Home bias and cross border taxation

Abstract

The relationship between cross border taxation and free float home bias is examined. This explicitly recognizes that insider shares are unavailable to foreigners. Other important explanations for home bias – information asymmetry, behavioural and governance issues – are controlled when examining the impact of cross border tax variables. In our sample of countries about sixty percent (eighty percent) withhold taxes on realized capital gains (dividends) of foreign investors and about thirty percent of the mature economies provide imputation of taxes paid on dividend income by domestic corporations. Dividend imputation is a statistically significant impediment to cross border equity flows. A tax credit variable for foreign taxes paid on dividends is constructed and found to be statistically significant in reducing home bias. A relatively high foreign tax rate that cannot be offset by tax credits is found to significantly increase home bias. These results hold for float adjusted home bias and traditional international portfolio home bias.