International Tax Policy, Capital Mobility, and Competition
National Tax Strategy and Capital Allocation
The decision on the setting of tax rates assumes strategic connotations for each country. It must assess revenues from its own fiscal measures and consider the other country’s possible response to its own choices.
The introduction of the tax levy on capital gains, being a distorting instrument, can only lead to a loss of efficiency and, therefore, a decrease in welfare.
The tax is relevant only for its ability to influence the allocation of capital between different nations and their performance, and not for its role in financing public spending.
Capital Flows in Open and Closed Economies
- Closed Economy: Condition of equality equilibrium (saving and investment are necessarily the same).
- Open Economy: Saving and investment are no longer necessarily the same.
A nation is a capital-importing nation if the interest rate determined in a closed economy, rH, is higher than the world interest rate, r. Therefore, when the nation opens up to other economies, it is positioned to attract capital.
Taxing Resident Capital Income Worldwide
If the country decides to tax the capital income of its citizens, wherever they invest, the supply curve shifts upward. However, a tax of this type implies a decrease in the net interest rate that resident citizens receive and therefore affects their savings decisions.
International Efficiency Criterion for Capital
From an international perspective, a fundamental criterion of efficiency that must be respected is the equality of the Marginal Product of Capital (MPC) across all nations. This equality prevents the possibility of increasing global well-being through the reallocation of capital between different countries.
Challenges in Taxing Mobile Financial Assets
One of the main problems that tax systems encounter in the design of the taxation of financial assets arises from the difficulties in determining and defining such income. The problem is compounded if the citizens of one country can freely export their capital to other countries.
Understanding Tax Competition
Withholding taxes, as mentioned, can lead to strategic behavior by nations aimed at attracting capital through rate reductions or other forms of reducing the tax burden. This phenomenon is known as tax competition.
Tax competition is not universally considered a negative phenomenon.
Benefits of Tax Competition
Many scholars consider it:
- A tool to improve the allocation of resources, limiting the growth of public expenditure considered inefficient;
- An instrument enabling the criterion of provision (benefit principle) to be applied as a criterion for sharing the tax burden.
Defining and Countering Harmful Tax Competition
The only phenomenon that must be hindered is harmful tax competition. This refers mainly to tax competition carried out not through generalized reductions in taxation (which may simply reflect the will of individual states to resize the role of their public sector), but through targeted tax decreases that aim to attract mobile tax bases from other countries via measures that reserve favorable treatment for non-resident citizens compared to resident citizens.
The scale reached by harmful behavior and evasive practices involving savers and companies has led the international community to adopt increasingly binding measures.