TAXATION AND THE COMPETITIVENESS OF SOVEREIGN WEALTH FUNDS: DO TAXES ENCOURAGE SOVEREIGN WEALTH FUNDS TO INVEST IN THE UNITED STATES?

Sovereign wealth funds ("SWFs") control large amounts of capital and have made, and are continuing to make, high-profile investments in the United States, especially in the financial services sector. Those investments in particular, and SWFs in general, are highly controversial. There is much discussion of the costs and benefits to the United States of investments by SWFs, and there is an intense and ongoing debate over what should be the United States' policy toward SWFs. In the course of that debate, some critics have called on the U.S. government to abandon its long-held position of neutrality toward foreign investment and to use the income tax to discourage investments by SWFs. Surprisingly, in light of such calls, there is little understanding of how the tax system affects the competition among SWFs, private foreign investors, and U.S. investors to acquire and hold U.S. assets. Accordingly, in this Article, I develop a model for how taxes influence the ownership of assets, and I then apply that model to investments in U.S. equities, U.S. debt, and U.S. real estate. Where feasible, I estimate the tax-induced advantage or disadvantage SWFs have relative to private foreign investors and U.S. investors for each asset class under current law. I also discuss how the international tax system could be reformed so that it does not distort ownership patterns. The basic idea is to divide the right to tax into two pieces. First, the source country has the right to tax an investment on the condition that the tax it imposes does not vary depending on who makes the investment or where the investor making the investment resides. Second, the home country has the right to tax the investor on the conditions that the home country taxes the investor at the same rate on income from all sources and that the home country allows a deduction, but not a credit, for any taxes paid to the source country.