In the United States, local government expenditures are heavily sub- sidized through a variety of sources. This paper explores theoretically and then simulates empirically the effects of eliminating either of two federal subsidies encouraging local government expenditures: (1) income tax deductibility of local tax payments, and (2) the tax exempt status of interest on municipal bonds.

In simple economic models, it is relatively easy to describe how to impose a value-added tax at a uniform rate on all consumption goods, and to demonstrate that this tax is equivalent to a proportional labor-income tax, plus a tax on existing assets. The equivalence involves little more than the national income identity relating the sources and uses of income. Once one attempts to incorporate the costs of financial intermediation, however, tax analysis becomes more complicated. In attempting to determine how a VAT should treat financial transactions, various authors have attempted to apply results from simpler models. Unfortunately, these results can lead to conflicting, ambiguous, and misleading prescriptions. In this paper, we argue that one needs to rely more on the fundamental objectives of a VAT to decide how it should treat financial transactions. Adopting this approach, we find that, in principle, the VAT should apply to resources devoted to financial transactions in the same manner that it does in other sectors. However, as discussed below, there are real problems in implementing such a tax on the financial sector which we do not attempt to address in this paper.

The evidence on international capital immobility is extensive, including the lack of international portfolio diversification, real interest differentials across countries, and the high correlation between domestic savings and investment. We develop a model with asymmetric information between countries that helps rationalize all the above observations and then examine the implications of this model for optimal domestic tax policy. Without asymmetric information, past work showed that small open economies should not impose corporate income taxes. With asymmetric information, the optimal policy instead involves government subsidies to capital imports. Some omitted factors that argue against subsidizing capital imports are explored briefly.

The double taxation of corporate income should discourage firms from incorporating. The authors investigate the extent to which the aggregate allocation of assets and taxable income in the United States between corporate and noncorporate firms responds to the size of this tax distortion during the period 1959-86. In theory, profitable firms should shift out of the corporate sector when the tax distortion is large, and conversely for firms with tax losses. The authors' empirical results provide strong support for these forecasts and imply that the resulting excess burden equals 16 percent of business tax revenue.

The double taxation of corporate income should discourage firms from incorporating. We investigate the extent to which the aggregate allocation of assets and taxable income in the United States between corporate and noncorporate firms responds to the size of this tax distortion during the period 1959–1986. In theory, profitable firms should shift out of the corporate sector when the tax distortion is large, and conversely for firms with tax losses. Our empirical results provide strong support for these forecasts, and imply that the resulting excess burden equals 16 percent of business tax revenue.

The double taxation of corporate income should discourage firms from incorporating. We investigate the extent to which the aggregate allocation of assets and taxable income in the United States between corporate and noncorporate firms responds to the size of this tax distortion during the period 1959–1986. In theory, profitable firms should shift out of the corporate sector when the tax distortion is large, and conversely for firms with tax losses. Our empirical results provide strong support for these forecasts, and imply that the resulting excess burden equals 16 percent of business tax revenue.