International tax neutrality: reconsiderations.

The conclusions of Part IV.A have significant and favorable implications on CON. Under the classic analysis, source-based taxation satisfies CON. This is because, with respect to any given investment, all investors, regardless of their residence, will be subject to the same tax rate--the source country's tax rate. It follows then that pre-tax rates of return will be reduced to after-tax rates of return by the same proportion and the same differential comparison between pre-tax rates of return among different investors will apply to the after-tax rates of return. By way of illustration, assume that Countries A, B, and C all impose source-based taxation at rates of 50%, 30%, and 40%, respectively. Further assume that the expected pre-tax rate of return from an investment in Country B is 12% if owned by a resident of Country A, 10% if owned by a resident of Country B, and 8% if owned by a resident of Country C. The after-tax returns for these investors will be 8.4%, 7%, and 5.6%, respectively. It would be most efficient under the classic analysis to allocate the investment to the investor from Country A--the one with the highest pre-tax return and for whom the investment would be most productive. Expecting the highest after-tax rate of return, the investor from Country A would outbid the others and "win" the investment opportunity. CON is achieved. Still, as Desai and Hines recognize, (79) under the classic analysis, source-based taxation faces difficulties in totally satisfying CON when potential investments in different jurisdictions are considered. Then, potential investments are subject to the different tax rates of the different jurisdictions, which may distort ownership patterns. For example, consider the situation of the previous example with an additional potential investment in Country A that, if owned by the resident of Country A, will yield a pre-tax return in the rate of 13% and an after-tax rate of return of 6.5% (the tax rate in Country A is 50%). While under the classic analysis it would be most efficient if the investor from Country A owned this investment, this investor will prefer the investment in Country B, which offers the higher after-tax rate of return. (80) Applying Part IV.A's analysis to CON reveals that this supposed problem with CON does not in fact exist.

The baseline of CON is the non-tax world in which ownership patterns are globally most efficient. Under the analysis presented in Part IV.A, by shifting the economic burden of source-based taxation to immobile factors, the pre-tax rate of return at the source-based taxing jurisdiction is increased to r=[r.sub.I]/(1-t) in order to allow an after-tax rate of return equal to [r.sub.F]. Thus, with the non-tax world as a baseline, pre-tax rates of return and associated differentials are tax distorted while after-tax rates of return and differentials thereof are tax neutralized. Consequently, ownership allocations based on after-tax rates of return are neutral for CON purposes and as such globally most efficient. In the previous example the non-tax world rates of return from the investment in Country B for the investors from Countries A, B, and C would have been respectively 8.4%, 7%, and 5.6% (81) (i.e., identical to the after-tax rates of return). (82) The non-tax world rate of return on the investment in Country A, if owned by the investor from Country A, would have been 6.5%, (83) not 13% (the pretax rate of return). In a non-tax world the investor from Country A will own the investment in Country B yielding 8.4%, not the investment in Country A yielding only 6.5%. This ownership pattern is considered by CON to be globally most efficient. With source-based taxation in effect, this pattern of ownership will continue to exist because, as illustrated above, the Country A investor will still prefer the investment in Country B to the investment in Country A. Here, the pre-tax rate of return differentials were distorted as a result of "grossing-up" different rates of return (8.4%, 7%, and 5.6% on the one hand, and 6.5% on the other) by different tax rates (30% and 50%, respectively), but the after-tax rates of return were neutralized by these different rates (30% and 50%, respectively).

In conclusion, source-based taxation seems to perfectly and unconditionally satisfy CON if the effects of source-based taxation on pre-tax rates of return are considered.

4. Conceptual Implications on National Ownership Neutrality (NON) Analysis

I mentioned above that NON, considered from the classic analysis, may not be viewed as a neutrality theory. (84) The classic analysis of NON uses, even exploits, tax differentials as means of promoting national efficiency. This is because, assuming that foreign inbound investments would compensate for outbound investments in terms of national tax revenue, NON encourages nationals to make outbound investments the after-foreign-tax return of which is higher than the after-tax return on alternative domestic investments. Such comparison between after-tax returns is not considered tax neutral by the classic analysis. Following the logic of the classic neutrality analysis, this argument overlooks the effects of source-based taxation on rates of return. Considering Part IV.A's conclusions, with source-based taxation in effect, pre-tax rates of return are tax distorted while after-tax rates of return are tax neutralized. While the classic neutrality analysis would consider a comparison between after-tax rates of return as tax distorted, the analysis offered here suggests the contrary (i.e., that with source-based taxation in effect, a comparison between pre-tax rates of return is tax distorted, and a comparison between after-tax rates of return reflects the comparison between the tax neutral rates of return). This analysis suggests that NON may in fact be conceptually viewed as a tax neutrality theory.

V. CONCLUSION

The CEN discussion since Horst's 1980 work has generally taken Musgrave's conclusions as a starting point and referred to CEN as a doctrine that requires the return on capital to be subject to the same total tax rate regardless of the location of the investment (residence-based taxation). (85) However, Musgrave's basic definition stated that CEN is satisfied if decisions about investment location are tax neutral. (86) Two main conclusions may be drawn from this article. First, for residence-based taxation to satisfy CEN, global uniformity with respect to tax systems is necessary. Furthermore, if the saving-consumption distortions of taxation are considered, global uniformity with respect to tax rates is also required. Under these circumstances, source-based taxation satisfies CEN as well. Because exercising full residence-based taxation is practically unfeasible, source-based taxation seems to be a better means for satisfying CEN. Second, following the classic framework and analysis of international tax neutrality, Part IV shows how the burden of source-based taxation will be borne by immobile factors (labor, land, etc.) rather than mobile factors (capital). This allows source-based taxation (not necessarily with globally harmonized rates) to fully satisfy CEN simultaneously with NN, CIN, CON, and NON. Part IV also calls for additional work in this respect.

Hence, in terms of efficiency, source-based taxation seems to be superior and preferable to residence-based taxation. Another interesting conclusion may be further drawn from Part IV's analysis. If the burden of source-based taxation is borne by immobile factors (labor, land, etc.), while the burden of residence-based taxation is borne by mobile factors (capital), capitalism may justify source-based taxation and socialism may call for residence-based taxation.

Fadi Shaheen*

* International Tax LL.M. and S.J.D., University of Michigan Law School (2005, 2007); Direct Doctoral Program in Laws, Hebrew University of Jerusalem Faculty of Law (2002); LL.B., Haifa University Law School (1996). This article is a short version of my S.J.D. thesis. I thank the members of my S.J.D. committee at the University of Michigan Law School, Reuven Avi-Yonah, David Hasen, and James Hines, without whose teaching, support, and comments this work could not have been done. Special thanks also to Yosef Edrey, Douglas Kahn, and Joel Slemrod. I also thank Francesco Capitta, Elizabeth Chorvat, David Gliksberg, Yoram Margalioth, the participants of the S.J.D. Colloquium (2005/2006) at the University of Michigan Law School, the participants of the first International Network for Tax Research (INTR) Conference of the OECD hosted by the University of Michigan Law School (Nov. 2006), the participants of the Tax Policy seminars (2005/2006) at the Haifa University, the Hebrew University of Jerusalem Law Faculty, and the Tel-Aviv University Law Faculty for their helpful comments. All views and errors are personally mine.

(1) Abu Nuwas, Save Your Reproach, in THE WINE SONGS OF ABU NUWAS, from DIWAN ABI NUWAS 225 (Beirut: Dar Al-Arab, n.d.). (I thank Anton Shammas for translating this line from Arabic.)

(2) PEGGY B. MUSGRAVE, UNITED STATES TAXATION OF FOREIGN INVESTMENT INCOME 65-66, 74, 104-07 (1969); PEGGY B. RICHMAN, TAXATION OF FOREIGN INVESTMENT INCOME, AN ECONOMIC ANALYSIS (1963).

(3) Thomas Horst, A Note on the Optimal Taxation of International Investment Income, 94 Q.J. OF ECON. 793 (1980).