INTERNATIONAL ASPECTS OF CORPORATE-TAX INTEGRATION - THE CONTRASTING ROLE OF DEBT AND EQUITY FLOWS

We analyze various corporate tax integration plans in an international simulation model of the United States and the rest of the world. The schemes considered include ''backward'' integration in which interest and dividends are not deductible at the corporate level and are exempt at the shareholder level. We distinguish between debt and equity flow s, because integration often has opposite effects on them. Such offset ting effects are one reason full integration and dividend credit propo sals have a small effect on international net investment positions. Ne vertheless, if integration benefits are denied to foreigners, the lowe r net investment income foreigners receive can have significant effect s on the long-run trade balance and sectoral outputs. These results di ffer from a closed-economy outcome, because higher United States incom e shifts output to nontraded goods, whose output would otherwise decli ne because of a larger noncorporate component. They also differ from a small open economy in which the cost of capital does not decline in t he corporate sector. The results also contrast with an all-equity mode l in which an outflow of equity is not offset by an inflow of debt. Ba ckward integration causes a large capital outflow, because foreigners derive no benefit if interest income is exempt from personal-level tax . As a result of the importance of debt, we also find, paradoxically, that an across-the-board increase in capital taxes may lead to a capit al inflow.