The international taxation of capital

We revisit the question of optimal capital taxation in an international context with endogenous international investment (portfolio) decisions and assets that are imperfect substitutes. According to the conventional view, increasing mobility of capital across borders should lead to a race-to-the-bottom in capital taxation when government do not coordinate their fiscal policy as the supply of capital becomes infinitely elastic to the return to capital. This result hinges however on a very strong assumption: claims on physical capital in different countries are perfect substitutes. Relaxing this assumption by introducing country specific aggregate uncertainty and endogenous international portfolio decisions across country in an otherwise standard two-country IRBC model lead to very different conclusions when government do not coordinate their fiscal policies. When setting capital taxes, governments (Ramsey planners) trade-off the benefits of imposing some of the burden of their spending on foreign capital holders with the costs of deterring capital accumulation. This leads non-zero capital taxes in the long-run. We investigate how the terms of this trade-off are affected by the degree of financial integration.