Nontraded goods and optimal foreign investments

The main purpose of the present paper is to discuss the optimal tax policy towards capital movements in the case where nontraded goods exist. We show that, in the case of generic capital, the instability of nontraded goods market in the passive country makes it optimal to subsidize the income from international investments. Furthermore, we show that complete specialization of the passive country invokes the orthodox tax policy of Kemp (1962, 1964, chs. 13 and 14), whether capital is generic or sector-specific.