Working Paper: NBER ID: w4796
Authors: Roger H. Gordon; A. Lans Bovenberg
Abstract: The evidence on international capital immobility is extensive, ranging from the correlations between domestic savings and investment pointed out by Feldstein-Horioka (1980), to real interest differentials across countries, to the lack of international portfolio diversification. To what degree does capital immobility modify past results forecasting that small open economies should not tax savings or investment? The answer depends on the cause of this immobility. We argue that asymmetric information between countries provides the most plausible explanation for the above observations. When we examine optimal tax policy in an open economy allowing for asymmetric information, rather than simply finding that savings and investment should not be taxed, we now forecast government subsidies to foreign acquisitions of domestic firms. Some omitted factors that would argue against subsidizing foreign acquisitions are explored briefly.
Keywords: Capital Mobility; Asymmetric Information; Tax Policy; Investment; Savings
JEL Codes: H25; F21; F23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| asymmetric information (D82) | capital immobility (F20) |
| asymmetric information (D82) | difficulties in establishing new firms (M13) |
| asymmetric information (D82) | likelihood of overpaying for existing firms (G32) |
| capital immobility (F20) | limited foreign investment (F21) |
| savings-investment correlations (E21) | rationalized through asymmetric information model (D82) |
| real interest rate differentials (E43) | rationalized through asymmetric information model (D82) |
| capital-importing country subsidies (F21) | align domestic returns with world market rates (F16) |
| domestic savings taxed (H24) | net return on domestic savings equals marginal product of domestic capital (E23) |