Page 12 - 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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                   principle. Since in this case income is taxed only   country only if  t*  > t  + t* , which is more likely
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                   according to the place of residency, regardless of   if the foreign country apply tax credit.
                   the source, it follows that
                                                                       Now we move to residents of the home country.
                    t  = t*  – t , t*  = t*  + t  and t  = t*    (23)  The tax imposed to them in the home country is t ,
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                                                                    and obviously foreign country does not impose any
                      We see that  when countries uses the same
                                                                    tax rate to the residents. It then become an obvious
                   regime of principle when levying the tax, reaching
                                                                    better-off  circumstance  if the home-country
                   equilibrium state seen in equation  (21)  is viable
                                                                    residents  move its capital  abroad to foreign
                   and thus given equal the same capital return, there
                                                                    country. In such condition, both home country and
                   will be no capital movement across border. But in
                                                                    foreign country do not impose any tax to them, and
                   practice, this is certainly not the case. Let us now
                                                                    thus they pay zero tax since t  = t* = 0.
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                   use the scenario  when the two countries do not
                   adopt  the  same  effective  principle.  Suppose,  for   To attract investors to flow their capital inside
                   instance, home country adopts in effect the source   the country, the government should realize that the
                   principle, while the foreign country adopts the   incentive for  cross-border  investment is  created
                   residence principle, so that                     by the  taxes  of  the host  country and residence
                                                                    country combined. To keep the  analysis simple
                              t  = t  and t  = 0   (24)             without losing the relevant aspect, let us keep the
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                                                                    system comprising of two countries: home country
                           t*  = t*  – t*  and t*  = 0  (25)
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                                                                    and foreign country. Inside the system, the capital
                      These  equations added  the already existed   owner based in the foreign country considers
                   constrain – equation  3 – that integrated  world   whether to invest his capital domestically (foreign
                   capital market cause to the country’s tax system.   country) or abroad (home country).
                   These  also give us the rationale that  as long
                                                                       The possible interactions are described below
                   as  equilibrium  does not  hold, countries will
                                                                    on Table 1. We show the analysis providing the best
                   continuously compete  each  other  in tax  matters,
                                                                    options for  capital  owners in each combination
                   through which firms maximize their capital return.
                                                                    of possibilities of tax  regimes the countries can
                      To examine the type of movement existed in the   use. Then, with the free movement of the capital,
                   framework built in (24) and (25), note that in the   government tries  to maximize the welfare, both
                   perspective of home country, the tax rate imposed   from increasing tax revenues and rent for immobile
                   by non-residents is t , while from the perspective   capital, which is labor wage. With such effort, the
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                   of the foreign country, the tax  rate imposed  to   government  tries  to  maximize  the  capital  inflow
                   them  is  t* ,  implying the total  tax  rate levied on   and minimize the capital outflow.
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                   the non-resident  is investing in home country
                                                                       Table  1 provides  us information about  the
                   equals to t  + t*  . It means that non-residents are
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                   only incentivized to move the capital to the home   level of incentive for foreign residents to invest at
                                         Table 1: Incentive for Capital Inflow Based on the Tax Regime
                                                                                                Level of incentive
                                                                          Total tax paid by foreign
                      Home country    Foreign country     Who collects?                          for cross-border
                                                                                 resident
                                                                                                   investment
                    Source based    Residence based without   Both country       t  + t* rF     Very low incentive
                                    alleviation
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                    Source based    Residence based with   Both countries (reduced)  t  + t*  - deduction  Low incentive
                                    deduction
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                                                                                  rF
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                                                                                rN
                    Source based    Residence based with   Both countries (reduced)  t  if t > t* rF   Moderate incentive
                                    credit
                                                                               t*  if t > t*
                                                                                 rF  rN       rF
                    Source based    Source based       Home country                t            Moderate incentive
                                                                                    rN
                    Residence based  Residence based without   Foreign country     t* rF        Moderate incentive
                                    alleviation
                                    Residence based with
                    Residence based                    Foreign country             t*           Moderate incentive
                                    deduction                                       rF
                    Residence based  Residence based with   Foreign country        t* rF        Moderate incentive
                                    credit
                    Residence based   Source based     None                         0           High incentive
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