International Competitiveness, Tax Incentives, and a New Argument for Tax Sparing: Preventing Double Taxation by Crediting Implicit Taxes
Michael S. Knoll
University of Pennsylvania Law School; University of Pennsylvania - Real Estate Department
August 25, 2008
U of Penn, Inst for Law & Econ Research Paper No. 08-21
Tax sparing occurs when a country with a worldwide tax system grants its citizens foreign tax credits for the taxes that they would have paid on income earned abroad, but that escapes taxation by virtue of foreign tax incentives. The supporters of tax sparing argue that it is a form of foreign aid, an obligation owed to developing countries, and a legitimate means of improving the competitiveness of resident investors. Tax sparing, however, has long been opposed by the United States on the grounds that it is an expensive and problematic concession to developing countries, inconsistent with basic and fundamental tax principles, and an inappropriate mechanism for improving the competitiveness of resident investors. The U.S. position appears to be carrying the day as tax sparing has been on the wane.
In contrast with the emerging consensus, I offer a new argument for tax sparing. Drawing on the literature on implicit taxes, I argue that tax incentives produce implicit taxes. From the perspective of the investor, implicit taxes are as real as traditional explicit taxes. Thus, tax sparing is best viewed as extending the foreign tax credit to include implicit taxes. Accordingly, I argue that tax sparing is consistent with the notion of a single level of taxation and the foreign tax credit. I also argue that tax sparing is necessary to prevent domestic investors from being disadvantaged by foreign tax incentives. In addition, I show that such arguments support a greatly expanded form of tax sparing. Finally, I demonstrate that the tax sparing credit, as currently calculated, will usually exceed the implicit tax paid and propose an alternative method of calculating the credit that will place investors residing in countries with worldwide tax systems on par with other investors.
Number of Pages in PDF File: 40
Keywords: tax sparing, foreign tax credit, worldwide taxation, competitiveness, tax competition, implicit taxes, foreign direct investment, international taxation, capital export neutrality, CEN, capital import neutrality, CIN, capital ownership neutrality, CON, national neutrality, NN
JEL Classification: E62, F00, F13, H21, H25, K34, O10
Date posted: August 29, 2008