Tax Treaty Legislation in the 110th Congress: Explanation and Economic Analysis

th
Tax Treaty Legislation in the 110 Congress:
Explanation and Economic Analysis
Updated May 22, 2008
Donald J. Marples
Specialist in Public Finance
Government and Finance Division



Tax Treaty Legislation in the 110 Congress:
Explanation and Economic Analysis
Summary
On July 27, 2007, the House of Representatives approved H.R. 2419, an
omnibus farm bill. The bill’s spending provisions exceeded the budget baseline for
agriculture, and to comply with House pay-as-you-go budget rules, the bill included
several revenue-raising tax provisions. In terms of revenue impact, by far the largest
tax measure is a proposal to restrict in certain cases the use of tax-treaty benefits by
foreign firms with operations in the United States. The Joint Tax Committee has
estimated that the provision would raise an estimated $3.2 billion over 5 years and
$7.5 billion over 10 years. Neither the Senate-passed version nor the conference
agreement for H.R. 2419 included a similar provision. On October 25, Chairman
Charles Rangel of the House Ways and Means Committee introduced H.R. 3970, an
omnibus tax bill entitled the Tax Reduction and Reform Act. Among its many
provisions, the bill includes a tax-treaty proposal similar to that of H.R. 2419, but
modified to reduce the possibility of conflict with existing tax treaties. Preliminary
revenue estimates are thus somewhat smaller than for H.R. 2419: a revenue gain of
$2.7 billion over 5 years and $6.4 billion over 10 years. Compared to several other
revenue-raising items in H.R. 3970, the provision is moderate in size. In the context
of H.R. 2419, the provision is likewise moderate, with its five-year revenue impact
amounting to 8% of the bill’s increased outlays.
The proposals are designed to curb “treaty shopping” — instances where a
foreign parent firm in one country receives its U.S.-source income through an
intermediate subsidiary in a third country that is signatory to a tax-reducing treaty
with the United States. The measure’s supporters argue that it would restrict a
practice that deprives the United States of tax revenue and that it is unfair to
competing U.S. firms. Its opponents maintain that it would harm U.S. employment
by raising the cost to foreign firms of doing business in the United States and may
violate U.S. tax treaties. In addition, some Members of Congress have objected to
the use of revenue-raising tax measures under the jurisdiction of tax-writing
committees to offset increases in spending programs authorized by other committees.
Economic theory suggests there is an economically optimal U.S. tax rate for
foreign firms that balances tax revenue needs with the benefits that foreign
investment produces for the U.S. economy. Under current law, the treaty-shopping
arrangements foreign firms in some cases undertake may combine with corporate
income-tax deductions to eliminate U.S. tax on portions of their U.S. investment. In
these cases, economic theory suggests that it is likely added restrictions on treaty-
shopping such as contained in the farm bill would improve U.S. economic welfare.
This analysis, however, does not consider possible reactions by foreign countries
where U.S. firms invest, nor does it consider possible abrogation of existing U.S. tax
treaties.



Contents
The Context: U.S. Taxation of Foreign Firms in the United States...........2
Treaty Shopping and How it Works...................................3
Treaty Proposals in H.R. 2419 and H.R. 3970 ...........................5
Pro and Con Arguments.............................................6
Alternative Approaches and Previous Legislation.........................6
Economic Analysis................................................7



th
Tax Treaty Legislation in the 110
Congress: Explanation and Economic
Analysis
On July 27, 2007, the House of Representatives approved H.R. 2419, an
omnibus farm bill. The bill’s spending provisions exceeded the budget baseline for
agriculture, and to comply with House pay-as-you-go budget rules, the bill included
several revenue-raising tax provisions. In terms of revenue impact, by far the largest
tax measure is a proposal to restrict the use of tax-treaty benefits by foreign firms1
with operations in the United States. The proposal is designed to curb “treaty
shopping” — instances where a foreign parent firm in one country receives its U.S.-
source income through an intermediate subsidiary in another country signatory to a
tax-reducing treaty with the United States. The measure’s supporters argue that it
would restrict a practice that deprives the United States of tax revenue and that is
unfair to competing U.S. firms. Its opponents maintain that it would harm U.S.
employment by raising the cost to foreign firms of doing business in the United
States and may violate U.S. tax treaties.2 In addition, some Members of Congress
have objected to the use of revenue-raising tax measures under the jurisdiction of tax-
writing committees to offset increases in spending programs authorized by other3
committees. The provision is estimated to raise $3.2 billion over 5 years and $7.5
billion over 10 years.4
On October 25, Chairman Charles Rangel of the House Ways and Means
Committee introduced an omnibus tax bill (H.R. 3970, the Tax Reduction and
Reform Act of 2007) that, in broad outline, would repeal the individual alternative
minimum tax for individuals, while coupling a reduction of corporate tax rates with
revenue-raising elimination of a number of corporate tax benefits. An anti-treaty-
shopping proposal similar to that of the House-passed version of H.R. 2419 was
included in the bill, but modified in a way designed to reduce its possible conflict
with existing tax treaties. Preliminary estimates indicate that H.R. 3970’s treaty


1 The conference agreement for H.R. 2149 did not include a corresponding provision curbing
“treaty shopping.”
2 Brett Ferguson, “House Votes to Repeal Treaty Advantages for U.S. Subsidiaries as Part
of Farm Bill,” BNA Daily Tax Report, July 20, 2007, p. GG-1.
3 Meg Shreve, “Grassley Warns Against Violating Tax Treaties with Farm Bill Tax
Provision,” Tax Notes, August 20, 2007, p. 627.
4 Estimates by the Joint Committee on Taxation, as reported in U.S. Congressional Budget
Office, H.R. 2419: Farm, Nutrition, and Bioenergy Act of 2007, October 5, 2007, posted on
the CBO website at [http://www.cbo.gov/ftpdocs/86xx/doc8686/hr2419HPassed.pdf],
visited October 23, 2007.

provision would raise somewhat less revenue than H.R. 2419: $2.7 billion over 5
years and $6.4 billion over 10 years.
The Context: U.S. Taxation of Foreign Firms
in the United States
The tax treaty proposals are directed at U.S. tax treatment of foreign firms that
conduct business in the United States, and to understand how the bill would affect
that treatment it is useful to take a brief look at the existing structure. A foreign firm
that earns business income in the United States is at least potentially subject to two
levels of U.S. tax: the corporate income tax and a flat “withholding” tax. The U.S.
corporate income tax may apply whether the foreign firm conducts its business
through a U.S.-chartered subsidiary corporation or through a branch of the foreign
parent that is not separately incorporated. In the case of a U.S. subsidiary, U.S. tax
applies because the United States generally taxes all U.S.-chartered corporations,
regardless of their ownership; U.S. taxes apply to foreign branch income because the
United States asserts the right to tax foreign-chartered corporations on their income
from the active conduct of a U.S. trade or business.
In addition, the United States applies a withholding tax on interest, dividends,
rents, royalties, and other “fixed or determinable” income foreign corporations and
other non-residents receive from sources within the United States.5 The tax is
required to be withheld by the U.S. payer (hence “withholding”) and is applied on a
“gross” basis without the allowance of deductions. The rate of the tax is nominally
30%. However — and importantly for the proposal at hand — the tax is frequently
reduced or eliminated under the terms of one of the many bilateral tax treaties the
United States has signed.
In principle, the withholding tax does not apply to intra-firm repatriations of
income where a foreign firm’s U.S. operation is not separately incorporated in the
United States. Since the Tax Reform Act of 1986 (TRA86; P.L. 99-514), however,
the United States has applied a 30% “branch tax” as a parallel to the withholding tax
(and that also may be reduced by treaty).
Theoretically, both levels of tax could apply to a foreign firm’s U.S. source
income. Picture, for example, a foreign firm that operates a U.S.-chartered subsidiary
that remits its income to the home-country parent by means of a stream of dividend
payments. Dividend payments are not deductible under the corporate income tax, so
the tax applies in full to the subsidiary’s earnings. Then, if the dividends are paid
directly to a parent in a non-treaty country, the 30% withholding tax applies. The


5 The tax is applied by Section 871 of the Internal Revenue Code. Capital gains, however,
are generally tax exempt. Also, most “portfolio interest” — that is, interest paid to
foreigners whose investment is strictly financial — is exempt from the tax. Interest on intra-
firm debt, however, a focus of H.R. 2419, is at least nominally subject to the withholding
tax.

combined rate of the two taxes on dividend payments could amount to as much as

53.8%. 6


This combined rate, however, is usually not reached. First, many types of intra-
firm payments are tax-deductible under the corporate income tax, even if the
payments are to related foreign parents. For example, interest on intra-firm debt is
tax deductible (albeit with some restrictions, as mentioned below); royalties paid for
the use of patents, trademarks, and other intangible assets are likewise deductible.
Thus, a foreign firm can eliminate the U.S. corporate income tax on income
transmitted to its parent via tax-deductible payments. The foreign parent can, for
example, finance its U.S. operations by making loans to the U.S. subsidiary; or it can
charge the U.S. subsidiary royalty fees for the use of patented technology.
Tax treaties frequently reduce or eliminate the withholding tax. Like most
developed countries, the United States is signatory to a large number of bilateral tax
treaties. The treaties address a variety of topics aside from withholding taxes — for
example, reciprocal assurances of non-discrimination and provisions for the
exchange of information by tax authorities. Reciprocal reduction of withholding
taxes is, however, a key element of most treaties. To illustrate, the U.S. Internal
Revenue Service publication on tax treaties lists tax-treaty withholding tax rates for
56 countries; the top 30% rate applies to intra-firm interest payments in only four
instances and is completely eliminated for 20 countries.7
In short, notwithstanding the two potential levels of tax, U.S. tax on payments
foreign subsidiaries make to their parents can be eliminated or substantially reduced
in the case of payments made to firms in a large number of countries. Both H.R.
2419 and H.R. 3970, however, focus on firms whose ultimate home country does not
have a tax-reducing treaty with the United States. We look next at how such firms
are nonetheless able to use “treaty shopping” to reduce or eliminate their U.S. tax.
Treaty Shopping and How it Works
Not all countries have income tax treaties with the United States, so if interest,
dividends, royalties, or similar U.S. income were paid directly to firms from these
countries, the full 30% withholding tax would apply. “Treaty shopping” is an
arrangement where a firm gets around the absence of a treaty by routing its U.S.
income through intermediate subsidiary corporations located in third countries where
lower or non-existent withholding taxes apply.8 Treaty shopping, further, is not used


6 The corporate tax rate is generally 34%. Since dividends are paid out of aftertax profits,
the withholding tax applies at a rate of 30% x (1 — 34%), or 19.8%. The total rate is thus

34% + 19.8%, or 53.8%.


7 U.S. Internal Revenue Service, U.S. Tax Treaties, Pub. 901, Rev. June 2007 (Washington:

2007), pp. 34-35.


8 In explaining an anti-treaty-shopping provision of the U.S. model income tax treaty, the
U.S. Treasury Department defined treaty shopping simply as instances where residents of
(continued...)

exclusively by foreign firms conducting business in the United States; it is also used
by foreign “portfolio” investors, whose U.S. investments are only financial.
However, H.R. 2419 and H.R. 3970 focus, as described below, on deductible
payments, implying that its focus is on treaty-shopping by foreign corporations, and
such is also the focus of this report.9
The following countries listed by the U.S. Commerce Department as having
significant direct investment in the United States10 are not on the IRS list of tax-treaty
countries:
Argentina Li beria
Bahamas Li echtenstein
BahrainMalaysia
BermudaPanama
BrazilLebanon
ChileSingapore
GibralterTaiwan
KuwaitUruguay
Thus, firms whose ultimate home is one of these non-treaty countries are
candidates to benefit from treaty shopping. But treaty shopping likely does not occur
exclusively in “either/or” situations, where a firm faced by the full 30% withholding
tax routes income through a country where no tax applies. Treaty-shopping is likely
a matter of degree; a firm facing a 10% rate in its true home country, for example,
could benefit substantially from routing U.S. income through a country where no tax
applies. Or, a firm facing the 30% rate could benefit by channeling income through
an intermediary taxed at only 15%. Further, while the exclusive focus of the current
legislative proposals is deductible payments — for example, interest and royalties —
treaty shopping can also benefit non-deductible payments such as dividends.
To be attractive as intermediate stops in the treaty-shopping process, a country’s
treaty provisions must reduce or eliminate the applicable withholding tax rate with
the United States, thus reducing U.S. tax on payments to the intermediate subsidiary.


8 (...continued)
third countries benefit from “what is intended to be a reciprocal agreement between two
countries.” U.S. Department of the Treasury, Office of Tax Policy, United States Model
Technical Explanation Accompanying the United States Model Income Tax Convention of
November 15, 2006 (Washington, November 15, 2006), p. 63. The model treaty’s anti-
treaty-shopping provision is discussed in more detail below.
9 For a broad discussion of treaty shopping in practice, see Denis A. Kleinfeld and Edward
J. Smith, “Limitations on Treaty Shopping,” in their Langer on Practical International Tax
Planning (New York: Practicing Law Institute, 2007), pp. 18-1 - 18:3.9.
10 U.S. Department of Commerce, Bureau of Economic Analysis, “Foreign Direct
Investment in the United States: Detail for Historical-Cost Position and Related Capital and
Income Flows, 2002-2006,” Survey of Current Business, vol. 87, September 2007, p. 69.
We define “significant” as a country’s having more than $100 million direct investment
assets in the United States.

In addition, however, the intermediate country must impose no taxes of its own that
negate the advantage of a reduced U.S. tax. According to the IRS list, a 0% rate
applies to 20 treaty countries in the case of interest payments.
Even if no withholding tax applies to a country, its treaty may contain
“limitation on benefits (LOB)” provisions that prevent its use as a conduit for U.S.
income. These provisions (also discussed below) have been included in every U.S.
treaty that has entered into force since 1990; they have all denied treaty benefits to
residents of third countries.11
Treaty Proposals in H.R. 2419 and H.R. 3970
The House-passed version of H.R. 2419’s treaty provisions are contained in
Section 12001 of the bill (in Title XII). The farm bill integrates the provisions of
H.R. 3160, proposed by Representative Lloyd Doggett on July 24, 2007. The
proposal provides that if a U.S. subsidiary makes a deductible payment to a foreign
corporation that has a common foreign parent, and the withholding tax rate on the
payment would be higher if the payment were made directly to the common parent,
the higher rate will be applied. Thus, for example, if the payment is made to a fellow
subsidiary in country Y where no U.S. withholding tax applies, and the common
parent of the U.S. subsidiary and country-Y subsidiary is resident in country X where
the applicable tax is 15%, the rate that applies to payments to the country-Y
subsidiary would be 15%, notwithstanding the nominal 0% rate.
The provision would only apply to payments deductible under the U.S.
corporate income tax — e.g., interest and royalties. The degree of common
ownership applied by the bill would be 50%. Thus, the provision would apply to
payments to a foreign corporation where the U.S. corporation and the payee
corporation are linked to a common foreign parent by chains of at least 50%
ownership.
According to the House Ways and Means Committee summary of H.R. 3970,
the bill’s modification of H.R. 2419 is designed “to ensure that foreign multinational
corporations incorporated in treaty partner countries will not be affected by this


11 One source lists treaties with the following countries as not containing limitation-on-
benefits provisions: Egypt; Greece; Hungary; Korea; Morocco; Norway; Pakistan; the
Philippines; Poland; Romania; and Trinidad and Tobago. Jeffrey L. Rubinger, “Tax
Planning with U.S. Income Tax Treaties Without LOB Provisions,” Tax Management
International Journal, March 9, 2007, p. 124. Sources engaged in or reporting one current
debate have cited Switzerland and the United Kingdom as being intermediary countries.
Respectively: Citizens for Tax Justice, Senate Should Enact the Doggett Proposal to Close
Loophole that Allows Foreign Corporations to Dodge Taxes on U.S. Profits (Washington:
August 8, 2007), posted on the Internet at [http://www.ctj.org/pdf/
doggettloopholecloser.pdf] (visited October 26, 2007); and Eoin Callan, “U.S. Move on Tax
Threatens London,” Financial Times, August 20, 2007, p. 1.

provision.”12 H.R. 2419 would apply the parent’s withholding tax rate in any case
where it is higher than that applicable to a payment made to a subsidiary; H.R. 3970,
however, provides that the tax on a payment to a subsidiary cannot be reduced unless
the withholding tax is also reduced on a direct payment to the parent. Thus, it seems
that H.R. 3970’s restrictions would not apply where a tax-reducing treaty exists with
a parent’s home country (a treaty the restriction might otherwise violate).
Pro and Con Arguments
A central concern of supporters of the anti-treaty-shopping proposal is tax
revenue: foreign firms that reduce their U.S. withholding taxes with the technique
reduce the tax revenue the United States collects on U.S.-source income, and in
international taxation, the country of source — in this instance, the United States —
traditionally has the primary right to the tax revenue it generates. Supporters cite
fairness as underlying this concern, contrasting the low U.S. taxes treaty-shopping
foreign firms pay with taxes paid by U.S.-resident individuals and businesses.13
Opponents of the measure have argued that the provision would increase the
cost to U.S. firms of doing business in the United States, and would thus harm U.S.
employment and wages. In addition, in the case of H.R. 2419 it has been argued that
the measure would abrogate existing U.S. tax treaties — an objection that apparently
led to modifications in H.R. 3970.14 The proposal’s opponents include the Bush
Administration, which has stated that it “strongly opposes” the farm bill’s tax-treaty
provisions, and has threatened to veto the bill for this and other reasons.15
Alternative Approaches and Previous Legislation
The tax-treaty proposals in the current Congress are not the first instance where
U.S. policymakers have attempted to restrict treaty shopping. Conceptually, one
alternative to legislation is to include such restrictions in tax treaties. As described
above, the treaties that the United States has negotiated in recent decades have all
contained limitation on benefits (LOB) clauses that deny treaty benefits to third-
country residents. The LOB provisions generally do so by requiring firms qualifying


12 U.S Congress, House, Committee on Ways and Means, Tax Reduction and Reform Act of
2007, October 25, 2007, p. 8. Available at the committee’s website, at
[http://waysandmeans.house.gov/ media/pdf/110/Summa r y% 2 0 f o r % 2 0 D i s t r i b u t i on.pdf],
visited October 26, 2007.
13 Rep. Lloyd Doggett, remarks in the House, Congressional Record, daily edition, vol. 153,
July 26, 2007, p. H8683.
14 “Grassley Warns Against Violating Tax Treaties with Farm Bill Tax Provision,” Tax
Notes, August 20, 2007.
15 Executive Office of the President, Office of Management and Budget, Statement of
Administration Policy, July 25, 2007. Available at OMB’s website, at
[http://www.whitehouse.gov/omb/legislative/sap/110-1/hr2419sap-r.pdf], visited October

23, 2007.



for a treaty benefit to be owned primarily by residents of the treaty country and not
erode the tax base of the treaty country by making deductible payments to third-
country residents.16 The current U.S. model income tax treaty contains such
provisions.17 One analysis has noted, however, that considerable time would be
required to renegotiate all U.S. treaties with such an approach, and not all treaty
countries would be likely to agree to stringent LOB provisions.18
The sole legislation explicitly restricting treaty shopping was included as part
of TRA86’s branch tax provisions. Under its terms, a treaty cannot reduce the branch
tax for a foreign firm where less than 50% of the firm’s stock is owned by residents
of the treaty country, or where 50% or more of the firm’s income is used to meet
liabilities to non-residents.19 Note that these conditions parallel those of the model
income tax treaty.
An existing provision of the tax code that does not directly address treaty
shopping, but that is nonetheless related, is the code’s “earnings stripping” rules
applied by Section 163(j). Earnings stripping refers to the removal by foreign firms
of profits earned in the United States by arranging for the subsidiary U.S. corporation
to make tax-deductible payments — for example, interest and royalties — to the
foreign parent. As described above, such a practice eliminates the U.S. corporate
income tax on the deductible payments and, in combination with treaty shopping, can
remove all U.S. tax on a foreign firm’s U.S. income. Provisions designed to limit
earnings stripping by foreign firms investing in the United States were enacted with
the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239) as Section 163(j) of
the Internal Revenue Code. The provisions deny deductions for interest payments
to related corporations, but apply only after a certain threshold of interest payments
and level of debt-finance is exceeded.20 While the provisions do not address treaty
shopping per se, they do address the same general policy goal: attempting to ensure
that foreign firms pay some amount of U.S. tax on their U.S. income.
Economic Analysis
Economic analysis of restrictions on treaty shopping begins by focusing on tax
revenue: when foreign firms avoid withholding taxes by routing income through
treaty-country intermediaries, the United States loses the tax revenue that it would
collect if the income were paid directly to a foreign parent and a higher withholding
tax were applied. As noted at the outset, the treaty-shopping restrictions proposed


16 Kleinfeld and Smith, “Limitations on Treaty Shopping,” p. 123.
17 U.S. Dept. of the Treasury, Office of Tax Policy, United States Model Technical
Explanation, p. 63.
18 Kleinfeld and Smith, “Limitations on Treaty Shopping,” p. 18:3.6.
19 U.S. Congress, Joint Committee on Taxation, General Explanation of the Tax Reform Act
of 1986, committee print, 100th Cong., 1st sess. (Washington: GPO, 1987), p. 1043.
20 For further information on the earnings stripping provisions, see Aaron A. Rubenstein and
Todd Tuckner, “Financing U.S. Investments After the Revenue Reconciliation Act of 1993,”
Tax Adviser, vol. 25, February, 1994, pp. 111-117.

in H.R. 2419 would increase revenue by an estimated $3.2 billion over 5 years and
$7.5 billion over ten years; H.R. 3970 would increase revenue by an estimated $2.7
billion and $6.4 billion over 5 and 10 years, respectively.
But beyond the proposals’ revenue effect, economic analysis poses a more
fundamental question: would the plans enhance U.S. economic welfare? The answer
to this question still involves the plan’s tax revenue impact, but it also looks at a
balance — that between the benefit from collecting tax revenue, on the one hand,
and from attracting foreign investment to the United States, on the other.
The economic benefit from collecting tax revenue from foreign firms is clear:
in collecting revenue, the United States retains in its own economy a portion of the
profit that foreign firms would otherwise repatriate to their home country. The
counterpoised benefit — the economic benefit from foreign investment — needs a
closer look. Popular discussions of foreign investment frequently focus on jobs. But
while “inbound” foreign investment can create new employment in particular U.S.
geographic areas, its positive impact on the U.S. economy as a whole is on wages
rather than jobs. Economic theory suggests that, in the aggregate, the economy is
either at or moving towards full employment. Thus, while foreign investment can
attract employment from one sector of the economy to another, it does not have an
appreciable long-run impact on aggregate employment — a policy goal that is the
target of aggregate fiscal and monetary policy rather than targeted tax provisions.
Foreign investment can, however, increase wages. Basic economic theory indicates
that increases in capital serve to increase labor productivity: foreign investment thus
increases productivity of domestic labor. Another basic economic principle holds
that, in smoothly functioning markets, labor is paid a wage that is equal to its
marginal product. It follows, then, that increases in foreign investment in the
domestic economy increases domestic wages.
The balance, then, is this: a given increase in taxes on foreign investors
increases tax revenue and produces tax revenue, on the one hand, and a given
increase in foreign investment produces higher wages, on the other. But if foreign
firms are sensitive at all to taxes, a given tax increase also reduces the U.S.
investment they undertake, thus reducing their positive impact on U.S. wages. From
an economic point of view, the optimal policy is to tax foreign investors such that the
added revenue from an increment of tax is just equal to the reduction in wages that
increment would cause. The analogy of a goose and golden egg is perhaps apt.
Is the rate of tax on foreign firms close to the optimal rate? Would the
proposals’ treaty-shopping restrictions move towards or away from the optimal
point? In part, the answer depends on exactly how sensitive foreign firms are to U.S.
taxes — the elasticity of supply of foreign investment, in economic parlance. The
more sensitive is foreign investment, the lower the optimal tax rate. A thorough
investigation of the elasticity of supply is beyond the scope of this report.
Importantly, however, in some cases foreign firms may be able to use treaty shopping
to eliminate all U.S. tax on their U.S. earnings, and it is unlikely that foreign
investors are so sensitive to U.S. taxes that the optimal tax rate on foreign investment



is zero.21 If this is the case, economic theory suggests that it is likely that the
proposal would increase U.S. economic welfare.
There are, however, a couple of important qualifications. One is economic: the
analysis does not take into account possible counter-actions by foreign governments,
which might erode or offset any benefit to the United States. For example, a country
that is home to firms that would be affected by the treaty-shopping proposals might
impose anti-treaty-shopping restrictions of its own that would affect U.S. firms’
investment within its own borders. The other is non-economic: as noted above, some
have argued that the anti-treaty-shopping proposal in H.R. 2419 would abrogate
existing U.S. tax treaties. An analysis of these questions is, however, beyond the
scope of this report.


21 In economic parlance, an optimal tax rate of zero requires perfectly elastic supply.
However, Slemrod, for example, found a negative relationship between U.S. taxes and
inbound investment, but not perfect elasticity. See “Tax Effects on Foreign Direct
Investment in the United States: Evidence from a Cross-Country Comparison,” in Assaf
Razin and Joel Slemrod, eds., Taxation in the Global Economy (Chicago: University of
Chicago Press), p. 112. Note also that since nominal rather than real interest is tax-
deductible, the actual tax burden for debt-financed foreign investment is probably less than
zero, which would suggest a less-than-optimal tax burden exists even if foreign investment
is perfectly elastic. For a further discussion, see CRS Report 91-582, Federal Taxes and
Foreign Investment in the United States: An Assessment, by David L. Brumbaugh, August

6, 1991. Copies are available by contacting CRS.