|WHT rate of country $i$ -<br>1/r*WHT rate of other<br>countries||-2.33<br>(4.95)||-7.09*<br>(5.01)||-12.54***<br>(3.03)|
|---|---|---|---|---|---|---|
|Time effects|yes|yes|yes|yes|yes|yes|
|Country-specific SD|2.40|2.42|2.40|2.42|2.40|2.42|
|Measure-specific SD|2.08|2.07|1.26|1.35|0|0|
|Idiosyncratic SD|1.43|1.41|1.50|1.47|1.09|1.06|
|Observations|1550|1550|1550|1550|1550|1550|

Estimates on the covariance structure suggest that around 40 percent of the unexplained variation is related to partner‐country specific factors while a third is related to measure‐specific factors.<sup>25</sup> Although we incorporate this information in our estimation approach, the coefficients are estimated with major imprecision, likely owing to the limited variation in tax rates and multicollinearity. The observed magnitude of the estimates reported in columns (1), (3), and (5) is unconvincing. It suggests an increase in the overall tax base as a result of a country level increase in the withholding rate. We therefore introduce an additional restriction to enhance the plausibility of our estimates.

Specifically, we incorporate the assumption that an increase in any tax rate does not increase the overall tax base of the affected income measure. Intuitively, the overall tax base does not increase in response to policy changes if the (negative) own‐price elasticity exceeds the (positive) cross‐price elasticity ‐ the substitution effect. A sufficient condition for this requirement can be stated as the linear restriction _a+r*b=0_ , where r is the ratio of average capital transfers to other countries, relative to capital transfers to some country with the smallest such transfers.<sup>26</sup> We incorporate the restriction in columns (2), (4) and (6), by replacing the tax variables with a combined � rate, defined by ������� ∗������ , and using the ratios r(div)=1.58, r(int)=16.71 and r(roy)=1.60, ���� which are based on income flows in 2014. The implied own price semi‐elasticities are close in magnitude to own‐price elasticities estimated before. Cross‐price elasticities then follow from the restriction. We use these in the calculation of revenue effects in the following sub‐section.

# **3.3 Direct revenue effects of WHT rate reductions**

Our estimation results presented above suggest strong own‐ and cross‐tax elasticities, meaning that income flows with all partner countries respond to changes in the withholding tax rate with any one specific country. More specifically, we find that country‐specific income flows tend to decrease following an increase in the relevant withholding tax rate. This effect reduces the simple mechanical revenue gain

> 25 The measure‐specific error component in royalty outflows is estimated to be marginally negative. We thus restrict this component to zero in estimating other error components.

> 26 Using linearized income streams, the condition of no‐tax‐base‐increase in response to higher tax rates translates � into: ��∗������∗ ��� ∑��� �����������0 in the case of constant cross price elasticities. From this, the ∑��� ���� � sufficient condition _a+r*b=0_ follows with �� ~~.~~ We use a weighted average in our empirical application. ��� ����

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