Introduction

The past decade has witnessed major changes in the volume, composition, and direction of international capital flows, as well as a wave of deregulation and financial innovation. For the most part, public-finance economists have concentrated their attention on the opportunities this new climate has created for tax evasion and tax competition (Mintz, 1992; Gordon 1995; Tanzi, 1995). By contrast, tax practitioners and financial-market participants have tended to stress the inconsistencies of existing tax systems, the tax impediments to the smooth working of markets, and the inefficiencies of the established anti-tax-avoidance mechanisms (Scholes and Wolf son, 1992; Plambeck, Rosenbloom, and Ring, 1996). Not surprisingly, these different perspectives suggest vastly different policy recommendations.

This study has three objectives. The first is to illustrate that, contrary to a view common among public-finance specialists, the contraction in source-based taxes on portfolio capital flows (i.e., withholding taxes) owes much less to tax competition for “hot-money flows” than to a number of other factors: (1) the increase in the number of institutional investors who benefit from a special tax status in their home countries that they wish to maintain abroad, (2) the expansion of international transactions in securities and the inefficiencies of withholding-tax regimes, and (3) the difficulty, if not impossibility, of applying gross-basis withholding taxes to a number of new financial instruments.

The second objective is to examine the complications involved in operating a full-fledged global income tax based on the residence principle in light of the changes that have occurred in the financial system.