The Sufficient Statistics Approach Applied To International Tax Policy

This paper extends the sufficient statistics approach to study international tax policy. International policy differs from domestic policies because i.) from the perspective of domestic policy makers the welfare weight on foreign agents lies below that of domestic agents, and ii.) behavioral changes by foreign agents have (general equilibrium) spillover effects on the domestic economy that are welfare relevant. I develop a tax model in which a domestic firm produces output by combining domestic and foreign inputs. Production also depends on the aggregate level of the foreign input, thereby generating a production externality. Factor prices are determined in general equilibrium by the interplay between the firm’s demand for factors and the supply provided by foreign and domestic private agents. The firm is taxed based on its factor inputs and factor prices but can avoid taxation using a costly tax avoidance technology. The cost of avoidance partly depends on investment in tax administration. Welfare is defined as a weighted sum of tax revenue and the surpluses of private domestic and foreign agents. I examine the welfare effects of marginal increases in both the tax rate and tax administration. These effects decompose into contributions to the production and fiscal externality and to transfers between domestic agents and the government, as well as between foreign and domestic agents. The sufficient statistics needed for welfare analysis are the elasticity of taxable income, the elasticity of factor prices, and the elasticity of the foreign input with respect to the policy variable of interest.