This paper shows that when uncertainty is taken into account explicitly, taxation of corporate income can leave corporate investment incentives, and individual savings incentives, basically unaffected, in spite of the sizable tax revenues collected. In some plausible situations, such taxes can increase efficiency. The explanation for these surprising results is that the government, by taxing capital income, absorbs a certain fraction of both the expected return and the uncertainty in the return. While investors as a result receive a lower expected return, they also bear less risk when they invest, and these two effects are largely offsetting.

Under the U. S. tax law, taxable income differs systematically from economic income when there is inflation. For example, nominal interest payments and nominal capital gains are taxable or tax deductible, and depreciation allowances are based on historic rather than replacement costs. Therefore, even fully anticipated inflation can have real effects. The purpose of this paper is to investigate to what degree an increase in the inflation rate, given these differences between taxable and economic income under existing tax law, ought to change corporate investment and financial policy, and cause capital gains or losses to existing owners of corporate equity.

In a Federal system of government, each unit of government decides independently how much of each type of public good to provide, and what types of taxes, and which tax rates, to use in funding the public goods. In this paper we explore what types of problems can arise from this decentralized form of decision-making. In particular, we describe systematically the types of externalities that one unit of government can create for nonresidents, through both its public goods decisions and its taxation decisions. The paper also explores briefly what the central government might do to lessen the costs of decentralized decision-making.

The equilibrium allocation of capital and equilibrium market prices are derived for a world economy with unified securities market, mobile capital, no uncertainty, and varying tax rates on different sources of income in each country. The paper then characterizes optimal tax rates for a small country in this setting, focusing on the peculiar incentives created when the before-tax rate of return differs among securities due to differences in their typical tax treatment.

Recent theoretical work has argued that a small open economy should use residence-based but not source-based taxes on capital income. Given the ease with which residents can evade domestic taxes on foreign earnings from capital, however, a residence-based tax may not be administratively feasible, leaving no taxes on capital income.

Optimal-tax theory forecasts that small open economies should not tax capital income. Yet, countries do tax capital income. Why the inconsistency? This paper shows that use of the double-taxation convention, whereby governments credit taxes paid abroad against domestic taxes, helps explain this inconsistency. In particular, capital income will be taxed if a dominant capital exporter acts as a Stackelberg leader when setting its tax policy. Due to the convention, other countries will then tax capital imports, making it attractive for the dominant capital exporter to tax capital income. Without a dominant capital exporter, however, the model still forecasts no capital-income taxes.

ABSTRACT Optimal‐tax theory forecasts that small open economies should not tax capital income. Yet, countries do tax capital income. Why the inconsistency? This paper shows that use of the double‐taxation convention, whereby governments credit taxes paid abroad against domestic taxes, helps explain this inconsistency. In particular, capital income will be taxed if a dominant capital exporter acts as a Stackelberg leader when setting its tax policy. Due to the convention, other countries will then tax capital imports, making it attractive for the dominant capital exporter to tax capital income. Without a dominant capital exporter, however, the model still forecasts no capital‐income taxes.