INTERNATIONAL ASPECTS OF CORPORATE TAX INTEGRATION: THE CONTRASTING ROLE OF DEBT AND EQUITY FLOWS

Abstract

We analyze various corporate tax integration plans in an international simulation model of the United States and the rest of the world. The schemes considered include "backward" integration in which interest and dividends are not deductible at the corporate level and are exempt at the shareholder level. We distinguish between debt and equity flows, because integration oñen has opposite effects on them. Such offsetting effects are one reason full integration and dividend credit proposals have a small effect on international net investment positions. Nevertheless, if integration benefits are denied to foreigners, the lower net investment income foreigners receive can have significant effects on the long-run trade balance and sectoral outputs. These results differ from a closed-economy outcome, because higher United States income shifts output to nontraded goods, whose output would otherwise decline because of a larger noncorporate component They also differ from a small open economy in which the cost of capital does not decline in the corporate sector. The results also contrast with an all-equity model in which an outflow of equity is not offset by an inflow of debt. Backward integration causes a large capital outflow, because foreigners derive no benefit if interest income is exempt from personallevel tax. As a result of the importance of debt, we also find, paradoxically, that an across-the-board increase in capital taxes may lead to a capital inflow.

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