The Coordination of Capital Income and Profit Taxation with Cross-Ownership of Firms

This paper investigates the scope for international coordination of capital income and profit taxation. The paper considers a world of many symmetric countries where public goods are financed by taxes on capital income and on profits. In the open economy, the authorities have at their disposal a residence-based saving tax, a source-based investment tax and a profit tax. Determinants of the tax mix are the foreign ownership of domestic firms, if any, and the extent to which the profit tax is feasible. Noncooperative tax policy in the open economy is compared to the corresponding tax policy in the closed economy where a single tax instrument determines the wedge between the returns to saving and investment. There generally is a scope for a coordinated increase in this tax wedge if the noncoordinated tax wedge is negative or very large, and vice versa. There is no need for tax coordination if there is no foreign ownership or if profits are taxed fully. The cases for tax coordination when in the noncoordinated scenario there either is no saving tax or no investment tax are also considered. In the absence of an investment tax, coordination can only lead to an increase in the saving-investment tax wedge, while in the absence of saving taxes this tax wedge has to be increased or decreased in the general case of a positive foreign ownership of domestic firms.