Pareto Efficiency in International Taxation

This paper addresses a key but neglected task in the theory of international taxation, lent increased urgency by growing awareness of the potential gains from tax coordination: the characterization of Pareto-efficient international tax regimes. It shows that the Diamond-Mirrlees theorem on the desirability of production efficiency, which underlies the key tenets of policy advice in international taxation—the desirability of destination basis for commodity taxation, of the residence principle for capital income taxation, and of free trade—is rendered inherently inapplicable to problems of international tax design by the distinctness of national budget constraints that is of the essence in thinking about international taxation. Conditions are established—relating to the availability of explicit or implicit devices for reallocating tax revenues across countries—under which production efficiency is nevertheless desirable, and a general characterization developed of the precise ways in which Pareto efficient international taxation may require violation of established tenets. Acknowledgments: We thank Bernd Genser and participants at the International Conference on Public Economic Theory (Tuscaloosa), the International Institute of Public Finance meetings (Moscow) and seminars at Harvard/MIT, Michigan, Vanderbilt and the IMF for helpful comments. The authors are solely responsible for any errors or omissions. Views are not necessarily those of the International Monetary Fund. ∗Fiscal Affairs Department, International Monetary Fund. † Martin School of Public Policy, University of Kentucky, Lexington, KY 40506-0027,