Balancing act: weighing the factors affecting the taxation of capital income in a small open economy

Alternative economic theories yield dramatically different prescriptions for optimal capital taxation in small open economies. On the one hand, foreign firms, including those with investments that yield firm-specific above-normal returns, have a large number of alternative investment opportunities; this suggests that the supply of foreign direct investment is highly elastic, which implies that small open economies should avoid imposing any source-based taxes on capital income. On the other hand, governments invariably want to tax any above-normal returns earned by location-specific capital, especially if the returns accrue to foreigners, and to take full advantage of the potential revenue increase from any “treasury transfer” effect that arises due to residence-based tax systems with foreign tax credits, such as that utilized by the United States. These factors suggest that investment is highly inelastic with respect to capital taxation, so that source-based capital income taxation is desirable; indeed, in one special case, the capital income tax rate for a small open economy should equal the relatively high US tax rate. Moreover, this difficult trade-off is in practice complicated by numerous additional factors: deferral of unrepatriated profits and cross-crediting of foreign tax credits for US multinationals, foreign direct investment from firms from countries that, unlike the United States, operate territorial systems, and the existence of opportunities for both international capital income shifting and labor income shifting. In this paper, we analyze optimal capital income taxation in a small open economy model that attempts to balance these conflicting factors

Essays on Capital and Personal Income Taxation

A principal consideration in evaluating any tax policy is the response of economic agents, which determines the economic costs and consequences of levying a tax. In three chapters, I study these responses both theoretically and empirically, extending the literature examining the impact of the corporate income tax, the interaction between corporate income taxation and individual-level capital income taxation, and the labor supply effects of the Earned Income Tax Credit (EITC). Chapter one is a theoretical exploration of optimal capital income tax reform, focusing on the choice between source-based and residence-based capital income taxes. By incorporating imperfectly mobile capital and allowing for income sheltering, this chapter adds to the literature by addressing the implications of an increasingly global economy, finding that capital distortions, not income sheltering, are the primary factors determining the nature of an optimal capital income tax reform. Chapter two is a project which studies the factors that affect the desirability of source-based corporate income taxation in a small open economy. Using both analytical derivations and computational simulations, this chapter formally balances the factors that strongly motivate the use of corporate income taxation, notably the opportunity to costlessly raise revenue by taxing firms based in foreign countries that provide foreign tax credits, the need to limit opportunities for individual income sheltering, and the desire to tax the returns earned by foreign-owned immobile capital, against those that discourage corporate income taxation, notably concerns about driving out highly-mobile capital investment and the availability of alternative opportunities to tax immobile capital directly. In a calibrated setting, this paper determines the relative importance of these factors, noting that the extent of foreign-owned immobile capital may be the most important determinant of optimal corporate tax rates. Chapter three is an empirical study that investigates the labor supply sensitivity of a group that has received minimal attention in prior studies: dependent adults. Focusing on the 1993 expansion of the EITC, this study finds that non-nuclear relatives increased their labor supply in response to their own newfound EITC eligibility, but that adult children decreased their labor supply in response to their parents' expanded credits

Supplemental Material, Marriage_Tax_Study_code - Hesitating at the Altar: An Update on Taxes and the Timing of Marriage

<p> Supplemental Material, Marriage_Tax_Study_code for Hesitating at the Altar: An Update on Taxes and the Timing of Marriage by Nick Frazier, and Margaret McKeehan in Public Finance Review </p