The optimal taxation of savings and investment in an open economy

Abstract

While the taxation of savings and of investment are equivalent in a closed economy, there is a real choice between the two in an open economy setting. A tax authority can, specifically, tax the return to domestic capital following the source principle, or it can tax the return to domestic savings following the residence principle. This paper examines the optimal joint taxation of savings and investment for a country that has access to the international capital market. Conditions under which such a country should tax only savings or investment are identified. Generally, however, countries optimally tax both savings and investment. Most countries' tax systems, indeed, are a mixture of the source and residence systems of taxation.