ABSTRACT
Economic views of tax jurisdiction tend to center around questions of world efficiency (how can tax jurisdictions be defined to maximize world income?) versus national goals (how can countries define tax systems to maximize national income?). Initial studies concluded that worldwide income could be maximized
by taxing worldwide income and allowing a credit for foreign taxes, while national income could be maximized with a deduction system (Richman 1963; Hines and Gordon 2002). These results follow from highly stylized models. For instance, the advantages of a worldwide system are most easily thought of in the context of a world of two countries where one is a capital exporter and the other is a capital importer. In this context, the worldwide system with an (unlimited) foreign tax credit will lead to the efficient allocation of capital in the world. This is because no matter where a company invests, it will pay the tax rate of its home country on the margin. If the company invests at home, it will pay the home tax rate on its investment income. On the other hand, if it invests abroad, then it will first pay foreign taxes. However, if the foreign tax rate is less than the tax rate at home, then the company will owe the difference to the home country; if the foreign tax rate is higher than the home tax rate, then the company will get a refund of the difference (assuming an unlimited tax credit). Hence, no matter where the company invests, it will pay exactly the same tax on the income generated and will have no tax-induced incentive to invest in one country over another. This is called capital-export neutrality and results in an efficient allocation of capital across countries. A second view is that the territorial system leads to an efficient allocation of savings across different countries. A territorial tax system exempts foreignsource income from tax, and consequently all investors in a country face the same tax rate on the margin. For this reason, it is said to comply with capital import neutrality. From an economic perspective, it is viewed as promoting savings efficiency, because any international saving (interest from foreign bonds for instance) is not influenced by the tax system. Both of these views have some validity. Worldwide residence taxation promotes investment efficiency but distorts saving decisions. A territorial system promotes the efficient allocation of savings but distorts investment decisions. A third view, developed primarily in the literature on subnational taxation, is the benefit view. Under this view, taxes are payments for the provision of public goods and services. People and companies willingly pay taxes in exchange for goods and services provided by the government. As people and businesses tend to consume public services where they are located, the tax jurisdiction should also be defined with respect to where they are located. A territorial system approximates this situation, and thus, under the benefit view, the territorial system may lead to efficient location decisions. Tax competition promotes efficiency in this view, because it tends to force governments to provide goods and services such that the marginal benefit of the public good is just equal to the marginal cost of the tax payment. A fourth view that has recently been raised is termed capital-ownership neutrality (Desai and Hines 2003; Devereux 1990). According to proponents of this view, ownership of assets is important, because owners who are better able to run certain types of companies can generate a higher return. Hence, it is important to distribute owners of capital to the type of capital in which they have a comparative advantage. This view sees efficiency as requiring the tax system to
be neutral with respect to the ownership of capital. Capital-ownership neutrality can be achieved if all countries use the same tax system, whether it is a worldwide system or a territorial system. To summarize, economic views of tax jurisdiction have concentrated on various types of worldwide efficiency criteria. These include capital-export neutrality, capital-import neutrality, capital-ownership neutrality and the benefit view of taxation. Capital-export neutrality is associated with a worldwide tax system and implies efficiency in the allocation of capital across countries. Capital-import neutrality is associated with a territorial system and implies efficiency in international savings decisions. Capital-ownership neutrality can be achieved under either a worldwide or a territorial system, and implies efficiency in the matching of assets and owners. The benefit view requires those who benefit from public services to pay the associated costs, which are closely approximated by a territorial division of tax jurisdictions.
