Territorial taxation system : a story of inequality and political process capture

Abstract

Under territorial individual taxation domestic source income is taxable, while foreign source income is not. Therefore, it incentivizes residents to remove capital out of the country, e.g. investing in stocks, bonds, and real estate offshore. Moreover, individuals migrating to territorial taxation jurisdictions may even be better off leaving their capital abroad. Hence, why do several governments choose to only tax their residents on domestic source income and not on international income? In other words, which countries are more likely to embrace territorial taxation? I argue that countries with a high level of inequality are more likely to embrace territorial taxation. That happens because, in unequal societies, elites (i.e. the ones with enough capital to invest abroad) have more de facto power to influence policies that please them. To test my arguments, I use a cross-sectional analysis with 228 countries and territories, along with a case study from Bolivia.