclose the possible non-linear effect of some
economic variables - for example, moderate differences in tax rates can
be irrelevant for a small level of asymmetry but can be reversed for large
differences when countries are perceived as engaging in harmful tax
competition. This is a reliable way to deal with non-linearity.
Econometric models, ordered logistic regression and OLS, were
extended by adding spatially lagged variables which include informa­
tion from the geographical neighbourhood. We consider this an impor­
tant novelty as the neighbourhood interactions of countries and over-
border similarities may matter in DTAs. The spatially lagged variables
(labelled with lag in the name) are derived with the use of a contiguity
spatial weights matrix W. This matrix assumes that neighbours are the
countries that share the border. The spatially lagged variable expresses
the arithmetic average of values from the neighbourhood. In the case of
islands or neighbours from outside the sample, the spatial lag of the
given variable equals 0.
The results of different types of analysis should be treated as com­
plementary, not substitutive, as they focus on various aspects of
modelled relations. Modelling this complex system of interdependencies
requires diversified approaches, which are capable of capturing non-
obvious relations. The proposed methodological solutions turned out
to be the most efficient ones among a wide menu of statistical and
econometric tools which were tested to solve this problem.
5. The results of modelling
Table 1 presents subsequent ANOVA models in rows, in which eco­
nomic variables are explained by the General rule and a set of tax
avoidance concordance rules for different types of assets or income
(Model 1). The penultimate column presents the results only for the
General rule (Model 2) and the last column only for Asymmetry (Model 3).
Asterisks point out the significance of taxation policies in the analysis of
type III sums of squares (i.e., regardless of the order of variables in the
model). Significant tax policies (with asterisks in a table) are the factors
that separate the groups of countries due to their economic performance.
Interpretation of Table 1 results is as follows: if the explanatory variable
(factor in a column) is significant in a given model (in rows), then the
value of the economic variable (in rows) matters for the similarity of
DTAs (in columns).
Discussing the results of specific double taxation avoidance rules, the
most significant variables are the rules relating to Royalties. Royalties are
linked to FDI and differences in personal income tax rates, but also to the
trade balance, so they cover variables from all three groups of factors
that can affect asymmetry. Interest is related to differences in personal
income tax rates, while Dividends to the EATR differences. It can indicate
J. Kudła et al.
that this group of rules is under the pressure of tax competition. The
other rules are not associated with taxation differences or the grouping
effect remains small (the latter refers to the Alienation of property and
Entertainers). The variables referring to the differences in bilateral trade
relations affect the Royalties and Alienation of property rules. In the
context of the stated hypotheses, the differentiation in terms of divi­
dends, royalties and interest rules is related to the intensity of bilateral
relations and tax competition, while the impact of inequalities between
countries is of lesser importance. This is in line with expectations
because the tax structures including royalties, interest and dividends are
frequently used for tax avoidance and minimisation of tax liabilities.
If we look at the general rule solely (without considering the indi­
vidual double taxation avoidance rules) in the penultimate column, only
inward FDI and differences in wealth per capita (PPSdiffabs) are signif­
icant. Finally, if we consider only Asymmetry, it is related to the intensity
of bilateral relations and differences in size and affluence between
countries, but not to the tax competition variables.
Table 2 shows the results of the hierarchical linear model. Estimated
models for consecutive economic variables are presented in the col­
umns. Only the random effects are reported as they refer to the
concordance of avoidance rules. The fixed effects are omitted as they
refer to the set of economic variables (they were controlling for inter-
dependency between economic factors). Each model considers the full
set of tax policies with Asymmetry and the General rule. It should be
stressed that HLM may yield different results than ANOVA due to
possible correlations between explanatory factors (economic variables),
embedded hierarchy and the use of random and fixed effects. In HLM the
focus is on the proportion of explained total variance by a given
grouping factor (represented by random effects - related to avoidance
rules concordance) when the other economic variables are present (fixed
effects, controls). Interpretation of Table 2 results is as follows: if the
explanatory variable (factor in a column) is significant in a given model
(in rows), then the value of the economic variable (in rows) matters for
the similarity of DTAs (in columns), when controlling for inter-
dependency of economic variables and hierarchy of impact. The
higher the proportion of explained variance, the more influential the
factor in the separation of groups of similar countries. (Asterisks in the
table represent the degree of explained variance.)
The Royalties are the most prominent and significant in six different
models. There is no significant impact for such double taxation avoid­
ance rules as Director’s fees and Business profits. Most economic variables
are related to between one and three tax avoidance concordance rules -
except the Expimp, which is related to four rules.
Table 2
Hierarchical linear model (HLM) – random effects.
Dependent Intensity of relations Tax competition
variables:
Explanatory Distance Expimp FDI. FDI. PITdiffabs
variables: inward outward
General.rule * .
Interest . ***
Royalties . ** *** *** ***
Alienation.of. . .
property
Independent. ***
personal.
services
Director.s.fees
Entertainers . **
Pensions ***
Business.
profits
Dividends
Asymmetry **
Note: Asterisks illustrate the share of a factor in total variance, greater than 0%, intervals are as follows: 2% * 5% ** 10% *** 20%.
Economic Modelling 122 (2023) 106244
Asymmetry is a grouping variable for Expimp, EATRdiffabs and
Tradebalnseabstogdpfirst – countries with a similar degree of similarity
(from 0 to 9) perform similarly economically for these variables. On this
basis, it can be concluded that a high level of trade, a large differenti­
ation in corporate taxation and a trade imbalance contribute to the
differentiation of double taxation avoidance rules. The asymmetry af­
fects the variables from all three groups of factors but is of the lowest
significance for the trade balance. The latter hints that true inequalities
between countries are less important than tax competition and bilateral
trade intensity. This result also indicates that differences in investment
do not affect the content of the treaties as much as trade differences. Due
to the correlations of economic and taxation factors, one can observe the
effect of, “the strongest” variable in the group (intensity of relations, tax
competition and inequality of relations) which becomes significant for
explaining the tax asymmetry.
Finally, we can compare the results of the regression of dependent
economic variables on the Asymmetry dependent variable (Table 3). In
general, all models reveal similar significant variables and consistency
in coefficient signs. The basic source of asymmetry is the concordance of
general rules between countries, which significantly increases the R2 of
models (in the 6th column, the only model without a General rule as a
dependent variable shows the lowest R2 equal to 0.05). Unfortunately,
data about FDI is not complete, so it generates gaps in spatially lagged
variables, and the number of observations drops in these regressions to
121, making these results less credible.
The level of FDI affects asymmetry but inward and outward in­
vestments work in different directions. Greater inward investments in­
crease the asymmetry of rules in a DTA, while greater outward
investments decrease it. The size of this effect is similar for both types of
FDI (inward and outward). Countries with greater outward investments
are likely to be more important for the first country, so the rules will be
more reciprocal than in the case where the first country (in general, a
larger country) is important predominantly for the second country. A
larger country is more attractive as a place for inward investment than a
small one, so this may increase the asymmetry in tax treaties due to
larger-country-bargaining-power. This is similar to the effect observed
between Canada and the United States (Whalley, 2011), with regula­
tions favouring American investors.
Intensifying trade mitigates asymmetry in tax treaties and this is
visible in the sign of spatially lagged variable Expimp. Interestingly, this
is a non-necessarily linear relationship (a very low and very high level of
asymmetry (0,1,9) is associated with low trade values, and a moderate
level of asymmetry (2–5) seems to be associated with high bilateral trade
Inequality of relations
EATRdiffabs PPSdiffabs Sizerelation Tradebalanseabstogdpfirst FDI. FDI.
netdiff. netdiff.
relative in.first.
GDP
***
**
***
** . ** .
***
*
.
*** *
9
J. Kudła et al. Economic Modelling 122 (2023) 106244

Table 3
Results of the regression models (values of continuous variables are standardised).
Dependent variable: Ordinary Least Ordinary Ordered logistic Ordered logistic Ordered logistic Ordered logistic regression
Asymmetry Squares with spatial Least Squares regression with regression regression without without General rule and
lags spatial lags General rule country dummies
Explanatory variables:

Distance − 0.33* − 0.2. − 0.67* − 0.34 − 0.13 − 0.37*

Expimp − 0.53. − 0.06 − 1.29* − 0.42 -*0.52 − 0.3
FDI.inward 0.94 0.78* 1.87. 1.24. 1.7** 1.22*
FDI.outward − 0.93. − 0.62 − 1.87. − 1.15. − 1.82** − 1.54*
PITdiffabs 0.2 0.23 0.34 0.33. 0.27 0.24*
EATRdiffabs 0.1 0.1 0.06 0.08 − 0.33 − 0.13
PPSdiffabs 0.18 0.22. 0.41. 0.39* 0.28 0.33*
Sizerelation − 0.18 − 0.31** − 0.73. − 0.81** − 0.57** − 0.48**
Tradebalanseabstogdpfirst 0.22 − 0.03 0.52 0.16 0.57** 0.51
FDI.netdiff.relative − 0.01 − 0.17 − 0.31 − 0.47* − 0.44* − 0.4.
FDI.netdiff.in.first.GDP − 0.55* − 0.17 − 0.81 − 0.28 − 0.59* 0.41
Expimp.lag − 0.35. − 1.1*
FDI.inward.lag 0.26 0.6
FDI.outward.lag 0.23 0.18
PITdiffabs.lag − 0.08 − 0.28
EATRdiffabs.lag 0.05 0.37
PPSdiffabs.lag 0.14 0.26
Sizerelation.lag − 0.32 − 0.64.
Tradebalanseabstogdpfirst. − 0.06 0.1
lag
FDI.netdiff.relative.lag − 0.01 0.01
FDI.netdiff.in.first.GDP.lag 0.32 0.28
Spain − 1.27.
France − 0.09
Italy − 1.18*
Germany 0.15
United Kingdom − 1.48*
General rule 4.82*** 4.72*** 7.98*** 5.89***
Constant 0.59*** 0.69***
R2 or Pseudo R2 0.82 0.79 0.41 0.33 0.07 0.05
Observations 117 162 121 162 162 162

Significance: *** 0.001; ** 0.01; * 0.05; . 0.1.

– Fig. 3). The intensity of bilateral relations is more visible for trade than
for direct investment. Perhaps, trade better reflects the importance of
close relations between countries than FDI, which may be more
geographically dispersed (occurring in countries with which a given
country does not have strong relations) and more random (direct in­
vestments are less susceptible to transaction costs compared to foreign
trade). This confirms hypothesis 1, that low-intensity trade and invest­
ment relations favour the choice of a very large or small asymmetry,
which probably means that a given country chooses the preferred
method of avoiding double taxation, and this method may be convergent
or different from that used by the second country. If the relations are
intense, the rules are more carefully negotiated and more differentiated.
Finally, the very high level of bilateral trade lowers asymmetry because
it points out that economies are very similar and the same provisions are
beneficial to both parties of agreement to the same extent.
The differences in size or affluence also affects DTA rules. The dif­
ference in affluence PPSdiffabs increases asymmetry in most models (the
exception is the OLS regression with spatial lags and OLR with country
dummies) but the size of this effect is relatively low. The analysis of the
box plot reveals that for the lowest level of asymmetry (0–2), the

Fig. 3. Expimp and the level of asymmetry.

10
J. Kudła et al.
difference in affluence is particularly low (Fig. 4). Contrary to this effect,
the relative size of economies (measured in GDP) is negatively related to
the asymmetry, so treaties with small countries (measured by the GDP)
are concordant in the applied rules of both parties. This relation seems to
be linear. The intuitive explanation behind this result is that greater PPS
per capita means a more diversified economy and requires different
provisions to cover specific relations. It should be noted that spatially
lagged Sizerelation is also significant and negative in the OLR with
spatial lag.
The results of regression point out the insignificance of tax variables.
Only in the models without the General rule (the last column in Table 3),
PIT’s absolute difference is significant at the 5% level; but this model
does not control for the preference of countries in one of the double
taxation avoidance rules. In general, we cannot identify the clear di­
rection of effects generated by this group of variables. This result is in
line with the results of ANOVA. However, we know from the HML that at
least EATRdiffabs can be used to group treaties concerning the level of
asymmetry. Therefore, the insignificance of this variable can be an effect
of the non-linear impact of taxation differences on the avoidance rules
(negligible for small taxation differences and substantial for large dif­
ferences). Indeed, analysis of the EATRdiffabs box plot (Fig. 5) confirms
various effects on asymmetry concerning the level of taxation differ­
ences. It is especially evident for the high level of Asymmetry (value 7–9)
where the value of this variable is higher than a moderate or low level of
asymmetry (0–6).
Similarly, for PITdiffabs, the value of this variable is higher for a level
of asymmetry between 7 and 8 (Fig. 6). The asymmetry of level 9 is
different but includes only three cases (treaties between France and
Ireland, the lack of a treaty between France and Denmark, and the treaty
between the United Kingdom and Belgium), so it is atypical.
The obtained result suggests that the existence of tax competition
could have an impact on the content of double taxation agreements but
only for the large differences in tax rates. For small differences, the
asymmetry of double taxation avoidance rules remains low, and the
differentiation of tax burden is not confirmed by the regression results. It
can indicate that countries have a high level of tolerance for govern­
ments granting tax preferences to entities in one of the contracting
countries and they react only when the differences are substantial. In the
latter situation, the rules cease to be symmetrical to limit the tax ad­
vantages offered by one of the parties to the agreement.
6. Conclusions and policy implications
This study confirmed that the variables representing all three groups
Fig. 4. PPSdiffabs and the level of asymmetry.
11
Economic Modelling 122 (2023) 106244
of factors have an impact on the asymmetry of double taxation avoid­
ance rules. However, the importance of these groups is not the same. The
most important group is the intensity of trade and investment relations
where trade is more important for asymmetry than investments (ac­
cording to the HLM results). This suggests that DTA rules are more suited
to the specific interests of the countries involved in the agreement.
We can guess what the reasons behind this result are. Probably one of
the important factors is favourable business environment. The investi­
gated countries cooperate intensively in the European Union (the UK
exit the European Union in 2021) establishing the free movement of
goods, capital, services and persons. These freedoms intensify relation­
ships between all members, reducing costs of trade and investments and
stimulating the development of more detailed DTAs. On one hand, the
quality of bureaucracy is another factor that may contribute to the
greater use of detailed provisions in tax treaties. A tax administration
can deal with complicated rules only if it is adequately effective which is
more likely in the developed countries signing a treaty. On the other
hand, we know that high quality bureaucracy stimulates international
investments, so the impact can be reciprocal (Busse and Hefeker, 2007).
The inequalities of countries signing a DTA is the second most
important group. The relative size of countries and differences in
affluence may be associated with taxation differences, as small and
poorer countries usually prefer lower levels of tax burdens to attract
capital and limit the outflow of workers abroad. However, these factors
affect asymmetry differently. The differentiation of citizens’ wealth fa­
vours higher asymmetry while differentiation in the size of the GDP of
countries favours lower asymmetry. Several explanations arise here. In
the case of differences in wealth, the treaties may be more asymmetric to
protect the investment benefits of a wealthier country. This result can
also stem from the differences in bargaining power among countries of
different affluence or is a consequence of different structures of econo­
mies at different levels of development. In the case of differences in GDP
size (but not affluence), the number of bilateral relations is limited and
thus leads to the simplification of DTA rules. The absolute value of this
effect is lower, not only from the variables representing the intensity of
bilateral relations but also from the effects related to the GDP difference.
Perhaps, the effect is weakened for countries in the region with rela­
tively small differences in affluence.
Tax competition is the third most important group. Particularly, tax
variables are not significant in regressions and, according to the ANOVA
and HLM results, they refer mainly to rules applied to Royalties and In­
terest. Probably, the impact of tax competition on tax treaty rules is non-
linear, as we can guess from the observation of box plots. For a low level
of asymmetry, the tax competition (measured by taxation differences) is
J. Kudła et al.
Fig. 5. EATRdiffabs and the level of asymmetry.
Fig. 6. PITdiffabs and the level of asymmetry.
moderate but for large asymmetry (seven or more) it increases rapidly.
One can conclude that a country’s government establishes other double
taxation avoidance rules if tax competition is evident than when tax
differences are on an average level. This observation supports the
statement of Rixen (2011), that changes in the tax regime are solely
insufficient to suppress harmful tax competition.
Referring to the hypotheses set out in the introduction, the first hy­
pothesis is true. The regression result confirms the negative relation
between trade turnover and asymmetry but the observation of box plots
reveals that asymmetry is increasing for lower levels of trade. The non-
linear impact of exports/imports confirms that countries with low trade
turnover choose rules in line with their general preferences to double
taxation avoidance rules. It provides either very large or very small
differentiation of avoidance rules (they choose tax credits or tax
exemption according to their general preference). This hypothesis is also
indirectly confirmed by the impact of distance between the capitals,
which indicates lower asymmetry when the countries are further apart.
The regression results indicate that the high value of FDI in a smaller
country decreases asymmetry. The latter can be an indicator of more
intensive and better-balanced investment relationships because one can
expect that a more populated country (ceteris paribus) is potentially
more attractive for investments than less populated ones. Therefore, for
12
Economic Modelling 122 (2023) 106244
low-intensive relations, inward investment should prevail. The second
hypothesis is not fully supported as the empirical evidence is mixed.
Inequality in a country’s size, measured by Gross Domestic Product,
decreases the asymmetry while the difference in affluence measured by
Purchasing Power Standard triggers higher asymmetry. Therefore, one
can expect that only the difference in the level of economic development
increases asymmetry in tax treaties while the difference in the size of
economies is not relevant.
The third hypothesis is not confirmed. Looking at the box plot of tax
variables, we can observe that a higher asymmetry on EATR and PIT’s
differences appears for very a high level of asymmetry (value of Asym­
metry of 7–9. Moreover, the difference in EATR is a grouping variable in
HLM but it does not directly explain the asymmetry of rules. Never­
theless, these results should be treated with caution as they refer to the
relatively small group of 11 DTAs with high asymmetry and they are
supported neither by the ordered logistic regression nor by ANOVA. We
can suppose that, if another country is perceived as engaging in harmful
tax competition, the double taxation avoidance rules are also altered,
providing a higher level of asymmetry; but it would require further
studies to better capture tax competition and the changes in tax treaties
with countries offering preferred tax regimes.
The basic policy implication of this study hints that there is no
J. Kudła et al.
universal principle for assigning tax treaties with symmetric and
asymmetric rules. When the benefits of a treaty are limited to selected
income or assets, a government should extract them by the asymmetry in
tax treaty rules. In this context, the practice of adopting rules that
comply with the general rule preferred by a given country, when bilat­
eral trade and investment relations are scarce, is not optimal. Such a rule
neither provides all benefits, which can be captured by the regulation,
nor is stable over time. It is because, with the intensification and
diversification of relations, such a simple rule generates distortions and
benefits only one of the parties of the treaty. The policy of asymmetric
rules is better at least in the middle run. In the long run, one can expect
that the symmetry of rules should be higher because of the intensifica­
tion of bilateral relations. It creates a space for renegotiation of tax
treaties in the direction of higher symmetry of rules. Similarly, it is
surprising that only high tax discrepancies reveal some asymmetry of
rules in tax treaties. Therefore, it is worth considering a higher differ­
entiation of rules between countries using different tax burdens where
tax difference indicates the possibility of harmful tax competition.
Funding
This research did not receive any specific grant from funding
agencies in the public, commercial, or not-for-profit sectors. The Open
access has been financed by the University of Warsaw.
Credit author statement
Janusz Kudła: Conceptualization, Methodology, Formal analysis,
Investigation, Data curation, Writing – original draft, Writing – review &
editing, Visualization, Supervision, Project administration, Katarzyna
Kopczewska: Methodology, Formal analysis, Writing – original draft,
Writing – review & editing, Monika Stachowiak-Kudła: Investigation,
Data curation, Writing – original draft, Writing – review & editing,
Visualization.
Declaration of competing interest
The authors declare that they have no known competing financial
interests or personal relationships that could have appeared to influence
the work reported in this paper.
Data availability
The dataset is attached to submission as an excel file.
Acknowledgements
Many thanks for valuable comments are due to the participants of the
10th Annual Conference of the Spanish Association of Law and Eco­
nomics (Porto, Portugal, June 27–28, 2019). We are also very grateful to
three anonymous referees and the editors of Economic Modelling for
their detailed comments, which helped us to improve the paper.
Appendix A. Supplementary data
Supplementary data to this article can be found online at https://doi.
org/10.1016/j.econmod.2023.106244.
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