Foreign Tax Credit and the Current Account

This paper provides a general equilibrium analysis of the effects of a foreign tax credit (FTC) provision on current account dynamics of a small, open economy. Because of the asymmetric functioning of FTC, the rate of return on domestic capital is determined by the arbitrage of the marginal investor, the investor in the creditor country. Thus a change in the home country capital income tax rate causes different responses in long-run foreign asset holdings and the current account dynamics depending upon whether the country is a net creditor or debtor and upon whether the country has a higher tax rate than the foreign country or not.