Withholding Taxes and Country-Specific Shocks

Soeren Bo Nielsen

No 95-02, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: This paper investigates aspects of capital income tax policy in a world economy with many symmetric countries, where production is subject to country-specific productivity shocks. Each country can levy both withholding taxes on income accruing to foreigners and dividend taxes on domestic citizens' income. Optimal dividend taxes generally tend to promote investment at home while discouraging investment in foreign assets. The sign of the withholding tax is seen to depend on the degree of internaitonal portfolio diversification at the outset. When all shares in domestic equity are held at home initially, and when foreign tax authorities employ dividend taxation of foreign source income, then the optimal withholding tax is negative.

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