For decades, U.S. international tax policy has shifted back and forth between territorial-source-exemption taxation and worldwide-residence-credit taxation. The former is generally associated with capital import neutrality (CIN) and the latter with capital export neutrality (CEN). One reason why national tax policy has shifted back and forth between those benchmarks is because it is widely accepted that a tax system cannot simultaneously satisfy both CEN and CIN unless tax rates on capital are harmonized across jurisdictions. In this essay, I argue that the international tax literature contains two different and conflicting definitions for CIN. Under one definition, which goes back at least to Peggy Musgrave’s early writings and which has been adopted by politicians, lawyers and lay readers, CIN is understood to refer to a tax system that was competitively neutral. That idea can be conceptualized as a tax system that does not distort the ownership of capital (ownership neutrality). In the economics literature, ownership neutrality is closely associated with the recent work of Mihir Desai and James Hines, who coined the phrase capital ownership neutrality (CON) to describe a tax system that does not distort the ownership of assets. Under the other definition, which goes back to Thomas Horst and which has been broadly adopted by professional economists, CIN is understood to refer to a tax system that does not distort the consumption – savings choice (savings neutrality). In this essay, I show that the widely accepted and often repeated proof that a tax system cannot simultaneously satisfy both CEN and CIN is based on the assumption that CIN refers to saving neutrality. In contrast, when CIN is interpreted as ownership neutrality, the global adoption of a worldwide tax system simultaneously satisfies both CEN and CIN. However, global adoption of a territorial tax system still cannot simultaneously achieve both CEN and CIN because a territorial tax system violates CEN. Not surprisingly, the use of the term CIN to denote two different types of neutrality – ownership neutrality and savings neutrality – has produced much confusion for those trying to understand, influence and set international tax policy. Accordingly, I recommend that commentators either stop talking about CEN and CIN and talk instead about locational, ownership, and savings neutrality or if they continue to talk about CIN that they clearly specify whether they mean CIN as ownership neutrality or as saving neutrality.
foreign tax credit, worldwide taxation, competitiveness, tax competition, foreign direct investment, international taxation, capital export neutrality (CEN), capital import neutrality (CIN), capital ownership neutrality (CON)
Tax Law Review
Knoll, Michael S., "Reconsidering International Tax Neutrality" (2011). Faculty Scholarship at Penn Law. 268.
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