Double taxation and tax deduction: A comparison

This paper examines the impact on capital flows and economic welfare of alternative domestic income tax policies toward foreign income tax payments, in a setting of international tax competition. In particular, we compare a system of full deductibility from taxable income with one that provides no allowance for foreign taxes. It is found that the walfare of the capital exporting country is always greater without deductibility than with it. Contrary to intuition, moreover, equilibrium capital flows and world income are also greater without deductibility. These findings extend the results of a recent contribution by Bond and Samuelson who compared tax deductibility with tax credits. The results underscore the importance of the general equilibrium approach for the proper evaluation of important tax policy alternatives.