Investor home bias and sentiment about the country benefiting from the tax revenue

This paper provides a novel tax behavior explanation for investor home bias. Specifically, we show that investors are reluctant to hold foreign equity with a tax levied by a foreign tax collector. Starting point is the observation that willingness to pay taxes depends on the attributes of the tax collecting country. This relationship indicates a form of country-specific tax behavior: taxpayers respond to country attributes as they indicate cooperative and trustworthy behavior of tax authorities, the government or other taxpayers. We conduct a laboratory investment experiment to explore the effect of sentiment towards different tax collectors, specifically of the view on home country taxation relative to foreign country taxation. The results suggest that investors prefer domestic equity and invest in riskier portfolios in case of a foreign tax rather than a domestic tax on foreign dividend income.

► This paper provides a tax behavior explanation for investor home bias. ► We conduct a laboratory investment experiment with variation of tax collectors. ► Investors prefer domestic equity with a foreign tax on foreign dividend income.