Capital structure and international debt shifting

This paper presents a model of a multinational firm's optimal debt policy that incorporates international taxation factors. The model yields the prediction that a multinational firm's indebtedness in a country depends on a weighted average of national tax rates and differences between national and foreign tax rates. These differences matter as multinationals have an incentive to shift debt to high-tax countries. The predictions of the model are tested using a novel firm-level dataset for European multinationals and their subsidiaries, combined with newly collected data on the international tax treatment of dividend and interest streams. Our empirical results show that a foreign subsidiary's capital structure reflects local corporate tax rates as well as tax rate differences vis-à-vis the parent firm and other foreign subsidiaries, although the overall economic effect of taxes on leverage appears to be small. Ignoring the international debt shifting arising from differences in national tax rates would understate the impact of national taxes on debt policies by about 25%.     

The theory of optimal taxation: what is the policy relevance?

The paper discusses the implications of optimal tax theory for the debates on uniform commodity taxation and neutral capital income taxation. While strong administrative and political economy arguments in favor of uniform and neutral taxation remain, recent advances in optimal tax theory suggest that the information needed to implement the differentiated taxation prescribed by optimal tax theory may be easier to obtain than previously believed. The paper also points to the strong similarity between optimal commodity tax rules and the rules for optimal source-based capital income taxation.      

Optimal International Taxation and Growth Rate Convergence: Tax Competition vs. Coordination

Optimal international taxation and its implications for convergence in long run income growth rates are analyzed in the context of an endogenously growing world economy with perfect capital mobility. Under tax competition (i) the residence principle will maximize national welfare; (ii) the optimal long run tax rate on capital incomes from various sources will be zero in all countries; and (iii) long term per capita income growth rates will be equalized across countries. Under tax coordination, (i) becomes irrelevant while (ii) and (iii) will continue to hold. In other words, optimal tax policies are growth-equalizing with and without international policy coordination. This revised version was published online in July 2006 with corrections to the Cover Date.     

Tax reform and external balance

This paper examines the effect of a transformation from capital taxation to consumption in an open economy. With the residential capital tax rate being endogenous, an increase in the domestic consumption tax rate decreases the interest rate, increases capital accumulation, and increases the domestic country's net foreign asset holdings and trade surplus. With the territorial capital tax rate being endogenous, an increase in the domestic consumption tax rate may either increase or decrease the domestic country's interest rate, net foreign asset holdings and trade surplus, depending on the interest elasticity of capital demand.     

Taxing multinationals in a world with portfolio flows and R&D: Is capital export neutrality obsolete?

This paper examines recent claims that capital export neutrality no longer serves as an effective principle for the taxation of income from foreign direct investment, due to the large and growing role played by portfolio capital in financing investment and to the recognition that R&D is an important determinant of international trade and investment. In our evaluation of these claims, we find capital export neutrality appears robust. Because both domestic and foreign activities may be financed with portfolio capital, and they both produce goods that compete in the world economy, there is no compelling reason to grant a lower tax to foreign income alone. Regarding the promotion of R&D or the entry of new competitors, cutting the tax on foreign income may be no more effective than cutting the tax on domestic income. A second focus of the paper is to calculate what the residual U.S. tax rate on active foreign income actually is. Based on 1990 data this rate is negative if foreign income is defined appropriately.     

Capital Mobility and Source-Based Taxation of Capital Income in Small Open Economies

This paper examines the taxation of capital income in a small open economy that faces a highly elastic supply of internationally mobile capital and increasing tax competition. The analysis considers a wide variety of additional factors that affect the determination of capital income taxation policy, including the desire to tax economic rents earned by foreign and domestic firms, the desire to take advantage of any treasury transfer effects, the role played by transfer pricing and other financial accounting manipulations by foreign multinationals, the need for a backstop to the personal income tax and various political concerns. The paper evaluates several potential income and consumption-based tax reforms in this context. JEL Code: H21, H25, H87     

Taxing Mobile Capital with Labor Market Imperfections

Taxing internationally mobile factors of production has been dismissed as an inefficient means of raising tax revenue. This paper addresses the question of whether it is efficient to tax capital at source when labor markets and the taxation of lumpsum income suffer from imperfections. Four reasons for taxing capital are identified: (i) institutional constraints rendering any taxation of profit income infeasible; (ii) market power in the demand for labor; (iii) market power in the supply of labor if it increases with the employment of capital; (iv) unemployment benefits that are not tied to net real wages. It is argued that the case for taxing capital is not particularly strong. By reinterpreting capital as energy the results are applicable to the discussion about ecological tax reforms.     

Why hasn’t tax competition triggered a race to the bottom? Some quantitative lessons from the EU

The integration of European financial markets in the early 1980s created an environment of near-perfect capital mobility across countries that had harmonized indirect taxes but maintained large differences in factor taxes. The years that followed witnessed several rounds of competition in capital taxes with puzzling results. Instead of the dreaded “race to the bottom” in capital taxes, the UK lowered its capital tax to a rate closer to those of France, Germany and Italy, while capital taxes changed slightly in these countries. The UK increased its labor tax marginally, but the other countries increased theirs sharply. This paper shows that these results are consistent with the quantitative predictions of a dynamic, Neoclassical general equilibrium model of tax competition that incorporates the key international externalities of tax policy operating via relative prices, wealth distribution and fiscal solvency. Tax competition is modeled as a one-shot game over time-invariant capital taxes with dynamic payoffs relative to a status quo calibrated to European data. The calibration is preceded by an empirical analysis that shows that the relationship linking taxes to labor supply and the investment rate in the model are in line with empirical evidence and that domestic taxes seem to respond to foreign taxes. The solutions of the games show that when countries compete over capital taxes adjusting labor taxes to maintain fiscal solvency, there is no race to the bottom and the Nash equilibrium is close to observed taxes. In contrast, if consumption taxes adjust to maintain fiscal solvency, competition over capital taxes triggers a “race to the bottom,” but this outcome entails large welfare gains. Surprisingly, the gains from coordination are small in all of these experiments.     

Free trade taxation and protectionist taxation

The goal of this paper is to seek new insight regarding international tax policy by recasting it in parallel with the theory of international trade. This is accomplished by defining a free trade taxation regime as one that is consistent with an efficient worldwide allocation of capital, and evaluating within this perspective various aspects of tax policy, such as value-added (axes, integration, income shifting, and the choice of worldwide or territorial system of taxes.Compatibility with free trade is not the only standard against which to judge an international tax system. Nevertheless, as national economies become more integrated the importance of international taxation for the efficient functioning of capital markets will become a central policy issue.     

Effects of Capital Gains Taxation on Life-Cycle Investment and Portfolio Management

We examine the impact of capital income taxation, both accrual forms of taxation and taxation of realized capital gains, on total savings and the demand for corporate financial instruments. We find that investors may hold both debt and equity in the face of effective collection of capital gains taxation even in a flat tax system. We also find that the two taxes will have substantially different effects on saving and consumption behavior, making it unlikely that the tax structure can be summarized by any single equivalent accrual tax rate.     

Deferred Shareholder Taxation – Implementing a Neutral Business Tax in the European Union

This paper proposes the replacement of the corporate income tax by shareholder-based capital income taxation. Our proposal would guarantee investment neutrality of taxation and reduced tax compliance costs. The proposal is based on the S-base cash flow tax. Under the S-base tax, transactions within the corporate sector are not taxable and only transactions between shareholders and corporations are subject to tax. In contrast to existing S-base cash flow tax systems, tax deductibility of investments is deferred. Rather, the acquisition costs and capital endowments are compounded at the capital market rate and are set off against future capital gains. Dividends and withdrawals are fully taxable at the shareholder level. Because of the deferral of the tax payments our proposal is called ‘Deferred Shareholder Tax’ (DST). The DST exhibits the same neutrality properties as the traditional cash flow tax. Moreover, the compounded inter-temporal credit method ensures that it is neutral with respect to the decision between domestic and foreign investment. To increase acceptance of the DST, current taxpayers’ documentation requirements will be reduced rather than extended. Our proposal could be realised in a single EU country or in all member states of the EU.     

Capital taxation and accumulation in a growing world economy with deficit finance

Prior analyses of the incidence of capital taxation have assumed that the government budget is balanced and changes in capital taxes affect either other taxes, transfers, or government expenditures. The general conclusion is that an increase in the capital tax rate will increase the gross-of-tax interest rate and decrease capital accumulation. This article examines the steady-state effects of capital taxation on the gross-of-tax interest rate and capital accumulation within a two-country model of overlapping generations, which allows capital taxation to directly affect government budget deficits. It is shown that, under the residence tax system, if the after-tax-interest rate is greater than the growth rate, an increase in the capital tax rate willdecrease the gross interest rate andincrease the capital-labor ratio. This result holds even under the territorial tax system, with some additional assumptions.     

传统逃税理论模型的进一步修正:以中国现行税制为框架

在现行税制基础上对逃税影响因素的分析更有针对性。在同时考虑选流转税和所得税的情况下，所得额多少及流转税税率高低对申报收入的影响方向都是不明确的；所得税税率对申报收入的影响在“负所得税“制度情形下，才会有利于鼓励诚实纳税，在其他情形下是不确定的；罚款率和查获概率的提高有助于减少逃税。     

Exemption vs. Credit Method in International Double Taxation Treaties

This paper examines the choice of international double taxation relief methods by two small countries that mutually exchange foreign direct investment. At the first stage, each country chooses between the exemption and the credit method (as prescribed by the OECD model treaty) and at the second stage, each country sets nationally optimal non-discriminatory capital tax rates. It is shown that in the subgame perfect equilibrium both countries choose the exemption method. Mutual application of the exemption method is also shown to yield the highest welfare for each country. While the tax export effect generally induces both countries to choose inefficiently high tax rates, this effect is weakest when both countries exempt foreign earned profits from domestic taxation.     

Unfair Trade? The Increasing Gap between World and Domestic Prices in Commodity Markets during the Past 25 Years

The early literature on international trade has debated extensivelythe constraints facing exporting countries in the major commoditymarkets. This article goes one step further by suggesting thatthe final demand for these products could not have increasedbecause the declines in world commodity prices were not transmittedor were transmitted imperfectly to domestic consumer prices.In contrast, upward movements in world prices were clearly passedon to domestic prices. As a result, the spread between worldand domestic prices almost doubled in all major commodity marketsduring 1975–94. This asymmetry, seldom discussed in theliterature, does not seem to be caused, at least systematically,by changes in trade and tax policies or factors such as transport,processing, and marketing costs. This article argues, therefore,that a special effort should be made to better understand thetransmission from world to domestic prices, especially the roleof large international trading companies that may have the capabilityto influence such spreads through one or several stages of processingin most major commodity markets.     

Is Tax Harmonization Useful?

It is a widely acknowledged result of the literature on international tax competition that an inefficient provision of public goods can only be avoided, if taxes are sufficiently coordinated. In this paper we use a model where governments use commodity and factor taxes in the tax competition game. We show that governments will always choose a second-best efficient tax structure in the Nash equilibrium if they have access to a residence-based capital tax and either a destination-based commodity tax or a labor tax. Moreover, we show that tax competition need not foreclose third-best efficiency in a world with a restricted tax policy toolkit.     

Reforming Business Taxation: Lessons from Italy?

We carefully review the recent Italian reform of business taxation, compare it with other international experiences and theoretical proposals, and calculate its effects on the cost of capital and on the effective average corporate tax rate. We argue that the Italian reform is an original attempt to find a compromise between two conflicting aims, both of which are unavoidable in an open economy: the first is to reduce the average rate of taxation on profits, and the second is to reduce the financial and real distortions produced by corporate taxation. In assessing the initial evidence in the Italian case, we argue that too much weight has been given to the latter objective, and that further reductions in average taxation on profits may be needed.     

Gross capital flows: Dynamics and crises

This paper analyzes the behavior of international capital flows by foreign and domestic agents, dubbed gross capital flows, over the business cycle and during financial crises. We show that gross capital flows are very large and volatile, especially relative to net capital flows. When foreigners invest in a country, domestic agents invest abroad, and vice versa. Gross capital flows are also pro-cyclical. During expansions, foreigners invest more domestically and domestic agents invest more abroad. During crises, total gross flows collapse and there is a retrenchment in both inflows by foreigners and outflows by domestic agents. These patterns hold for different types of capital flows and crises. This evidence sheds light on the sources of fluctuations driving capital flows and helps discriminate among existing theories. Our findings seem consistent with crises affecting domestic and foreign agents asymmetrically, as would be the case under the presence of sovereign risk or asymmetric information.     

Financial friction in an emerging economy

The objective of this study is to evaluate the role of the frictional domestic credit market in an emerging country by using a small-open-economy DSGE model with a banking sector. The calibration results show that the financial friction does not significantly influence the macroeconomic effects of the shocks to the domestic productivity, foreign interest rate and export demand. We also evaluate whether and how the trade and financial openness can influence the effects of the domestic financial shocks that in turn affect the supply of loans in the credit market. We show that greater trade and financial openness can reduce the macroeconomic impacts of the domestic financial distress. Under a more open international capital market, the capital outflow caused by the domestic financial shock does not lead to drastic exchange rate variation. This helps dampen the adverse effects of the financial distress on the economy.