Optimal International Taxation and Tax Competition: Overcoming the Contradictions
Posted: 26 Jan 2004
International tax law today reflects a consensus reached seventy years ago by the international community as to the appropriate divisions of the income tax base among nations. Assuming two independent and mutually exclusive jurisdictional bases for taxation, source and residence, conflict between nations was resolved by establishing that source taxation was primary. As a consequence, residence taxation would unilaterally defer to source.
This resolution failed to reflect the force of economic principles and equity among nations. The economic tax constructs that foster the economically efficient allocation of capital in the world are Capital Export Neutrality (CEN) and Capital Import Neutrality (CIN). Contrary to traditional wisdom, when one examines the underlying purposes and goals of these doctrines, it can be shown that these doctrines are not incompatible, but are harmonious parts of an optimal economic approach to international taxation. The strength of these economic forces can be seen in how present day nations are moving away from traditional source taxation of capital income.
While economic efficiency allows for several compatible tax options, equity among nations and among taxpayers establishes one optimal approach to the division of the tax base internationally. Equity establishes that each nation has the right to tax the income that is produced in accordance with the value that the nation has added to the world. This follows the principles of CIN establishing exclusive source taxation, but source taxation reinterpreted in accordance with the principle that it is not the place where capital and assets are used that merits the tax, but the place that provided the environment for the creation of that property. This means that the normal return on all capital, debt, equity, intangible assets and tangible assets, is sourced to the country from which it came.
What remains for traditional source or territorial taxation is the income in excess of the normal return on capital, economic rent. Territorial taxation of economic rent should exclusively belong to the capital-importing nation because that nation has provided the system responsible for the creation of the economic rent.
What is left for the capital-importing nation after the normal return on capital is allocated to the capital-exporting nation is consumption. Thus, traditional source taxation of business can be implemented by a broad-based expenditure tax. Traditional resident taxation is restricted to worldwide taxation of the normal return on capital.
Under these optimal tax principles, the effects of tax competition are minimized because the tax base on capital in all of its forms does not shift when capital is mobile. Low taxation on the returns from assets and technologies by capital importing nations would then no longer influence the decision to locate abroad.
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