Abstract
We examine the effect of compliance frictions in reclaiming foreign withholding taxes on Foreign Portfolio Investments (FPI) using a comprehensive panel of FPI stocks of 83 countries, including EU Member States, between 2005 and 2019 and country-pair specific withholding tax rates. We find a negative and statistically significant elasticity of the FPI stock of equity and debt holdings to “overwithheld” withholding taxes. The estimated elasticities imply that a 1 percentage point reduction in “overwithheld” withholding taxes increases the FPI stock of equity holdings by 1.5%. In a second step, we employ a general equilibrium model to quantify the macroeconomic implications of compliance frictions. In absence of costs in the withholding tax refund process, average GDP in the EU countries would increase by 0.26% (equivalent to EUR 46 billion in 2024), while capital and wages would rise by 0.72% and 0.26%, respectively, suggesting noticeable macroeconomic costs arising from such compliance frictions.