A Pecking Order Theory of Capital Inflows and International Tax Principles

IMF Working Papers, April 1, 1996

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Even though financial markets today show a high degree of integration, the world capital market is still far from the textbook story of high capital mobility.
The purpose of this paper is to highlight key sources of market failure in the context of international capital flows and to provide guidelines for efficient tax structure in the presence of capital market imperfections.
The analysis distinguishes three types of international capital flows: foreign portfolio debt investment, foreign portfolio equity investment, and foreign direct investment.
The paper emphasizes the efficiency of a nonuniform tax treatment of the various vehicles of international capital flows.

Identifies key sources of market failure affecting international capital flows in integrated financial markets.
Distinguishes among three vehicles of capital flows:
- foreign portfolio debt investment
- foreign portfolio equity investment
- foreign direct investment
Argues for efficiency gains from a nonuniform tax treatment across these vehicles.

Provides guidelines for efficient tax structure in the presence of capital market imperfections.
Emphasizes tailoring tax treatment to the specific type of international capital flow rather than applying uniform taxation across all vehicles.

Subjects: Balance of payments, Capital flows, Capital income tax, Capital inflows, Corporate income tax, Foreign direct investment, Taxes
Keywords: borrowing firm, Capital flows, Capital income tax, Capital inflows, capital investment, Corporate income tax, economic value, Foreign direct investment, J firm, n firm, rate of interest, rate of return, representative firm, solvent firm, Western Europe, WP