On the Relevance of Export Demand Conditions for Capital Income Taxation in Open Economies

Abstract

This paper highlights the role of export demand conditions in determining the real cost of external funding for a country that has unrestricted access to funding from the international capital market at a predetermined real interest rate. If such a country enters into a free trade arrangement which includes national treatment provisions for foreign investment, then the capital income tax becomes an appropriate second-best instrument for ensuring that national welfare is maximized. If the capital income tax is set optimally, the national return on savings will always be at least as great as the domestic marginal product of capital.