Page 10 - Working Paper (Optimal Corporate Income Tax Policy for Large Developing Countries in an Integrated Economy)
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DDTC Working Paper 1416
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                         This move can be very useful four countries   hold for each country separately.  It rather holds
                      with various type of investment opportunities.   for world  saving  and  investment  in  aggregative.
                      For  example,  the differentiation can be made   As a consequence, the removed economic border
                      based on the region, like mentioned before.   between countries certainly brings out the issue of
                      Second, the tax rate can be differentiated based   the efficiency of the international allocation of the
                      on the type of investment. The latter example   world investments and savings.
                      is usually applied when the government also
                      intend to develop the sector. In most practice,   As economic  border  between countries  is
                      countries tend to use tax incentives to attract   continually dematerialized, especially  within  a
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                      capital  inflow , simultaneously followed by   specific  zone,  corporation  will  freely  invest  its
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                      effort to enlarge the tax bases  and increasing   capital freely across countries. Investors will choose
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                      tax  expenditure.  The tax  incentives include   countries where their profit can be maximized, and
                      tax holiday, tax allowance, cost deduction, loss   on the contrary, will pull its capital from the less
                      carry forward, etc. Through these facilitations,   profitable  country.  Hence,  interest  rate  in  each
                      firms  can  then  be  temporarily  attracted  to   country will eventually get into equilibrium level,
                      utilize such opportunity.                     where marginal rate of capital return is equalized
                                                                    between countries.
                   4.  Interaction between  Tax Systems:               However, one should note that  it  is the after-
                   Source vs Residence Principle                    tax  investment return that an investor  seek  to
                                                                    maximize in making decision. Having tax rate too
                      Up  to  the  discussion  here,  we  assumed  that   high to certain level will nullify the desirability of
                   each involved country  uses the same treat  the   capital owners to invest, and conversely, lowering
                   existing capital with the same principle, that  is,   the tax rate will attract capital to flow in. Thus it
                   ‘source’ principle.  But  in international  practice,   is also of consideration for government in deciding
                   the world consists  of  nationals  using the mix of   the rate through which the society welfare can be
                   source and  residence principle.  In  fact,  a  single   maximized.  Recall  as  stated  previously  in  ZMW
                   country might implement both of these as the basis   model, welfare is  gained  from  private goods
                   to levy different type of  activities.  Incorporating   consumption – paid from immobile capital  rent,
                   this certainty will be very illuminating in sensing   which can be equally stated as labor ncome – and
                   the  investment  flow  direction  in  an  integrated   public  provision  –  funded by tax  revenue of the
                   economy.                                         government.

                      Speaking  of  unrestricted  capital  flow,  one   The problem  becomes more puzzling when
                   should reexamine the practical aspect of equality   countries have different approach in determining
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                   between saving and investment.  In a closed      the tax base. With such international mobility, the
                   economy, savings collected in the country will be   capital flowing overseas may be subject to two tax
                   solely used  for investment in the territory. The   jurisdiction. The occurrence of double taxation has
                   relation  of both saving and investment will  then   far reaching consequences  for  the direction and
                   bring investment return  to an equilibrium state.   magnitude of the flows of capital in the international
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                   This modest perspective, however, is contextually   economy.  For instance, if the home country taxes
                   vanished  in a borderless economy. When an       its residence on their capital income originating in
                   investor have better opportunity of investment   the foreign country and the foreign country taxes
                   return – partially represented  by interest rate –   non-residence on their capital income originating
                   in another country, he is incentivized to move his   in the foreign country, the generated income would
                   capital abroad. Hence, as a result, a country could   be subject to taxation.
                   not set an  interest rate independently without
                                                                       Two common approaches  of international
                   considering other countries’ interest rate.
                                                                    taxation which lay the foundation for many national
                      In a world with a borderless economy, the     tax systems are the residence principle and source
                   equality between saving and investment does not   principle. The former uses the place of residency
                                                                    of the tax payer as the basis for assessment of tax
                                                                    liabilities, while the latter emphasizes the source
                   25. OECD, “Choosing Broad Base: Low Rate Approach to Taxation”,
                   OECD Tax Policy Studies, No. 19, (2010): 11.     of income. Accordingly, under the residence
                   26. Richard M. Bird, “The BBLR Approach to Tax Reform in Emerging   principle, residents  of the country are taxed
                   Countries”, University of Toronto, (Agustus, 2008).
                   27.  Darussalam and  Bawono  Kristiaji, “Tax  Expenditure atas  Pajak
                   Penghasilan: Rekomendasi bagi Indonesia”,  DDTC Working Paper 0814,   29.  Salvador  Barios,  “International Taxation  and  Multinational Firm
                   (2014).                                          Location Decision,” Economic Papers, No. 356 (2009).
                   28. In an efficient economy, the every money that is saved is capitalized to   30. William B. Barker, “Optimal International Taxation and Tax
                   fulfill the clearance condition. This process is comprehensively explained   Competition,”  Northwestern Journal of International Law &Business,  Vol.
                   in Olivier Blanchard, Macroeconomics, (2008).    22 (2002).
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