Why Is Capital So Immobile Internationally? Possible Explanations and Implications for Capital Income Taxation

The evidence on international capital immobility is extensive, including the lack of international portfolio diversification, real interest differentials across countries, and the high correlation between domestic savings and investment. We develop a model with asymmetric information between countries that helps rationalize all the above observations and then examine the implications of this model for optimal domestic tax policy. Without asymmetric information, past work showed that small open economies should not impose corporate income taxes. With asymmetric information, the optimal policy instead involves government subsidies to capital imports. Some omitted factors that argue against subsidizing capital imports are explored briefly.