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     

Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data

The theory of international tax competition suggests a shift of tax burden from mobile to immobile tax bases, especially for small open economies. This paper assesses these hypotheses empirically using a sample of 23 OECD countries and the time period 1965–2000. In accordance with tax competition theory, we find that capital mobility exerts a negative impact on capital tax burden, and a positive one on labor tax burden. Further, we observe a positive effect of country size, suggesting that small open economies are levying lower capital and labor taxes than larger ones. Finally, we analyze the time pattern of tax competition and demonstrate that tax competition has intensified since the mid 1980’s.JEL Code: H7, H87, C23     

A Note on the Composition of Public Expenditure under Capital Tax Competition

Keen and Marchand ( Journalof Public Economics, 1997, 66, 33–53) argue that undercapital tax competition, the composition of public expenditureis inefficient in that too much is spent on public inputs benefitinglocal business and too little on public goods benefiting residents.Their result depends on labor immobility. This note shows thatthe Keen-Marchand argument may not hold if both labor and capitalare mobile. An interesting case is identified where capital taxationdoes not distort the mix of public goods and public inputs, eventhough the overall level of public expenditure is inefficientlylow.     

Interjurisdictional Tax Competition in a Federal System of Overlapping Revenue Maximizing Governments

Academic literature in public finance has focused on interjurisdictional tax competition—namely among similar types of local governments—but has leaved vertical externalities arising from interactions between two overlapping governments sharing the same tax base aside. The purpose of this paper is to provide a simple model within which interjurisdictional tax competition and vertical interactions between two overlapping governments that share the same tax base can be analyzed simultaneously. We find that interjurisdictional tax competition reduces the global tax rate set by both overlapping governments (federal and local) but is unable to solve completely the distortion arising from vertical externalities. The model is also extended to allow for government subsidies to industrial capital. We give sufficient conditions for capital subsidies to be more efficient to attract capital when they are granted at a federal level rather than at a local level.     

Tax Competition, Income Differentials and Local Public Services

This paper examines strategic tax setting between fiscal authorities in the presence of mobile workers who locate across these jurisdictions in response to differing tax structures and congestable local public amenities. We find that the nature of the tax setting outcomes depend crucially on the proximity between cities. For distant cities with the same size populations, the pressure on tax rates of a more mobile workforce depends on the whether mobile workers are net beneficiaries or net contributors. If mobile workers are either high or low income earners, cities lower tax rates. If mobile workers are middle income earners, cities raise tax rates. For close or neighbouring cities, workers locate in one of the cities and tax rates and local public amenities are dispersed.     

Asymmetric capital tax competition and choice of tax rate

This article provides an alternative mechanism that explains differences in capital tax rates, which applies to small jurisdictions. In the framework of standard capital tax competition models, regions have to be large, in the sense of having market power, otherwise they will tax capital, a mobile factor, at the same rate. In this paper, we consider a second mobile factor, labor, which is mobile only within metropolitan areas. We will show that this spatially limited mobile factor may explain the capital tax rate differences levied on the global mobile factor as long as no source-based wage tax is available. In addition to the theoretical treatment, numerical simulations also confirm this result and show a significant tax differential.     

Tax Coordination and Unemployment

This paper analyses the implications of unemployment for fiscal competition and tax coordination among small open economies. Unemployment is modeled as resulting from wage bargaining. The analysis focuses on the effect of labour and capital tax coordination on welfare. We show that, while coordinated capital and labour tax increases unambiguously raise welfare if labour markets are competitive, different results emerge if labour markets are unionised. It turns out that coordinated capital and labour tax increases may reduce welfare. This revised version was published online in July 2006 with corrections to the Cover Date.     

Tax Competition and Foreign Capital

This paper derives welfare equivalence of double taxation rules in a tax competition model with discriminatory home taxes and the ability to finance subsidiary operations with host country capital. For a more general model, we provide sufficient conditions on the number of host sectors and factors that support double-tax-rule equivalence. Examples violating these conditions help identify economic factors under which a home country has strict preferences over double taxation rules. If the home tax rate can influence host factor prices, the home country weakly prefers deductions over credits as in the pure-home-equity financing case.     

Two Games of Interjurisdictional Competition When Local Governments Provide Industrial Public Goods

In this paper we investigate two different games of interjurisdictional competition when local governments provide public goods that benefit industry. Governments play a game either in tax rates on mobile industrial capital or in public expenditures. Although the literature suggests that competition in public expenditures is more competitive than in tax rates, this is not necessarily true in the case of industrial public goods. Moreover, in the presence of industrial public goods interjurisdictional competition may also lead to overprovision of public services.     

Corruption and Transparency in a Growth Model

We develop a Ramsey type model of economic growth in which the “Engine of Growth” is public capital accumulation. Public capital is a public good, and is financed by taxes on private output. The government may either use the taxes gathered to fund public capital accumulation or consume the resourses itself; that is engage in corruption. There is an irreducable level of endogenously determined corruption which constitutes rents for which potential governments compete. This competition takes the form of choosing a time path for public capital invesment, which implies time paths for output and household consumption. We study both the model’s steady state, and dynamical behavior along the saddle path. The predictions of our theory accord well with the existent empirical evidence on the relationships between the level and growth rate of output, corruption, public investment and fiscal transparency. Our analysis also provides a perspective on the transition experiences of several Eastern European economies. JEL Code: O41, H41     

Profit tax competition and formula apportionment

We analyze corporate income tax competition with international capital mobility when the common tax base is allocated to governments according to an apportionment formula. Labor can be either internationally mobile or immobile. We compare the Nash equilibria for different apportionment methods. Tax competition produces lower tax rates the more elastically the formula share responds to tax rate changes. More specifically, equilibrium tax rates are typically lowest when apportionment is based on property-shares, followed by payroll- and sales-shares apportionment. Compared to their cooperative levels, equilibrium tax rates are too low for property-share apportionment but tend to be too high for the other formulas. JEL Classification H77 · H25 · F23     

Neutral Taxation of Shareholder Income

A Norwegian tax reform committee recently proposed a personal tax on the realized income from shares after deduction for an imputed risk-free rate of return. This paper describes the design of the proposed shareholder income tax and shows that it will be neutral with respect to investment and financing decisions and decisions to realize capital gains, provided that full loss offsets are granted. Thus the tax allows some non-distortionary double taxation of corporate equity income. With an appropriate choice of tax rates, it also solves the problem of income shifting under a dual income tax. JEL Code: H24, H25     

Information Sharing and International Taxation: A Primer

The sharing between national tax authorities of taxpayer-specific information has emerged over the last few years as a—probably ‘the’—central issue on the international tax policy agenda. Yet this refocusing of the debate on international taxation—away from parametric tax coordination and towards strengthening information exchange—has gone largely unnoticed in the public finance literature. This paper gives an overview of this increasingly important area of international taxation, reviewing the key economic, legal, and practical concepts and issues bearing on the analysis and implementation of information exchange, and providing an account of recent policy initiatives and emerging theoretical insights. JEL Code: H77, H87, F42     

Fundamental Tax Reform in The Netherlands

The Netherlands has abolished the tax on actual personal capital income and has replaced it by a presumptive capital income tax, which is in fact a net wealth tax. This paper contrasts this wealth tax with a conventional realization-based capital gains tax, a retrospective capital gains tax with interest on the deferred tax, and a mark-to-market tax which taxes capital gains as they accrue. We conclude that the effective and neutral taxation of capital income can best be ensured through a combination of (a) a mark-to-market tax to capture the returns on easy-to-value financial products, and (b) a capital gains tax with interest to tax the returns on hard-to-value real estate and small businesses.     

Tax Mimicking and Yardstick Competition Among Local Governments in the Netherlands

This paper provides a spatial-econometric analysis of the setting of property tax rates by Dutch municipalities. We find evidence of tax mimicking: a ten percent higher property tax rate in neighboring municipalities leads to a 3.5 percent higher tax rate. Mimicking is less pronounced in municipalities governed by coalitions backed by a large majority. This points to yardstick competition as the most likely source of tax mimicking. We also find that Dutch voters seem to be able to penalize incumbents for anticipated tax rate differentials, but not for unanticipated tax rate differentials. This limits the effectiveness of yardstick competition as a mechanism to reduce political rent-seeking.JEL Code: D72, H71     

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.     

Environmental Policy and Public Revenue with International Capital Mobility

In the presence of preexisting distortionary taxes, it is often argued that auctioned emission permits are preferable to non-auctioned permits, because the former generate revenues that may be used to reduce other taxes. This paper shows that when capital is internationally mobile, it may be optimal to use a combination of non-auctioned and auctioned emission permits, for both environmental and fiscal reasons. By letting the number of non-auctioned permits be a positive function of the amount of capital used domestically, they will attract capital to the home country. This may create environmental benefits in terms of reduced transboundary pollution and may lead to increased public revenue because the price of emission permits may increase and because the tax base may be enhanced. It is also shown that the optimal number of non-auctioned permits may increase as the marginal costs of public funds increase. JEL Code: D62, F21, Q28     

Capital mobility,wage bargaining,and social insurance policies in an economic union

In a two-country model with mobile capital we analyse decentralized social insurance policies. These policies are a compromise between the preferences of workers and capital owners. Due to wage bargaining, worker-based social insurance contributions are borne by capital owners. These contributions affect the profitability of investment, and consequently the direction and size of capital flows. Countries will take account of these effects in determining social insurance policy. Noncooperative decision making results in tax competition and an underprovision of social insurance. In addition, increasing economic integration, represented by increasing capital mobility, could imply a divergence of social insurance levels in the two countries.     

Tax Competition and International Public Goods

A well known result in the tax competition literature is that tax rates are set too low in the Nash equilibrium to finance an efficient level of public consumption goods. In this model we introduce international spillovers in public goods provision and show that such spillovers reduce, and in the limiting case of perfect spillovers, eliminate tax competition. There is, however, always underprovision of the public good in equilibrium, since larger spillovers increase the problem of free riding. In an extension to the model, we demonstrate that congestion costs may result in overprovision of the public good.     

Tax avoidance and ex ante cost of capital

This study examines the association between tax avoidance and ex ante cost of equity capital. Based on prior research, we develop two proxies for investors’ expectations of tax avoidance and explore whether deviations from those expectations result in higher ex ante cost of equity capital. We find that the ex ante cost of equity capital increases with tax avoidance that is either below or above investor expectations and that the increase is larger for tax avoidance that exceeds investors’ expectations. We then examine whether firms that alter their future tax avoidance exhibit a lowering of their ex ante cost of equity capital and find that tax avoidance decreases (increases) from the prior year for firms that were above (below) investors’ expectations in the prior year. These results are consistent with the trade‐off suggested by the Scholes and Wolfson framework and reinforce the notion that balancing tax benefits and non‐tax costs is an important feature of firms’ tax planning.