International tax neutrality: reconsiderations.

(67) The classic theory as to the effects of taxation on labor supply in a nut shell is as follows. Taxation reduces the net reward for an hour of work and reduces the opportunity cost of an hour of leisure. Therefore, the decision as to the hours worked might be distorted as compared to the non-tax world. Two competing effects generated by the imposition of tax are to be considered. On the one hand, since the net reward for work and the opportunity cost of leisure are reduced, individuals will have the tendency to substitute leisure for work (the substitution effect). On the other hand, the income effect works in the opposite direction. Assuming that leisure is a normal good and that other things are equal, the reduction in the individual net income due to the imposition of tax leads to reduction in the consumption of leisure. Assuming that individuals either work or consume leisure (i.e., any time not devoted to work is spent on leisure, and vice versa) the decrease in leisure hours means an increase in work hours. The conflict between the two effects renders ambiguous the theory as to the effects of taxation on labor supply. See HARVEY S. ROSEN, PUBLIC FINANCE 402-05 (7th ed. 2005).

(68) See, e.g., Sam Bucovetsky & John D. Wilson, Tax Competition with Two Tax Instruments, 21 REGIONAL SCI. & URB. ECON. 333, 343-44 (1991).

(69) The saving-consumption distortions theory suffers similar ambiguity as the labor-leisure distortions theory. Put in terms of substitution and income effects, since saving accounts for future consumption, tax on saving reduces the present value of future consumption as compared to the non-tax world in favor of current consumption (the opportunity cost of which is reduced by the tax), so the substitution effect works in the direction of decreasing saving and increasing current consumption. The income effect works in the opposite direction in two different forms. First, the reduction in the net rate of return from saving means a reduction in income available for consumption. Second, in the case of a "target saver" whose target is to have a fixed amount of future consumption (saving), the imposition of tax would have the effect of increasing saving. Due to the imposition of tax, the only way to reach the saving target is to increase saving. See ROSEN, supra note 67, at 411-21.

(70) See discussion supra Part III.C.3.

(71) Labor-leisure distortions are irrelevant with respect to residence-based taxation for purposes of neutrality analysis. This is the case because the economic burden of residence-based taxation is supposed to fall on capital and not on labor and other immobile factors. Likewise, if the analysis suggested here is correct, saving-consumption distortions should be immaterial for purposes of neutrality analysis with respect to source-based taxation (the economic burden of which is supposed to be borne by labor, land, and other immobile factors).

(72) See, e.g., B. Douglas Bernheim, Taxation and Saving, 3 HANDBOOK OF PUB. ECON. 1173 (2002); Robert A. Moffitt, Welfare Programs and Labor Supply, 4 HANDBOOK OF PUB. ECON. 2393 (2002).

(73) See supra note 23 and accompanying text.

(74) See supra note 26 and accompanying text.

(75) See discussion supra Part II.

(76) MUSGRAVE, supra note 2, at 134.

(77) Id.

(78) [[r.sub.D][t.sub.D]]/[1 - [t.sub.D]] = [[r.sub.D]/[1 - [t.sub.D]]] - [r.sub.D].

(79) International Tax Reform, supra note 13, at 495; cf. J. Clifton Fleming & Robert J. Peroni, Exploring The Contours of a Proposed U.S. Exemption (Territorial) Tax System, 109 TAX NOTES 1557, 1573-74 (Dec. 19, 2005).

(80) Compare International Tax Reform, supra note 13, at 495-96 (arguing that the economic loss resulting from such distortions is possibly offset by the fact that the investment in the lower tax country is owned by the most productive owner), and Mihir A. Desai & James R. Hines, Reply to Grubert, 58 NAT'L TAX J. 263 (2005), with Fleming & Peroni, supra note 79, at 1574-75, and Harry Grubert, Comment on Desai and Hines, "Old Rules and New Realities: Corporate Tax Policy in a Global Setting," 58 NAT'L TAX J. 263 (2005). This debate is beyond the scope of this work mainly because the underlying problem rises only under the classic analysis but not under the analysis offered here.

(81) If r=[r.sub.F]/(1-t) then [r.sub.F]=r(1-t).

(82) Note that despite the fact that the pre-tax rates of return are tax-distorted, the real incidence differentials are kept neutral since all pre-tax rates of return are in this case grossed-up from the non-tax world rates of return by the same proportion (the tax rate of Country B).

(83) If r=[r.sub.F]/(1-t) then [r.sub.F]=(1-t). In this case [r.sub.F]=13%(1-0.5)=6.5% (the tax rate in Country A is 50%).

(84) Supra notes 20-22 and accompanying text.

(85) See, e.g., Hines, supra note 11; Rousslang, supra note 11, at 590; see also International Tax Reform, supra note 13, at 492.

(86) See MUSGRAVE, supra note 2, at 109; RICHMAN, supra note 2, at 5.