Part 1 - AL-Tax

International Taxation Handbookwithholding taxes under the residence principle generates an implicit revenuetransfer from the residence to the source country. In the knife-edge case of a foreignwithholding tax rate equal to the income tax rate on residents, the residencecountry does not collect any revenue at all! And, the revenue transferred in thisway is not unimportant. Keen and Wildasin (2004) discussed the case of the USA,in which implicit transfers to foreign countries exceed the amount of explicit USforeign aid (averaging about 0.2% of GDP during recent years). 11If countries, however, could sign a treaty specifying the socially efficient withholdingtax rates and required revenue transfers, an efficient and equitable outcomein line with pure residence-based taxation would be obtained. But theunderlying conflict of interest between countries evidently prevents this fromhappening. Countries with no or a low tax rate fear losing out from a harmonizedwithholding tax rate at some minimum level (because these countries are netimporters of capital). In this political game, an international tax agency – coinedthe World Tax Organization (WTO) by Tanzi (1999) – could have a meaningfulrole to play (of course, the WTO could also play a useful role in negotiating information-sharingtreaties).Recent literature (e.g. Keen and Ligthart, 2006b) shows that information exchangeis more efficient than withholding taxes in the sense of generating larger global revenues.Intuitively, information sharing brings additional taxpayers into the tax netby their home country, and these taxpayers are typically taxed at (income tax) ratesexceeding the nonresident withholding tax rates paid abroad. The size of this effectis larger the greater the difference between the rates of the resident income tax andthe foreign withholding tax, the larger the probability of the evader being caught bythe foreign authorities, and the larger the imposed fines. Moreover, informationexchange has the further advantage that it may also help tax authorities uncover taxevasion in other tax categories (for example, wage or social security taxes) 12 or provideleads in detecting criminal activities, including money laundering. Indeed,evasion of the capital income tax is not the only motive to deposit money abroad; Itis likely that some share of the funds is earned in the underground economy or isgenerated by criminal activities, and therefore must be concealed.If all countries were identical, one would expect information sharing to emergeas the preferred outcome. Once allowance is made for asymmetries in countrysize, it is not immediately evident what kind of taxation regime would result.Very small countries – often operating as tax havens (section 10.4.2) – may preferto levy nonresident withholding taxes. Moreover, this would allow small countriesto maintain their bank secrecy legislation or tradition (if any is applicable).As was argued above, by passing some of the additional revenue collected as a250