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The Optimal Taxation of Foreign Source Investment Income

  • Martin Feldstein
  • David G. Hartman

Our paper begins with the relatively simple problem of optimal taxation as viewed by the capital-exporting ("home") country when it can assume that its actions do not alter the tax rate in the host country. Section I also shows that when foreign investment accounts for a significant fraction of production in the host country, the capital-exporting country should tax foreign source investment income more heavily than is implied by the "full taxation after deduction" rule. The important question of tax rate interdependence is developed in Section II. In the third section we replace the assumption that all foreign investment is financed by a transfer of equity capital from the home country with the more realistic description that subsidiary firms borrow in the host country. Although this raises the profitability to the home country of investment by its foreign subsidiaries, we show that this need not alter the conclusions of the previous sections. We regard the present paper as only a first step in a proper analysis of the complex issue of optimal taxation of foreign source investment income. . The static analysis of the present paper should be extended to consider investment paths in growing economics. Finally, the purely nationalistic optimality criterion could be generalized to give some weight to the real income of the rest of the world.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0193.

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Date of creation: Nov 1980
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Publication status: published as Feldstein, Martin and Hartman, David. "The Optimal Taxation of Foreign Source Investment Income." Quarterly Journal of Economics, Vol. XCIII, No. 4, ( November 1979), pp. 613-629.
Handle: RePEc:nbr:nberwo:0193
Note: PE
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  1. Feldstein, Martin & Sheshinski, Eytan & Green, Jerry, 1979. "Corporate Financial Policy and Taxation in a Growing Economy," Scholarly Articles 3203643, Harvard University Department of Economics.
  2. Murray C. Kemp, 1962. "Foreign Investment And The National Advantage," The Economic Record, The Economic Society of Australia, vol. 38(81), pages 56-62, 03.
  3. G. D. A. MacDougall, 1960. "THE BENEFITS and COSTS OF PRIVATE INVESTMENT FROM ABROAD: A THEORETICAL APPROACH," The Economic Record, The Economic Society of Australia, vol. 36(73), pages 13-35, 03.
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