Although the UK, Japan and most other major countries no longer tax dividend income from outbound investment, the appropriate taxation of such investment remains the subject of important policy debates in the USA. A wide theoretical literature has provided conflicting results for guiding policy. Yet it has been hard until now to identify clearly the sources of the different policy prescriptions. This research synthesises and extends the literature on the taxation of foreign source income in a framework that covers different forms of outbound investment, and which allows for different possible effects on domestic investment. We find that, unless domestic investment is determined completely independently from outbound investment, then the domestic tax on foreign-source dividend income should be set to ensure the optimal allocation between the two forms of investment. Moreover, we find that the rate should be set in accordance with the “classical” rules; maximising domestic national income requires the deduction rule, while maximising global national income requires the credit rule. Allowances should be set to ensure that domestic and outbound investment is undistorted by the tax system: this requires a domestic cash-flow tax, or an allowance for corporate equity, on both domestic and outbound investment. These results extend to a number of extensions of the theoretical model.
Michael P Devereux, Clemens Fuest and Ben Lockwood