The Significance of International Tax Rules for Sourcing Income: The Relationship between Income Taxes and Trade Taxes

48 Pages Posted: 29 Mar 2010 Last revised: 8 Aug 2022

See all articles by John Mutti

John Mutti

Grinnell College - Department of Economics

Harry Grubert

U.S. Department of the Treasury, Office of Tax Analysis (OTA); CESifo (Center for Economic Studies and Ifo Institute)

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Date Written: April 1996

Abstract

This paper examines how rules to determine the source of income internationally for tax purposes can have important effects on the form in which taxable income is reported and on the location of economic activity. In the case of U.S. law, two provisions are significant: allowing a portion of export income to be regarded as foreign source and treating royalties received as foreign source. These source rules have become increasingly important due to tax policy changes adopted in the 1980s and to the growing role in U.S. production and trade of goods that require intangible intellectual property. In addition, very similar transactions can be carried out as trade in goods, trade in services or production by a foreign affiliate, and tax incentives can influence that choice. How the source rules operate and the incentives they create are demonstrated in a set of stylized calculations to determine after-tax returns under various assumptions about relevant income and withholding tax rates, tariffs, and the importance of tangible and intangible capital in production. An assessment of the empirical importance of these provisions is based on recent studies of the determinants of trade and investment by U.S. multinational corporations. The treatment of royalty income appears to encourage royalty payments from high-tax countries and to promote real economic activity there.

Suggested Citation

Mutti, John and Grubert, Harry, The Significance of International Tax Rules for Sourcing Income: The Relationship between Income Taxes and Trade Taxes (April 1996). NBER Working Paper No. w5526, Available at SSRN: https://ssrn.com/abstract=1578692

John Mutti (Contact Author)

Grinnell College - Department of Economics ( email )

P.O. Box 805
Grinnell, IA 50112
United States
515-269-3143 (Phone)
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Harry Grubert

U.S. Department of the Treasury, Office of Tax Analysis (OTA) ( email )

1500 Pennsylvania Ave. NW
Washington, DC 20220
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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