International Handbook on the Economics of Integration, Volume II
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International Handbook on the Economics of Integration, Volume II

Competition, Spatial Location of Economic Activity and Financial Issues

Edited by Miroslav N. Jovanović

With this Handbook, Miroslav Jovanović has provided readers with both an excellent stand-alone original reference book as well as an integral part of a comprehensive three-volume set. This introduction into a rich and expanding academic and practical world of international economic integration also provides a theoretical and analytical framework to the reader, presenting select analytical studies and encouraging further research.
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Chapter 17: Puzzles Over International Taxation of Cross-border Flows of Capital Income

John Whalley


John Whalley1 1 INTRODUCTION The theme of this handbook is economic integration, and here I focus on the tax treatment of transborder flows of capital income. Arrangements actually in use in this area are characterised as much by cooperation, through treaties, as by competition;2 and by seemingly non-strategic unilateral actions in the form of country reliefs from double taxation. Unilateral reliefs from double taxation are offered by source countries typically involving a foreign tax credit, although in some countries systems of exemption from domestic taxes operate if taxes are paid abroad. These systems seemingly embody no strategic response to taxes abroad, and have remained invariant to tax redesign in host countries over the years. Tax treaties are negotiated pairwise between countries (typically following the OECD model treaty). Under these, pairs of countries agree to mutually reduce withholding tax rates on bilateral flows of interest, dividends, and royalties to rates below those applying in the absence of treaties. Different tax rates apply to these three categories, and also between different pairs of countries. These treaties represent cooperative behaviour by national governments. Somewhat surprisingly there seems to be relatively little that has been written by academic economists on this combined system of reliefs. An early paper by Hamada (1966) shows how in the two (non-small) country case, source and host countries have incentives to use retaliatory tax policies towards income generated by transborder investments. Hamada characterises a Nash equilibrium in the two-country tax game in ways which are closely related to...

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