Tax-Induced Investor Behaviour in International Capital Markets: Theoretical Foundations, Empirical Evidence, and Implications for Tax Policy and Treaty Design

The differential taxation of dividends and capital gains has long been recognized as a potential determinant of investor portfolio choice. The dividend clientele hypothesis posits that investors sort themselves into portfolios of dividend-paying or growth stocks according to their relative tax treatment. This article reviews the theoretical foundations and (empirical) evidence relating to tax-induced dividend clienteles across developed and emerging markets and finds substantial support for the hypothesis. It extends the analysis to the international context by examining how differential taxation under domestic tax rules and bilateral tax treaties may influence not just capital allocation but also the volume and volatility of cross-border equity flows. It concludes that greater tax neutrality between dividends and capital gains deserves serious policy consideration, subject to the constraints of treaty design, market frictions, revenue implications and the role of tax incentives in attracting risk capital.