Tax policy in general and international income tax policy in
particular has long been a subject of discussion and argument by tax
philosophers, economists, and lawyers. Theories have often been
introduced to support the establishment of new tax systems, to justify
existing ones, or to call for changes. Economists introduced
"economic efficiency" as a criterion for evaluating tax
systems. At the international level, tax neutrality theories were
introduced as criteria for achieving economic efficiency. Different tax
neutrality theories supported different theoretical international income
tax systems. Some theories called for compromise, jeopardizing
coherence, and increasing complexity. While reconsidering the classic
tax neutrality analysis, this article argues that residence-based
taxation has, at best, no advantages over source-based taxation in
satisfying capital export neutrality. This article then introduces the
idea of best satisfying capital export neutrality, simultaneously with
the other tax neutrality theories, simply by source-based taxation (not
necessarily with globally harmonized rates) that effectively cures the
distortions resulted by its imposition.
"Save your reproach, reproach makes temptation increase,
You'd better heal me with the very cause of my disease" (1)
I. INTRODUCTION
Since Peggy Musgrave's 1963 and 1969 works, (2) and their
reformulation and restatement by Horst in 1980, (3) the economics and
legal literature has broadly discussed international tax neutrality
theories and introduced new ones seeking to enhance economic efficiency.
The development of the discussions was, historically, fairly limited
because Musgrave's conclusions, rather than the basic definitions,
served as the undisputed baseline. This article reconsiders the
international tax neutrality theories by referring to the basic
definitions, questioning the accepted conclusions, and suggesting
different ones.
Five international tax neutrality theories have been introduced:
(1) capital export neutrality (CEN), (2) capital import neutrality
(CIN), (3) national neutrality (NN), (4) capital ownership neutrality
(CON), and (5) national ownership neutrality (NON). It is undisputed in
the tax literature that CEN can only be achieved through residence-based
taxation or once all countries adopt source-based taxation with
identical tax rates; CIN through source-based taxation; NN if home
countries tax foreign source income and allow deductions for foreign
taxes; CON through either residence- or source-based taxation; and NON
through source-based taxation. The main idea of this article is that
CEN, as well as the other neutrality theories, is best and
simultaneously satisfied by source-based taxation, not necessarily with
globally harmonized tax rates.
After the introduction in this Part I, Part II presents and
discusses the classic international tax neutrality theories and
analysis. Part III next reconsiders the classic analysis of tax
neutrality, especially CEN, and its conclusions. Part III argues that
pure residence-based taxation satisfies CEN only when global uniformity
with respect to tax systems is achieved. Furthermore, if the
saving-consumption distortions of taxation are to be considered, global
uniformity with respect to tax rates is also needed. Given such
limitations, source-based taxation seems to be a theoretically,
practically, and politically superior means for achieving CEN. Part IV
follows the classic framework and analysis of international tax
neutrality by disregarding the saving-consumption distortions of
taxation, consistently disregarding the labor-leisure distortions of
taxation, and showing 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 to fully satisfy CEN
simultaneously with NN, CIN, CON, and NON. Part IV also calls for
additional work in this respect. Part V is reserved for conclusion.
II. ECONOMIC EFFICIENCY AND THE CONCEPT OF TAX NEUTRALITY
Economic efficiency is fundamentally associated with economic costs
and benefits. Maximizing economic efficiency requires, to the extent
possible, maximizing economic benefits and minimizing economic costs.
Maximizing economic efficiency is thought to result in maximum wellbeing
in overall terms. It logically follows that economic efficiency
disregards distributive considerations: insofar as benefits are
maximized and costs are minimized in overall terms, economic efficiency
is satisfied regardless of how wealth is distributed. From a national
perspective, economic efficiency is concerned with maximizing the excess
of overall economic benefits over overall economic costs within the
nation. From a global perspective, worldwide economic efficiency is
thought to be concerned with maximizing overall wealth in worldwide
terms. (4)
International tax neutrality policies are economic theories
believed to enhance economic efficiency as an international tax policy
matter. The basic assumption of all international tax neutrality
theories is that capital is perfectly mobile and that labor and land are
perfectly immobile. The baseline of the classic tax neutrality analysis
seeking to maximize global economic efficiency is a non-tax world in
which investment and other business decisions are considered
economically most efficient. (5) Tax neutrality theories strive to keep
such investment and business decisions tax neutral--that is, to keep
investment and business decisions unaffected and undistorted, compared
to a non-tax world, by the imposition of tax and tax consideration. All
international tax neutrality theories will be generally introduced in
this part, but each will also be discussed in greater detail in the
following parts.
Taking the non-tax world as its baseline, CEN seeks a tax system
that does not distort the locational allocation of investment capital in
an "ideally efficient" non-tax world. For a tax system to
satisfy CEN, capital should be invested in the same locations where such
capital would have been invested had there been no taxes. (6) Only then
will the decision as to the location of investment be tax neutral. Under
the classic tax neutrality analysis, only pure residence-based tax
systems would satisfy CEN. (7) International tax differentials might
distort such allocation by resulting in higher after-tax rates not
necessarily associated with the higher pre-tax rates of return. The
distortion in capital allocation occurs because investors seek to
maximize their net profits, and ergo invest where after-tax rates of
return ar