International Tax Competition and Gains from Tax Harmonization

Abstract

In a world economy there are two types of distortions which can be cauaed by capital income taxation in addition to the standard closed-economy wedge between the consumer-saver marginal intertemporal rate of substitution and the producer-investor marginal productivity of capital: (i)international differencea in intertemporal marginal rates of substitution, implying an inefficient allocation of world savings across countries; and (ii) international differences in the marginal productivity of capital, implying an inefficient allocation of world investment across countries. The paper focuses on the structure of taxation for countries which are engaged in tax competition and on potential gains from s tax harmonization. We show that if the competing countries sre sufficiently coordinated with the rest of the world then tax competition leads each country to apply the residence orinciole of taxation and there are no gains from tax harmonization. If, however there is not sufficient coordinstion,tax competition leads to low capital income taxes and the tax burden falls on the internationally immobile factors. The outcome is nevertheless still efficient relative to the available constrained set of tax instruments.

Capital Mobility and Capital Tax Competition

“…attract perfectly mobile capital. In this context, if a tax on immobile local factors is available, then a source-based tax on mobile capital is undesirable-the now-standard "zero tax result" indicative of a "race to the bottom" in capital income tax rates (Zodrow-Mieszkowski, 1983;Gordon, 1986;Razin-Sadka, 1991). The logic underlying this result is that, even purely from the perspective of local residents, a source-based tax on capital income is counterproductive; specifically, such a tax would drive out perfectly mobile capital until the nationally or internationally determined after-tax rate of return to capital was achieved, with the burden of the tax borne entirely by local residents in the form of lower wages and land rents or higher prices for non-tradable goods.…”

Fiscal Policy, Economic Integration and Unemployment

“…First, since the government subsidises wages in the presence of profit taxation, an immediate implication of Proposition 4 is that welfare is lower in the case of restricted profit taxation. Second, Proposition 4 at first sight stands in contrast to the results derived in Razin and Sadka (1991) and Bucovetsky and Wilson (1991). These models are based on a constant returns to scale production function and demonstrate that a small country, which faces an infinitely elastic supply of capital on the world market, taxes wage income when the only tax on capital is source-based.…”

Can Capital Income Taxes Survive? And Should They?

“…A fundamental theorem -originally derived by Gordon (1986) and forcefully restated by Razin and Sadka (1991) -states that in the absence of location-specific rents, a small open economy should not levy any source-based taxes on capital. 6 Under perfect capital mobility a small open economy faces a perfectly elastic supply of capital from abroad, so the burden of a sourcebased capital tax will be fully shifted onto workers and other immobile domestic factors via an outflow of capital which drives up the pre-tax return.…”