Chicago Journal of International Law


Implicit in the allowance of foreign tax credits is the view that other countries' taxes on the outbound investments of one's residents are relevant to one's own policy choice regarding taxation of these investments. Unilaterally granting foreign tax credits is generally not in a country's short-term self-interest, since, by fully reimbursing foreign taxes up to the credit limit, it invites residents to be indifferent to foreign taxes and foreign governments to impose "soak-up" taxes on inbound investment. Mitigating double taxation through foreign tax credits is therefore quite different from favoring free trade, which generally increases national welfare, even if done unilaterally. However, reciprocal allowance of foreign tax credits, even if well short of an ideal coordination technique, may leave both cooperating countries better off than would unmitigated double taxation. A country may, therefore, promote both national and worldwide welfare (at least, relative to doing nothing) when it grants foreign tax credits with the understanding that other countries are reciprocating but would likely play tit-for-tat if it reneged. Tax policy debate in the United States frequently ignores or misconceives the relevance to both worldwide and national welfare of interactions between our tax rules and those of other countries. This has been particularly apparent in the ongoing debate concerning what are known as "cross-border tax arbitrage" transactions. The United States Treasury has proposed to deny American tax benefits to taxpayers engaging in these transactions, provoking vehement opposition from taxpayers who would be adversely affected. Unfortunately, the debate has too often failed to focus adequately on national and worldwide welfare considerations. This paper therefore briefly examines cross-border tax arbitrage, in light of these considerations as affected by countries' strategic interactions. [CONT]