Capital Flight and Tax Competition: Are There Viable Solutions to Both Problems?

James R. Hines Jr., University of Michigan Law School

This material has been published as Giovannini, Alberto and James R. Hines, Jr. "Capital Flight and Tax Competition: Are There Viable Solutions to Both Problems?" In European Financial Integration, edited by Alberto Giovannini and Colin Mayer. Cambridge: Cambridge University Press, 1991. This version is free to view and download for private research and study only. Not for re-distribution or re-use. © Cambridge University Press (1991)


The history of European capital taxation is one of 12 disparate systems, competing for revenue not only with each other but also - and sometimes dramatically - with their own taxpayers. With the imminent arrival of 1992 the fiscal landscape will change significantly: if current capital tax systems are left untouched, European governments are likely to find it very hard to collect revenue from internationally mobile capital. Indeed, Europe may transform itself into a single (large) tax haven. In this paper we perform an exercise in applied positive economics: we design a model of residence-based corporate taxation that, while preserving national tax sovereignties, minimizes the distortions arising from international capital mobility. This type of exercise is in our view especially useful because in the current debates over tax reform in Europe there is much confusion between administrative problems and political constraints. Analysis of models of taxation like ours can help clarify where administrative issues end and political issues begin. To motivate our study, we begin in section 2 with a look at the data on revenue from capital income taxes and a brief discussion of the role of the history of capital taxation in shaping the fiscal institutions and private practices that are visible today. After listing in section 3 the ( often unintended) distortionary incentives embodied in current tax treatments of international income, we analyse in section 4.1 a plan for a system of corporate income taxation that is consistent with the goal of minimizing the distortions arising from the international mobility of capital. The plan is inspired by the full application of the residence principle of taxation of international capital income.