CREDIT AND DEFERRAL AS INTERNATIONAL INVESTMENT INCENTIVES

Many governments tax the foreign income of their firms, using a system that grants credits for foreign taxes paid and permits tax deferral for unrepatriated income. This paper shows that such tax systems encourage firms to restrict their equity stakes in new foreign investments, and to finance their new investments with considerable debt. These incentives exist even when transfer price regulation effectively limits the profit rates foreign subsidiaries can earn. The behavior of the foreign subsidiaries of US multinationals in 1984 appears to be consistent with these incentives.