A simple two-country model of redistributive capital income taxation

Abstract

This paper presents a simple two-country model with mobile capital and immobile labour, in which there are two classes of individuals, the workers and the capital owners. A source-based tax on capital income is used to finance transfers to workers. If the two countries are homogeneous in all respects (preferences for equity, population size, and social composition), capital income is shown to be undertaxed at the non-cooperative equilibrium relative to the autarkic situation. In the case of heterogeneous countries, it can be either undertaxed or overtaxed: our simple setting enables us to obtain an easy-to-interpret formula for each country's capital income tax, and numerical examples indicate how the two countries' tax decisions interact at the noncooperative equilibrium. The normative issue of imposing minimal tax standards across countries is also analyzed. The paper provides conditions under which enforcing such policy will be beneficial to all countries.