This paper considers the impact of international taxation on patterns of foreign direct investment and on the extent of international tax avoidance activity. Recent evidence indicates that taxation significantly influences the location of foreign direct investment, corporate borrowing, transfer pricing, dividend and royalty payments, and R&D performance. Reactions to worldwide tax rate differences, as well as to changes in international tax rules, provide important information concerning the extent to which taxpayers respond to incentives. The generally high degree of responsiveness in turn carries implications for the design of domestic as well as international tax policy.

4. Japan and the United States are not alone in taxing the worldwide income of their resident companies while permitting firms to claim foreign tax credits. Other countries with such systems include Greece, Italy, Norway, and the United Kingdom. Under Japanese and U.S. law, firms may claim foreign tax credits for taxes paid by foreign affiliates of which they own at least 10 percent, and only those taxes that qualify as income taxes are creditable.

American corporations earn a large and growing share of their profits from their foreign operations. U.S. law taxes American corporations on their worldwide income, and in so doing may discourage new firms from making the United States their primary residence while encouraging American corporations to leave the country for offshore tax havens. This paper evaluates the incentives American firms face in considering whether to relocate their site of legal residence abroad. The case of McDermott Inc., an American multinational that reorganized as a Panamanian corporation in 1982, is considered in detail. Aggregate data suggest that firms' incentives to follow McDermott in relocating offshore rose steadily through the 1980s until passage of the Tax Reform Act of 1986, which substantially reduced the payoff from relocating.

The ability to defer home country taxation of foreign income is widely criticized as encouraging excessive foreign investment. This criticism is based on a model in which the function of deferral is to reallocate a fixed supply of capital between foreign and domestic uses. In realistic situations, however, deferral enhances the value to home countries of inframarginal foreign investment, taxation raises the value of marginal foreign investment, and the trade-off between foreign and domestic investment need not be onefor-one. Together, these considerations imply that deferring home taxation of foreign income can enhance economic efficiency.

The United States imposes substantial federal taxes on estates, gifts, and generation-skipping transfers exceeding high exemption levels (currently US$5.25 million). These transfer taxes are very distortionary compared to other federal taxes, and raise little revenue; their appeal lies in their distributional properties. Gratuitous transfers benefit both those who make the transfers and those who receive them; transfer taxes therefore impose burdens on both donors and recipients, in addition to distorting economic behavior. This article considers a potential reform of replacing federal transfer taxes with greater income taxes on the highest-income earners. Such a reform holds the prospect of raising additional federal tax revenue with improved efficiency and greater measured tax progressivity.