The relation between taxation and risk-taking has occupied an important place in tax scholarship in recent years. To date the focus has been on the domestic, or closed economy, setting. This Article expands existing analysis to the open economy setting, with specific emphasis on the distributional consequences of the taxation of risky cross-border investments. The Article describes a phenomenon, labeled “divergence,” under which common international tax instruments result in the systematic splitting of upside and downside risk across jurisdictions. Divergence can, in turn, be split into “public divergence” and “private divergence,” depending upon whether the excess downside risk is borne by the fisc or by the taxpayer. The rate of divergence is a function of source jurisdiction tax policy, but the split between public and private divergence is a function of residence jurisdiction method of double tax relief. Divergence is both quantitatively substantial (approximately $10.6 billion for a sample year with respect to U.S. outbound investment) and normatively problematic from the standpoint of political legitimacy. The political economy of divergence, however, suggests that it is likely to continue as a pervasive feature of cross-border taxation. The Article accordingly concludes with a discussion of how divergence should shape policy-making in the following important areas: domestic loss offsets, tax subsidies, transfer pricing, double tax relief, and foreign aid.
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