Globalization Spurs Need to Adapt Taxes to Address Highly Mobile Financial Capital

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With globalization intensifying and vast amounts of capital instantly mobile, national authorities are growing increasingly concerned about their ability to tax financial capital appropriately and effectively. Communication innovations, increasingly complex and mutable financial instruments, and intensifying international tax competition are rapidly eroding the effectiveness of traditional means of collecting taxes on capital income.

What options are available to national authorities and what opportunities are there for multilateral solutions? A recent internal study prepared by the IMF's Fiscal Affairs Department explores the nature and the extent of the changes introduced by highly mobile financial capital. The study suggests that the simplest and most effective solution may lie in withholding taxes, although this step would require a broad multilateral approach.

Background

One of the most pressing questions posed by globalization is which national policies, crafted in an era of more inward-looking national economies, are beginning to lose their effectiveness in a more international environment. In tax policy, the study finds, the most notable policy degradation has occurred in the taxation of capital income. Increasingly, capital income has proven to be highly responsive to international differences in tax policy, thus frustrating the scope that national authorities have to set domestic capital income tax rates and mobilize revenue.

Traditional tax policy concerned itself with basic issues such as choosing a residence-based or source-based principle of taxation, addressing economic effects (notably the impact on saving and investment), applying credits or exemptions to avoid or lessen the burden of double taxation, making provisions to implement the chosen regime, and negotiating bilateral agreements where needed. These precepts largely presuppose, however, that the taxable income to be drawn from economic activities and their location can be readily identified and that the primary residence of the involved parties can be verified.

In fact, the study says, the highly integrated nature of international commerce and the speed and volume of flows are no longer allowing authorities to take these basic steps for granted. Identifying economic transactions-and the parties involved in them-is becoming an increasingly complex task, and has spurred a rethinking of...