This paper presents a simple two-country model of the role of taxation in
capital flows between developed countries ("The North") and developing
countries ("The South"). The Southern country is assumed to be unable to
enforce a tax on its residents' foreign-source income, and the Northern
country chooses not to impose a withholding tax on portfolio income earned in
The world equilibrium in the model is characterized by excessive (by the
standard of global efficiency and Southern welfare) flows of capital across
borders, and insufficient investment located in the South. National income of
the South could, under certain conditions, be improved if the North would
impose a withholding tax on portfolio income that leaves the country, even
though the South sacrifices tax revenue to the North. A Southern tax on
foreign-source income may dominate this, depending on the resource cost of
enforcing such a tax.
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