Taxation and inflation: A new explanation for capital flows

In a world of mobile capital, the current system of taxation implies that the after-tax cost of capital and return to saving in each country are negatively correlated with the rate of inflation. Thus a country's net foreign asset position ought to be negatively correlated with its long-run inflation rate. The magnitude of these effects is shown to be potentially large. For OECD countries, cross-section and time-series regressions confirm that inflation rates are good predictors of net foreign assets. The existing distribution of net foreign assets may therefore largely reflect tax distortions.