A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Desai, Mihir A. Article Capital flows, taxation, and institutional variation NBER Reporter Online Provided in Cooperation with: National Bureau of Economic Research (NBER), Cambridge, Mass. Suggested Citation: Desai, Mihir A. (2008) : Capital flows, taxation, and institutional variation, NBER Reporter Online, National Bureau of Economic Research (NBER), Cambridge, MA, Iss. 3, pp. 6-10 This Version is available at: http://hdl.handle.net/10419/61915 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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In eco- imposes financial costs, such as a reduc- August 2005, and Advances In Health nomic jargon, there is a positive exter- tion in wages in some cases. My research Economics And Health Services nality from becoming obese, because the suggests that the vast preponderance of Research, 17 (2007), pp.279–318. benefit from the induced research on these costs is private and paid for by obese 2 J. Bhattacharya and M.K. Bundorf, heart attacks and diabetes will not accrue individuals themselves. Moreover, some “The Incidence of the Healthcare Costs solely to obese individuals. We estimate of the costs that are traditionally identi- of Obesity,” NBER Working Paper No. that this positive externality, which ben- fied as public costs may actually be ben- 11303, May 2005. efits thin people, is at least as large as the efits. Rising obesity rates, for example, 3 I. Rashad and S. Markowitz, transfer induced by Medicare from thin may bring forth greater innovative activ- “Incentives in Obesity and Health to obese people. ity and ultimately treatments that benefit Insurance,” NBER Working Paper No. The conclusions of this research thin people as well. In this setting, poli- 13113, May 2007. agenda cast doubt on the conventional cies such as taxes on junk food may lower 4 J. Bhattacharya and M. Packalen, wisdom about the costs of obesity, social welfare rather than raising it while “Is Medicine an Ivory Tower?” NBER which fails to distinguish between pri- placing substantial burdens on obese indi- Working Paper No. 1382, March 2008. vate and public costs. There is no doubt viduals who already pay a substantial cost 5 J. Bhattacharya J and M. Packalen, that becoming obese imposes substan- for their girth. “The Other Ex-Ante Moral Hazard tial medical costs on the obese individ- in Health” NBER Working Paper No. ual, who is more likely to develop Type 1383, March 2008. II diabetes, heart disease, strokes, and a 1 J. Bhattacharya and N. Sood, “Health number of other unpleasant chronic dis- Insurance and the Obesity Externality,” Capital Flows, Taxation, and Institutional Variation Mihir A. Desai* Tariff reductions, falling transport held by foreigners. Foreign holdings of folio decisions and firms’ operational and costs, and reduced barriers to interna- American stocks increased from $400 bil- financing decisions. tional capital flows have created extensive lion to $2.3 trillion over the last decade, Recent research has advanced our opportunities for multinational firms and while American holdings of foreign stocks understanding of the role of taxation and investors in increasingly integrated global increased from $600 billion to $3 trillion. investor protections on capital flows and markets. For example, the outbound for- In the midst of this rapid integration, patterns of FPI. We also have considered eign direct investment (FDI) position of investors and firms still face tax systems the causes and consequences of tax avoid- American firms grew at an average annual and investor protections that differ across ance activity; we have established how for- rate of 11 percent to $2.4 trillion from countries, and these differences have the eign and domestic activity interact in order 1982 to 2006 while inbound FDI to the potential to affect major investment and to inform new welfare measures; and we United States grew to $1.8 trillion. Foreign financing decisions. Governments anxious have elaborated on how investment and portfolio investment (FPI) has grown sim- to attract FDI often consider the use of tax financing decisions by multinational firms ilarly. By 2005, 16 percent of all U.S. long- incentives to lure multinational firms, and reflect the effects of taxes and varying insti- term securities (equity and debt) were governments of FDI source countries — in- tutional regimes. cluding the United States — often won- * Desai is a Research Associate in the der whether their tax treatment of foreign Portfolio Flows NBER’s Programs on Public Economics income is appropriate. Similarly, investor and Corporate Finance and a Professor protections and the broader institutional Empirical efforts to isolate how taxa- of Business Administration at Harvard environment remain distinctive around the tion influences portfolio choice have pro- Business School. His profile appears later world and may influence investors’ port- duced mixed results. Investigating the in this issue. NBER Reporter • 2008 Number 3 relationship between cross-sectional dif- ferential changes in the preferences of increase in a foreign country’s investor ferences in marginal tax rates and asset American investors, or investment oppor- protections is associated with a 24 per- holdings is complicated by the incom- tunities, or time trends in investment, or cent increase in U.S. investors’ equity FPI plete nature of most household portfolios any changed behavior towards tax eva- holdings. These results are robust to vari- and the fact that income levels can influ- sion. These results show how FPI, and ous controls, are not evident for debt ence both risk preferences and marginal portfolio decisions more generally, are capital flows, and are confirmed using an tax rates. Efforts to examine how port- influenced by taxation. instrumental variables analysis. The use of folios change in response to tax reforms Corporate taxes and investor protec- FPI to bypass home country taxation of must overcome the possibility that the tions also have the potential to influence multinational firms is also apparent using observed changes reflect endogenous sup- FPI by changing the relative attractive- only portfolio investment responses to ply responses or other general equilibrium ness of FPI and FDI as means of achieving within-country corporate tax rate changes effects that may confound the influence of international diversification. Dharmapala in a panel from 1994 to 2005. Investors taxation on portfolio choices. and I analyze whether the composition of appear to alter their portfolio choices sig- Dhammika Dharmapala and I U.S. outbound capital flows reflects efforts nificantly to circumvent home and host attempt to overcome these empirical diffi- to bypass home country tax regimes and country institutional regimes. culties by analyzing a tax reform that dif- weak host country investor protections.2 ferentially changed the tax treatment of The potential effects of taxation on FPI Causes and Consequences otherwise similar instruments in a man- result from the interaction between home of Tax Avoidance ner that is unlikely to have produced any and host country taxes. In particular, the endogenous supply response.1 Specifically, United States taxes multinational firms Changing patterns of multinational we investigate how taxes influence port- legally domiciled here on their worldwide firm activity have drawn attention to the folio choices by exploring the response income. As a consequence of this policy, role of tax havens and their effects on to the distinctive treatment of foreign U.S. investors should prefer FPI as a means neighboring countries. More generally, dividends in the Jobs and Growth Tax of accessing foreign diversification oppor- accounts of rising tax avoidance by firms Relief Reconciliation Act (JGTRRA). tunities, particularly in low-tax countries have generated interest in the effects of JGTRRA lowered the dividend tax rate where the residual tax imposed by the tax avoidance on economies, tax authori- to 15 percent for American equities and United States will be most burdensome. ties, and investors. International variation extended this tax relief only to foreign In effect, FPI allows investors to avoid in tax systems and the activities of mul- corporations from a subset of countries. any residual