A North-South Model of Taxation and Capital Flows

This paper presents a simple two-country model of the role of taxation in capital flows between developed countries ("The North") and developing countries ("The South"). The Southern country is assumed to be unable to enforce a tax on its residents ' foreign-source income, and the Northern country chooses not to impose a withholding tax on portfolio income earned in its country. The world equilibrium in the model is characterized by excessive (by the standard of global efficiency and Southern welfare) flows of capital across borders, and insufficient investment located in the South. National income of the South could, under certain conditions, be improved if the North would impose a withholding tax on portfolio income that leaves the country, even though the South sacrifices tax revenue to the North. A Southern tax on foreign-source income may dominate this, depending on the resource cost of enforcing such a tax