This paper deals with optimal income taxation under international outsourcing and FDI. We show how the joint effect of outsourcing and FDI on the optimal marginal income tax rates depends on whether FDI is horizontal or vertical.

This paper concerns optimal taxation and outsourcing. If the government has a direct instrument for taxing outsourcing, the policy rules for marginal income taxation remain as in the standard model. Otherwise, outsourcing contributes to a more progressive income tax structure.