Monthly Archives: July 2016

Book review: Global Tax Governance – What is wrong with it and how to fix it

One of the major 21st century challenges for politicians and polities at both the national, regional and international levels is the governance of ever-more global, mobile and flexible economic and financial flows. No more so than in the area of taxation, which looks likely to remain the last bastion of entrenched perceptions of national sovereignty, an undisputed cornerstone of the independent and authoritative government, the undeniable prerogative of national policy-makers in the face of growing global economic integration.

Or perhaps world leaders are slowly warming to the fact that they need international co-operation, if they want to address tax competition and the pilloried global tax system in any meaningful way? Peter Dietsch and Thomas Rixen’s recent edited volume on Global Tax Governance (sub-titled “What is wrong with it and how to fix it” – straight to the point) certainly seeks to leave you with the feeling that it is both desirable and irrefutable, “an idea whose time has come”, with reform proposals waiting for the Obamas and Merkels of this world to wake up and smell the coffee.

Global Tax Governance comprises fifteen chapters from a very strong line-up of contributors across the disciplinary divides, compiled by Dietsch and Rixen into 350-or-so pages of excellent reading. International tax competition and co-operation are not simple issues; they are multifaceted, difficult, wicked phenomena, so the diversity of inputs is both welcome and necessary. The chapter authors include economists, legal scholars, political scientists, and political philosophers. This provides a well-rounded gathering of perspectives, which covers many of the key stories of both the problems and solutions related to global tax governance. But there is no denying that this is first and foremost a political economy book – the pure economic and pure legal perspectives, for instance, are marginal. Still, for anyone looking for an intermediate dive into tax competition and the state and issues of international tax governance, this is, to my mind, the top place to start today.

Compared to other recent books on global tax issues, this one scores as the least morality-born but most refined in terms of its problem-identification and solution-building. While Thomas Pogge and Krishen Mehta’s Global Tax Fairness covers more ground and is provocative in its content at times, Global Tax Governance is a more academic book (incidentally because they are more academic authors), with a greater focus on succinct analysis and structure, and probably greater overall coherence. And compared to Dietsch’s previous Cathing Capital, as a compilation it is much more diverse and yet more detailed, though the reading flow is obviously worsened by its amalgamative nature.

Dietsch and Rixen have both written extensively on the topic before, and the book emanates with their footprints. Dietsch’s work on political philosophy and economic governance, which has often touched upon taxation, provides the backdrop to many of the normative and ethical arguments throughout the book, while Rixen’s research on the nature of tax competition and the international tax system as well as his proposed institutional framework solution (an International Tax Organisation) feature especially in the opening and closings of the volume. Moreover, the flavour of Dietsch and Rixen’s close associates (including Philipp Genschel and Laura Seelkopf) shine through. A quarter of the book chapters are written by this group, and several more are based on or build directly on their work. Which is okay (it is their book after all), though you might get the feeling that this analysis and solutions are the only game in town (and of course they won’t tell you otherwise).

The purpose of the book is to identify the need for global tax governance (i.e. the cause problem), take stock of the current international institutional make-up and its shortcomings, set out the normative foundations for a new direction, and propose specific political solutions. The book is divided into four parts to reflect these purposes.

In Part One, we’re treated with two superb walkthroughs by top tax economist Kimberly Clausing and Genschel/Seelkopf on the economic and political nature of tax competition and its impacts. Tax competition is damaging on national coffers and on the economy, we’re told in resounding detail. And it is widely harmful, except for capital and everyone in small open democracies, of course. But it’s a negative-sum game, so in the end the world is worse off. So why haven’t we fixed it? The “winner group” – small economies and capital owners – have powerful voices. And that voice includes the argument that every country has the sovereign right to set their tax rates as they see fit – a significant argument in a world apparently stuck in 1648 Westphalia. And besides, as Lyne Latulippe argues in chapter three, national policy-makers tend to internalise the idea (with a nudge or two from the “winner group”) that they must keep their tax offerings competitive, just like a firm’s market offering must be competitive, no matter that it is probably an awful and damaging analogy. Latulippe’s argument that national tax policy discussions are soaked with competitiveness discourse is something I have also shown for the international level in the OECD/G2o BEPS project.

So where we have gone wrong? In a lot of places, Part Two tells us. Enforcement of international tax governance is a mess (Richard Woodward, chapter five); it will only succeed when, once in a blue moon, the US gets its act together (Lukas Hakelberg, six and Itai Grinberg, seven); and even current international tax reforms are unlikely to succeed (Richard Eccleston and Helen Smith, eight). Woodward emphasises the national implementation dimension of international tax governance, arguing that tax havens do “mock compliance” to OECD’s tax information exchange standards, feigning alignment while muddling enforcement behind their backs. As we’re also seeing in the current BEPS project and elsewhere, the national take-up of global tax standards is highly varied, so this is an interesting point to follow – and Richard has promised more work on this topic, which is absolutely welcomed.

Aside from technical and political shortcomings, Dietsch (in particular) and Rixen often emphasise the normative underpinnings of international tax governance. It’s not enough to say the system doesn’t work, we need to say, ethically, why it must work differently. Thus, Part Three takes us through the ethical case for global tax governance. Miriam Ronzoni (chapter nine) weighs global justice arguments in political philosophy, sketching out why and how either of various positions should address tax competition. And Laurens van Apeldoorn (10) discusses in detail different notions of sovereignty and how they relate to the argument for tax governance. While work by both Rixen and Dietsch (see my book review) have contended that national sovereignty isn’t harmed by tax competition, Apeldoorn mounts the stronger claim that tax competition outright harms national sovereignty, discussing sovereignty recast as a responsibility (rather than a right), requiring not merely non-interference in extraterritorial affairs but a positive obligation to support sovereignty and democracy abroad. Dietsch’s chapter (11) is essentially a shortened version of part I of his previous book, though without a discussion of implementation through an International Tax Organisation (you’ll see why shortly).

The book testifies to that fact that national sovereignty seems to have emerged as the favourite argument against tax competition/for tax governance among the Dietsch/Rixen et al. group (even if they discuss different types of sovereignty and related arguments). The sovereignty-focus has been picked up from earlier work on tax havens, such as that by Alan Hudson and Ronen Palan, but it aligns rather poorly with the political discourse of today. The book does tune into, occasionally, the popular stories of tax competition’s effect on inequality or the national coffers of developing countries, financial system risk or human rights, but those are peripheral to the sovereignty argument. I did say this book is less morality-borne than others, but in arguing their cause, it is strange to see so many well-known and well-founded arguments lay idle.

Having thoroughly assessed the issue and outlined the burning platform, Part Four finally gives us the solutions. To be honest, my hopes weren’t high for the final chapters, as I feared they would merely re-state old proposals. And indeed, the chapters pick up on existing reform ideas – unitary taxation and formulary apportionment (Reuven Avi-Yonah, chapter 13), financial transactions tax (Gabriel Wollner, 14), and an International Tax Organisation (Rixen, 15) – while not considering other fundamental questions of the international tax system (e.g. source v. residence). But still, I was to be pleasantly surprised. The chapters do a very good job of not only explaining the proposals in the context of the book, often the authors provide specific links back to the first three parts of the book, explaining to the reader why a given solution addresses current shortcomings identified in Part Two, or why they would fulfill the normative cases of Part Three.

Markus Meinzer (chapter 12), a Tax Justice Network board member and an academic, provides a strong and thorough study of and argumentation for the failure of tax haven blacklists (something I have also discussed). Not merely an advert for the TJN’s Financial Secrecy Index, his chapter is a detailed exploration of historical blacklist shortcomings, the moral and political foundations for change, and the needed response. Meinzer’s illustration of blacklist issues is very useful:

Udklip

Reuven Avi-Yonah, who has published an infinite (it seems like) number of pieces on unitary taxation proposes, as we would expect, to heal the broken global tax system through unitary taxation with formulary apportionment (UT+FA). However, here Avi-Yonah is more compromise-seeking than elsewhere, where he has mostly proposed UT+FA as a “system overhaul”. His short ‘sweeping away’ of UT+FA criticism leaves something to be desired, but he puts forth the applicability of the UT+FA solution to the current issues (including as identified throughout the book) with usual pomp. Rather than promoting a full UT+FA installment, he proposes here a compromise with the prevailing arm’s length standard (ALS), using the UT+FA method selectively (within the confines of the current ALS system, notably), in situations where transfer pricing requires profit split attribution, and he discusses the need for further reconciliation between the two approaches.

Rixen himself rounds it all off, detailing the institutional solution to others’ material policy proposals. And of course, it is the International Tax Organisation (ITO), untouched by Dietsch in chapter 11 but brought back to the surface here. Rixen’s ITO is a WTO-style arbitration/enforcement solution with a forum-capacity, just as described by Dietsch in his recent book (who has the idea, I believe, from Rixen in the first place). The novelty for regular Dietsch/Rixen readers is modest, but he does engage in a much more detailed explanation of the proposed institutional design, which may serve as a blueprint for policy-makers.

Still, while Part Four contains good chapters, it remains a compilation of various proposals with Rixen’s institutional shell, and not really a coherent solution on how to “fix” global tax governance, as the book’s sub-title promises.

All in all, though, this is a fine body of work, recommendable and readworthy. It provides the fundamentals of tax competition, the burning platform, and a number of well-known policy proposals, all nicely wrapped in a book that explains well what it wants and where it is going. It can be read as a whole or as individual chapters, each of stands on their own as contributions to the literature. There are some odd chapters here and there, and there is a definitive bias in favour of certain argument (e.g. sovereignty), which leaves some interesting points and explorations on the table. But those are minor appeals in the grander scheme. The authors have told us why tax competition is damaging, why international tax cooperation is needed, and the direction of travel for policy-makers. Now, I think the authors would agree, it is up to policy-makers, academic colleagues and other interested parties to take up and discuss their ideas more widely.

My interview with TaxLinked on blacklists and Danish tax

TaxLinked, a relatively new and very interesting online community for tax professionals, publishes a weekly interview series with various people of the tax world. Previous interviews have featured Tax Notes’ Stuart Gibson on the Panama Papers, Texas A&M prof. William Byrnes on FATCA and TJN’s Alex Cobham on tax transparency, and many more fascinating talks.

For this week’s interview, I was very humbled to have the TaxLinked team reach out. I was happy to participate and I think it made for an interesting back-and-forth on tax haven blacklists and what’s going on in Danish taxation.

You can head on over to their site and check out the interview here.

 

 

We’re changing the equation of tax competition and corporate profit shifting

Within tax economics, one of the central arguments for tax competition and low(er) taxes on capital, including corporate profits, is that it leads to increased investment and growth (at least in some countries, mostly small open economies).

Why? In short, we know that corporate tax rates and rate changes have behavioural effects. Capital income may change legal forms (between two corporate forms or between corporate and non-corporate forms), firms may change their debt/equity ratios, they may shift profits abroad or increase/reduce investments. It is the nature and size of these effects that determine the result of corporate tax increases or decreases. The ‘go to’ for empirical evidence on this is De Mooij & Ederveen’s 2008 “reader’s guide”. Their literature review finds that, in an average situation surveyed by the literature, the total semi-elasticity of the corporate tax base for these effects (i.e. the % change in the tax base from a 1% increase in the relevant tax, see below) is -3.1, with profit shifting (-1.2) the largest single effect:

Udklip

I.e. if the statutory corporate tax rate increases by 1%, the corporate tax base is predicted to shrink by 1.2% from increased profit shifting.

There are a myriad of potential arguments to question the certainty and applicability of these findings, but that is for another potential blog; suffice to note here that these figures represent the most accepted available evidence in economic literature on the behavioural effects of corporate taxation.

Based on this evidence, it is regularly argued that corporate tax rate reductions in isolation and tax competition more broadly positively support economic growth as facilitators of investment and eliminators of tax avoidance (again, in some countries at least).

Now, a key element in such assertions is that the status quo is taken for grantedCurrent behavioural effects (tax elasticities) are assumed as universally true. Rather than endogenous to economic tax competition models (i.e. “they can be changed”), behavioural effects are treated as exogenous (i.e. “this is how the world is”). As my review of Peter Dietsch’s recent book on tax competition notes:

One of the key points in Dietsch’s dismissal of tax cooperation as economically inefficient concerns optimal tax theory. Proponents of tax competition that leverage optimal tax theory hold that lowering taxes will result in increased labour supply and decrease tax evasion and avoidance. Analytically, the consequence is less need for tax cooperation to stem a race to the bottom of capital taxation. And this may be empirically true today. But these elasticies (the extent to which the labour supply and evasion/avoidance change with tax rate changes) are (partly) institutionally determined, and thus Dietsch argues there is no reason to assume today’s elasticities for tomorrow – they can be modified through policies and thus we can change the factors in the optimal tax calculation. For instance, by introducing stronger international cooperation on capital tax evasion, it is possible limit the tax evasion elasticity, and thus make tax systems more progressive by increasing the optimal levels of capital taxation, shifting the tax burden back on to mobile capital factors.”

The highlighted part is, in fact, exactly what is happening today and what has been happening for the past decade in particular. We’re changing the equation of tax competition and corporate profit shifting. Numerous and continuous reforms to combat tax evasion and avoidance are contributing to this evolution (even if some commentators questions their effectiveness). This includes regulatory initiatives (such as (automatic) exchange of information, FATCA and the CRS, the OECD MCAA, the revised EU Parent Subsidiary and Savings Tax Directives, the OECD Harmful Tax Campaign, Dodd-Frank, country-by-country reporting, the BEPS project, the EU ATAD and the EU tax state aid investigations) and voluntary standards (EITI, PWYP and the Fair Tax Mark), but also other significant developments (such as the Offshore Leaks, LuxLeaks and PanamaPaper).

Not just in their material effect but also in their normative impact do these reforms and events lessen the ability and willingness of corporations to shift profits as part of tax and regulatory arbitrage, thus decreasing the predicted elasticities (i.e. the positive corporate tax base effect from decreased corporate tax rates). This is not an unreasonable assumption, in any case. To my knowledge, there is still no systematic studies of the effects of these regulatory and normative changes on corporate tax elasticities.

This realization is what led Pascal Saint-Amans, Director of the OECD Centre for Tax Policy and Administration, to make the following comments in to the Wall Street Journal this week:

“For the past 30 years we’ve been saying don’t try to tax capital more because you’ll lose it, you’ll lose investment. Well this argument is dead, so it’s worth revisiting the whole story,” Pascal Saint-Amans, the OECD’s tax chief, said in an interview.

“In the past people, notably with international income, could use foreign bank accounts to receive and make payments and their home tax office would never know. That era will be over,” Mr. Saint-Amans said optimistically. “In the lead up to this new regime some countries have allowed their citizens to declare their foreign income without penalty, that alone has raised 50 billion euros in extra tax.”

Saint-Amans’ comments also come on the back of the OECD’s release of a new report entitled “Tax Design for Inclusive Growth“, which, as a lead up to this weekend’s G20 Finance Ministers meeting in China, breaks with the advice of prior decades, arguing that the case for low capital taxation and tax competition are “not as clear-cut as previously thought” (p. 40). Although this specific messaging was not included in the G20 meeting communique, the report’s section on capital income taxation is highly recommendable for those interested, and there is no understating the language used here and its policy implications.

The OECD is sending a message, which is likely to become increasingly prevalent: As reforms squeeze regulatory room for and normative consequences of tax competition, capital is less likely to flee national boundaries, and thus countries can, just perhaps, slowly start to ease the foot off the tax competition throttle.

* POST-SCRIPT JUNE 2018 *: A new paper by the IMF was released on this exact topic recently. I shared some thoughts on the paper on Twitter, which provides a relevant addendum to this blog post. To read, see below:

Catching Capital: Thoughts on Dietsch and tax competition

Globalisation and the intensified competition among firms in the global marketplace has had and continues to have many positive effects. However, the fact that tax competition may lead to the proliferation of harmful tax practices and the adverse consequences that result, as discussed here, shows that governments must take measures, including intensifying their international co-operation, to protect their tax bases and to avoid the world-wide reduction in welfare caused by tax-induced distortions in capital and financial flows.

(OECD, 1998. Harmful Tax Competition – An Emerging Global Issue, p.18)

While tax competition had been an interest to academics for decades before, the 1998 OECD report really put ‘tax competition’ on the global political agenda. A substantial literature has followed, but rarely does it touch upon the ethical foundations of tax competition.

A recent book by Peter Dietsch, professor at the Department of Philosophy of the University of Montreal, does just that. ‘Catching Capital: The ethics of tax competition‘ sets out to accomplish three main things: It seeks to investigate the phenomenon of tax competition and its ethical underpinnings, to argue that it is damaging, and to offer a useful solution to the issue.

Given the book was published in almost a year ago, in August 2015, it seems to have received relatively little buzz. As far as I was able to identify, there is only a few available reviews and just a handful of citations and mentions. But perhaps it is too early to judge. Having read the book with interest, I offer my thoughts below, not quite as a pure review but also as a repository for thoughts on the arguments and ideas put forward by Dietsch in the book.

As an introductory summary, I found the book both entertaining in both its specific point of attack (ethics), its substantive arguments and its normative character. Dietsch delves fascinatingly into the political philosophy of taxation, a theme so basic yet so far from modern tax discussions, whilst connecting the philosophical discussions to relevant, important real-world issues. The discussions go deep when the author desires (for instance when dismissing the economic efficiency arguments against tax cooperation) and shallow elsewhere (for instance when discussing current international tax reform streams). The structure, at times, leaves something to be desired – the argument flow within and across chapters can become muddled and in its persistence to immediately address all potential angles and criticisms of the topic at hand, the pace is often disturbed or broken. But all in all, it is a well-argued and thoughtful piece that succintly explains both a burning platform, an interesting future solution, and a roadmap towards addressing tax competition today.

The book is structured around five chapters, which – to give it all away – can be crudely summed up as follows:

1: Tax competition harms fiscal sovereignty.

2: The solution to tax competition is WTO-style international tax law and arbitration based on “do no strategic harm” principles.

3: Tax cooperation is not inefficient in economic models, and even if it were, this would not mean that it is inefficient in the real world.

4: National sovereignty is enhanced by international tax cooperation, not eroded.

5: Compensatory duties are needed for low-income countries that currently win from tax competition in order to smooth a transition to the new system.

Tax competition harms fiscal sovereignty

On the first point, the point made by Dietsch is clear: Tax competition renders national polities unable to tax capital at their choosing, given that it can escape and transform flexibly to avoid the tax grasp of states. Put simply, capital is darn difficult to tax under current national and international tax systems and in today’s world of globalised capital markets. And the effect is damaged national fiscal sovereignty; citizens cannot any longer decide how and how much they want to tax capital – their choices are institutionally limited and some will inevitably be ineffective.

What has become the ‘natural’ consequent conclusion in policy circles is that we should stop trying to tax capital, and instead tax immobile factors (consumption, land and to a lesser extent labour), as my blog on European tax policy plainly shows. Thus, the most popular current streams in addressing tax competition to accept this slipperiness and nudge us to avert the tax gaze elsewhere. Even more radical reform ideas, such as unitary taxation, which are viewed as a means to tax corporations more effectively, are based on formulary apportionment through less mobile factors such as sales and employees.

But it raises the question of whether or not it is really a good idea to just ‘give up’ taxing capital because it is hard? It may create outcomes that are problematic from an ethics or equity viewpoint. As Dietsch writes, the trend to shift taxation from capital to labour, consumption and land has had the effect that “OECD countries have bought fiscal stability in terms of revenue at the cost of a less redistributive system” (p. 48).

“No strategic harm” and an International Tax Organisation

So what are national politicians to do these days? In chapter 2, Dietsch offers his reply: An International Tax Organisation (ITO), modeled on the World Trade Organisation (WTO), with two key principles of global tax justice, enshrined in international law and enforced via arbitration and expert panels:

  1. The membership prinicple (with a transparency corollary)
  2. The fiscal policy constraint

The former is simple in wording, but the devil is in the detail. Individuals and corporations should pay tax in the state where they are members, i.e. where they benefit from the services provided by the corresponding tax expenditure (e.g. public services or infrastructure). And in order to make this assessment, states need transparency, i.e. access to information on economic agents’ behaviour and assets across borders.

Hallelujah, on we go. Right? Not quite. What exactly constitutes ‘benefits from’? Is there a certain threshold, in terms of time, resources invested, or other tangible support received? Unfortunately, Dietsch does not offer a sufficient detailing of the practical implementation of the principle. How are we to judge whether and to what extent a person or a company is a member of a state? In this respect, the membership principle is somewhat analogous to the ongoing discussions at the OECD and EU levels on what exactly constitutes “taxing profits where value is created” – a phase repeated so often by international tax policy-makers that it has lost all meaning. The challenge lies in defining membership, as it does in defining value-creation.

The fiscal policy constraint holds that countries should not engage in tax competition which collectively puts countries worse off. In order to do so, Dietsch holds, tax policies must not:

a) Strategically (deliberately) be designed to attract economic activity from other states, and
b) Negatively affect the aggregate fiscal self-determination of the countries in question

If a national fiscal policy is strategic but non-damaging, it’s okay. This could be where Scandinavian countries invest heavily in free education so as to attract foreign capital. If it is damaging but non-strategic, that’s okay. This could where citizens, say of the US, have exercised their democratic voice to express a preference for relatively low taxes and public spending. If it is both, that’s not okay. Dietsch cites the Irish tax regime as an example here.

The main ideational and theoretical novelty in Dietsch’s proposals here is these principles. The question of a World Tax Organisation has been discussed for decades. But Dietsch’s ethics-oriented inquiry has produced two key principles that are open to challenge but coherent and useful in assessing what is and what is not ‘acceptable’ tax competition. Indeed, Dietsch himself notes that the key challenge of his book is to “identify where the boundaries of the fiscal autonomy prerogative should lie, and what institutions serve to protect them”. But whereas most proposals to address this question, including those surveyed by Dietsch in the book (capital controls and unitary taxation), offer technical solutions to regulating capital (or abstaining from it), Dietsch’s solution is fundamentally different. It is philosophical and principles-based.

The above is not to dismiss his contribution on the enforcement-side. Dietsch usefully substantiates the case for sovereignty-pooling, which is a key prerequisite for most effective enforcement proposals. (I’ll discuss this further when addressing chapter four, which concerns sovereignty.)

On the other hand, the high-level nature of his solutions also means certain technical details are unaddressed. Though the author does touch upon these points, it never becomes quite clear how the membership principle is to be determined, how the intentions and outcomes of national fiscal policies are to be evaluated, or how exactly to avoid all the pitfalls of ITO’s inspiration, the WTO (for instance the continued geopolitical features of its decisions and its rules).

Now, the effect of Dietsch’s proposals, if carried out, are not to be understated. He characterises three types of tax competition, of which the two former are the most problematic and harmful: Competition for portfolio capital, for paper profits and real FDI. These are, to some extent substitutive. As long as businesses can shift paper profits, there is less need to reallocate real FDI. The effect of decreasing competition, in particular of the two first types, will be to produce a more real and true market and economic competition for actual investment and actual economic activity. This is a similar argument we often hear about other proposed solutions, such as unitary taxation and the EU CCCTB – that in limiting ‘backdoor’ tax competition (or poaching), “real” competition would intensify. And that is most likely correct. But as Dietsch details, open, real and fair competition should be preferred – even though it creates other issues – to hidden, on-paper and selective competition. One reason is that the former follows the membership principle, so that when income or assets are shifted between countries, it will align with the location where benefits are obtained from the expenditures of taxes paid.

Tax cooperation is not inefficient

Having outlined the burning platform and the solution, Dietsch needs to defend his proposals. There is no shortage of economic and legal analysis to counter-argue his case. Meeting the former head on, Dietsch adds to his analysis on tax competition as damaging fiscal sovereignty in a philosophical sense, with the point that tax cooperation is not inefficient from an economic point of view. Note that Dietsch’s focus is not on ambitious arguments that tax cooperation is efficient or that tax competition is inefficient per se. He sets out to demonstrate the more moderate claim that tax cooperation, of the sort he advocates, is not economically inefficient.

I was happy to see Dietsch open this argument with an important point, which often gets lost in popular tax debates: Tax is only one side of the fiscal coin. The other side is public spending. In standard economics, taxation is often a bad thing, because the corresponding expenditure is assumed not to outweigh the welfare loss created by the the tax. But Dietsch argues that this general assumption is importantly flawed. Tax provides basic market-enabling (legal frameworks, health and safety, etc.) services and public goods, along with investments in education, health, infrastructure, etc. – all of which may outweigh deadweight losses. Similarly, arguments that tax competition is efficient because it leads to economic growth often rely on assumptions that markets are perfectly competitive and that resulting economic growth will lead to welfare gains that outweigh the corresponding losses. Dietsch finds this to be unrealistic and improbable, in particular at the global level, not least because of the presence of public goods and negative spillover effects. (It may lead to national gains at the expense of neighbouring countries, but this is a lesser argument as it guarantees a race to the bottom.)

One of the key points in Dietsch’s dismissal of tax cooperation as economically inefficient concerns optimal tax theory. Proponents of tax competition that leverage optimal tax theory hold that lowering taxes will result in increased labour supply and decrease tax evasion and avoidance. Analytically, the consequence is less need for tax cooperation to stem a race to the bottom of capital taxation. And this may be empirically true today. But these elasticies (the extent to which the labour supply and evasion/avoidance change with tax rate changes) are (partly) institutionally determined, and thus Dietsch argues there is no reason to assume today’s elasticities for tomorrow – they can be modified through policies and thus we can change the factors in the optimal tax calculation. For instance, by introducing stronger international cooperation on capital tax evasion, it is possible limit the tax evasion elasticity, and thus make tax systems more progressive by increasing the optimal levels of capital taxation, shifting the tax burden back on to mobile capital factors.

The upshot of Dietsch’s line of argumentation is two-fold. Firstly, because the assumptions underlying economic pro-tax competition models assume away key institutional features and fail to capture real life features adequately, they tend to prescribe levels of capital taxation that are below the optimum. Secondly, because these standards models are insufficient, Dietch calls for better empirical research on whether specific tax policies represent aggregate (Pareto) improvements or deteriorations of welfare, rather than whether tax competition in general is good or bad. On these points, it is fair to question whether Dietsch’s assessment of economic theory and research is somewhat stylised. The economic literature on tax competition is diverse and comes to conclucions all along the spectrum, as Dietsch also recognises. Yet his dismissal of this literature rests mostly on general traits and models, which may be dominant in the literature, but which do not paint the full picture.

Tax cooperation enhances, not erodes, national sovereignty

The second key defense that Dietsch makes for his proposals is that tax cooperation does not undermine national sovereignty. Traditionally, this has been the main argument against international tax cooperation. Countries want to retain full rights over taxation, often viewed as a cornerstone of the sovereign nation-state and a key part of the social contract. More than anything else, this is why we do not have international cooperation on tax to the same extent we have it on trade or human rights.

But the trade-off between cooperation and sovereignty, and the notion of sovereignty which this perception of a trade-off implies, is inadequate in today’s world, argues Dietsch. The choice today is to maintain full authority, based on the outdated Westphalian concept of sovereignty, remaining unable to tax capital effectively, or to pool some sovereignty for effective capital taxation, thus reinforcing sovereignty itself.

While Westphalian sovereignty – the agreement on non-intervention in a states’ internal affairs by other states, named after the 1648 Peace of Westphalia – may have been a useful framework for fiscal policies in a world of immobile production factors, it falls short in a globalised world. The fundamental mismatch between internationally mobile capital and territorially-bound states cannot be ignored.

As Dietsch’s colleagues, Thomas Rixen and Philipp Genschel have detailed, any individual country faces a trilemma in addressing tax competition. It can only curb tax competition by relaxing sovereignty or unilaterally engaging in double taxation.

Udklip

The international tax system of today is based on the historical choice to pick national sovereignty and avoiding double taxation, as countries avoid real international cooperation and emphasise the avoidance of double taxation through bilateral tax treaties.

One of the most important interventions of this book is to remind us that national sovereignty is not absolute. Just like with individual personal freedom, the authority of an individual country will always, at some point, impact the authority of another. The myth of absolute freedom or absolutely sovereignty is just that – a myth.

Here, Dietsch latches on to recent developments in international law and argues that sovereignty needs to be re-cast as a responsibility rather than a right. This means it comes with caveats, of which Dietsch in particular highlights the requirement to respect the fiscal self-determination of other states. If we accept this argument, that sovereignty is a responsibility, the act of tax cooperation becomes in fact not a violation or sovereignty but a central feature of it.

This is an idea becoming increasingly loud. As recent as July 10, Harvard professor Lawrence Summers launched a call for “responsible nationalism” in the Washington Post. His words align well with Dietsch’s analysis:

What is needed is a responsible nationalism — an approach where it is understood that countries are expected to pursue their citizens’ economic welfare as a primary objective but where their ability to damage the interests of citizens of other countries is circumscribed.

Unfortunately for Dietsch and Summers, this is also an idea that is unlikely to take hold just yet. Whether based on a correct analysis or not, national self-determination remains the ultimate backstop to international cooperation (in particular on tax) in the eyes of national policy-makers.

Transitional justice

Before rounding off, Dietsch explores a number of subsidiary ethical questions related to the implementation of his proposals. Should small developing countries be allowed to continue tax competition? How should we calculate compensatory duties (Dietsch’s proposal for sanctions under the new ITO regime)? And what about the populations of existing tax havens? While these are interesting explorations, the book skips quickly across the topics, which leads us to conclude they are included largely for the sake of mention. The limited analyses, e.g. on calculation of tax losses from competition (an extremely difficult topic in itself), also means this is the weakest part of the book.

A diligent, normative, and also non-normative book

In conclusion, it is worth highlighting that Dietsch’s book is a normative one. It argues that tax competition is significant and damaging, and it proposes a real solution to deal with this problem. But then again it also deliberately avoids, somewhat awkwardly, being normative. In fact, the author is extremely careful to emphasise what he is and is not making claims about. Dietsch notes, for instance, that income inequalities within and between countries are exacerbated by tax competition, but makes no definitive claims as to whether this is good or bad. At times, the author provides almost all the arguments necessary to make further normative claims, but avoids going all the way, perhaps for fear of over-stretching or because he finds their solutions immediately unfeasible or out of scope. This is, in a sense, admirable integrity, but also to some extent disappointing.

In avoiding some of those conclusions, I think a lot is missed. I applaud Dietsch for his diligence in bringing his arguments, again and again, back to questions of ethics. To my mind, most of the key questions we discuss today on tax issues always somehow trace back to questions of morality. (For Dietsch, of course, this question of ethics is not about individual agents but rather the ethics behind the design of institutional system to deal with tax and tax competition – another debatable omission.) Unfortunately, Dietsch often avoids actually making any substantive claims regarding ethics, beyond those concerned with national fiscal sovereignty. For instance, Dietsch’s book is adamant that tax competition is really only a problem for the sovereignty of large states (because small states benefit from it), and the solution should come from these countries. If the book finalised its lines of argument that tax competition worsens inequality (which may hurt the economy too), that it increases risk of and exacerbates financial crises, that it distorts fair market competition, and so forth – in addition to the substantiated claim that it undermines sovereignty – he might have come to the conclusion that it is not only detrimental to large states, and that is a problem more wide in scope than sovereignty.

On the other hand, the deliberate lack of normativity is also a strength at times. Dietsch proposes no subjective theory of ‘fairness’ or ‘justice’, nor any opinion on the ‘right’ levels or balance of taxation and similar questions, and he develops principles and recommendations that are applicable largely without reference to national or international politics or tax systems. In this way, he leaves the utilisation of his arguments open to a range of actors and groups with varying interests.

Because of the authors diligence, while there are and will continue to be prominent counter-arguments to the ideas advanced by Dietsch in this book, the book has already surveyed and responded to many of the most obvious ones, at every turn of the argument, though with varying conviction and success. But even if one only buys halfway into the proposals put forth, accepting some of the ideas as relevant, this is an important stepping stone. As Dietsch, citing Pablo Gilabert, notes:

.. If the institutional reforms laid out in part I turn out to be unfeasible for political reasons today, there still are a number of things we can and should do to make their implementation possible in the future.

 

The bark IS the bite, but ..: Why tax haven blacklists are not the answer

The OECD has been working on criteria for a tax haven blacklist. At the request of the G20 Finance Ministers, this has been a work in progress since April of this year. And the results are set to be presented at the G20 finance minister’s meeting in China next month.

This morning, the FT reports that those criteria are now set, and I turned to Twitter to evaluate the news:

My immediate thoughts were aligned with comments I’ve previously made, which are clear on these types of blacklists:

Why the skepticism? Surely, tax haven blacklists are a strong and effective tool? Indeed, they are. For certain purposes.

Tax haven blacklists have been one of the key international tax policy tools to combat illegitimate and harmful tax competition throughout the past decades. Starting with the OECD ‘Harmful Tax Competition’ (HTC) project, campaigns by international organisations to ‘name and shame’ uncooperative states has been very successful. There is no doubt that the HTC project, along with similar action by the Financial Action Task Force, the G20, the EU and others, have brought about significant compliance by states around the world to international tax standards.

Jason Sharman, in his excellently titled “The bark is the bite“, explains why exactly ‘naming and shaming’ works: It creates a discourse of illegitimacy and damages the reputations of non-compliant states and those associated with them, creating key psychological and material disincentives for tax haven behaviour. Of course, we still have tax havens, so it’s not an “be all, end all” tool, but blacklists advanced the agenda of harmful international tax competition probably more than any other tool in the 1990-2010 period.

My main contentions today with tax haven blacklists and my suspicion of their effectiveness can be summed up as follows:

  • Blacklists target small states, but not larger states with proportionally greater influence
  • Blacklists are inherently political, a reflection of geopolitics and national power
  • Blacklists express the pathologies of international organisations, rather than strictly

On the first and second points, you have to look no further than the current ‘gold standard’ for international tax haven blacklists: the OECD’s list of commitments to automatic exchange of tax information:

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Three small island states are non-compliant: Bahrain, Nauru and Vanuatu*. Oh, and then the United States of course, but they are only mentioned in a footnote. In short, if you’re big and powerful, or if you have the right friends, you will not end up in any international tax haven blacklist; if you’re small and powerless, you risk the blacklist treatment.

That is why the United States, the UK (City of London etc.), Switzerland, Luxembourg, the Netherlands and others will not end up on the tax haven blacklists of the OECD or the EU, even though they are widely considered key tax havens.

To be fair, a completely factual reason these states do not figure on tax haven blacklists is that they comply with the established blacklist criteria (with the notable US exception, of course). But that is exactly the point – the established criteria favour certain states in their design, while disadvantaging others.

And it makes perfect sense. International organisations and their member states don’t want to upset key trading partners. International trade and diplomatic relations are simply prioritised over naming and shaming on tax. I can understand that train of thought. I think most people can, in fact. But when you are trying to nudge the world towards less ‘harmful international tax competition’, this approach causes a fundamentally ineffective solution. We may name and shame small islands states all the way to tax haven extinction, but we are not addressing the wealth of similar activity generated through larger, more powerful states.

Finally, international tax haven blacklists are not, although one might think so, based on “objective” criteria. There is no such thing. When OECD and EU staff members and their member state counterparts are constructing blacklist criteria, they are surely doing what they think is “objectively” correct, but they are also influenced by their organisational, professional and national environments. They have different purposes for and ideas about the blacklists. They are influenced by organisational pathologies.

When the EU Member States publicised national tax haven blacklists in 2015, France labelled eight countries, Portugal labelled 80, Denmark didn’t offer a list. And, by the way, only eight Member States had Panama on their list.  And whenever the OECD makes a blacklist, the criteria conveniently revolve around subscribing to OECD tax standards (on information exchange, on harmful tax practices, on administrative cooperation, on transparency minimum standards, etc. etc.). This makes sense from an OECD perspective. But as Richard Woodward and Eccleston have written, the organisational culture of the OECD (and other international organisations) and the internal focus can lead to weak, lowest common denominator standards in tax. As such, while the blacklists might make sense for the individual or the organisation, it does not necessarily provide an effective solution if the goal is to diminish harmful international tax competition.

More than anything else, the new OECD tax haven blacklist criteria will probably lead small states to expand their subscription to OECD tax governance standards. Most of them already cooperate with OECD standards, but maybe they don’t subscribe to all three requirements. Currently there are eight countries past review that are not “largely compliant” with information exchange standards. And there are three* countries uncommitted to automatic exchange of information (see above). So how much will this move? I have my doubts.

(*Endnote: As Christian Hallum pointed out to me, there are in fact no longer any jurisdictions defined as non-committed.)