Author Archives: phdskat

Varieties of Something

What is a tax haven really (if anything at all)? How can we classify them? And what are the existing attempts at doing so? In connection with a research project, I recently asked for your help in pointing out sources discussing different “varieties” of tax havens, i.e. what different countries “specialise” in. That fostered a series of long and detailed discussions. (Thanks for the comments all.) In this post, I will try to sum up some of the insights and some of my own thoughts on these questions.

What is a tax haven?

Let me start with the first ponder: What is a tax haven really, if anything at all? This is not an easy question. In fact, it is an absolutely grueling question. In popular culture, tax havens are typically thought of as sun-kissed islands full of bankers with money-stuffed suitcases – the Curaçaos and Bermudas of the world. But in reality, the binary “either/or” classification fails to capture the true nuance. As Aisling Donohue noted, “every country has some aspect of their tax regime more favourable than that of others.” And the world of tax havens have changed substantially over the past half century; today, there is more transparency than ever and regulatory reform has fundamentally altered the possibilities for and in tax havens.

Moreover, the act of classification itself – of designating the “tax haven” label to some country – has always been and remains an exercise marked by political inequalities and a fragmented, confused nature. As Allison Christians rightly pointed out, this labeling is almost always a “rich countries deride poor countries” type of dynamic – which is a key reason we typically think of tax havens as these precarious resorts. Blacklisting is a geopolitical power game, an uneven discriminatory battleground that does not recognise the different constraints faced by different countries.

The sheer volume of different “lists of tax havens” or “criteria for identifying a tax haven” is testament to the general confusion around the phenomenon. Today, practically every country, every NGO, and every international organisation has their own unique list with distinct criteria, for different purposes and for different audiences. When asked by a journalist recently for help to identify “the best list of tax havens”, I had to disappoint by pointing out this messiness. The reply came back: “It would be nice if we could just agree what a tax haven is”. Indeed, but alas. In the absence of anything resembling agreement at any level, people usually have recourse to their personal favourite list. This creates significant bemusement and obscures discussion.

(A brief anecdote: When I wrote one of my very first papers at university on tax havens almost ten years ago, my student colleague and I concluded that, “perfect consensus definition is not necessary in order to deal with the offshore world”. This remains true but I have certainly grown more skeptical of how much it actually hinders effective action.)

Is tax havens the right label?

The corollary to the question of what a tax haven really is, is: is “tax havens” even the proper label? While tax-related activities remain a core component of this world, it is equally a secrecy and regulatory avoidance more broadly. (And there are many detailed discussions of this definitional/framing challenge – I refer you e.g. to this piece by Cobham, Jansky and Meinzer). Should we perhaps forget the “tax haven” framing altogether? Should we rather subscribe to alternatives such as “secrecy jurisdictions”, “offshore financial centres” or “uncooperative territories”? I’d argue that these alternatives pose many of the same problems as the tax haven label, although some are certainly better than others. The “secrecy jurisdictions” framing, for instance, comes from the Financial Secrecy Index, which has contributed to dispelling the idea of tax havens as small island retreats, highlighting the problematic regimes of major global powerhouses.

However, the convenience of the “tax havens” label is unparalleled; it has instant and widespread recognition. People know what it is, or so they think. Beyond the specialist audience, the words “tax havens” have a distinct connotation that gives them unique discursive value. The framing is problematic and confusing, but popularly recognisable. As a researcher – and I suppose that goes for stakeholders more broadly – the challenge is to resolve those underlying issues whilst still using the “tax haven” or related concepts, suspect as they may be, and at the same time not feeling bound by popular framing.

Varieties of …?

While keeping these thoughts in mind, grouping or classifying havens through analysis can be of use, though one needs to be very careful in doing so. Perhaps surprisingly, there are very few systematic attempts at divvying up the world of tax havens/offshore financial centres/etc. And those that exist vary widely in their approaches. You can imagine categorising countries in a million ways – by their size, region, service industry, client type, client location, income source, and so forth. In my original question, I had thought of service specialisation, but the ‘varieties’ wording clearly means different things to different people. Let’s look at some of the existing typologies:

Citation Categorisation Examples
Garcia-Bernardo et al. 2017 Global ownership chain position Sinks (e.g. BVI, Jersey, Bermuda) and conduits (e.g. Netherlands, UK, Ireland)
Bruner 2016 Service specialization Insurance (e.g. Bermuda), wealth management (Singapore) and business entities (Delaware)
Sharman 2012 Growth trajectory Leaders (e.g. Cayman), stagnants (e.g. Vanuatu), growing (e.g. Belize), exited (e.g. Nauru), and entering (e.g. Somalia)
Avi-Yonah 2000 Value proposition Production (e.g. Ireland), HQ (e.g. Belgium) and traditional (e.g. Luxembourg) tax havens
Z/Yen Connectivity, diversity, specialty Globally connected, deep and diverse (e.g. Singapore); locally focused, emerging and narrow (e.g. Cyprus)

Most recently, the folks over at University of Amsterdam categorise offshore financial centres (although that definition includes decidedly “onshore” countries such as the Netherlands and the United Kingdom) by their function and position in global corporate ownership structures, as “sinks” (where ownership chains “end”) and “conduits” (where ownership flows through). The former includes the British Virgin Islands, Taiwan, Jersey, Bermuda, the Caymans and other such “tax havens” as popularly understood. The latter, however, features the Netherlands, the United Kingdom, Ireland, Singapore and Switzerland. The UvA paper also contains the geographical specialisation for each of these conduits. For instance, the UK conduits from Europe to Luxembourg and the Cayman Islands, while Ireland is a primary conduit from Japan and the US to Luxembourg. Finally, the paper discusses industry sector specialisation. Here, it figures that the Netherlands specialises in holding companies, while administrative entities are Luxembourg’s metier.

In another relatively recent piece, Georgia law professor Christopher Bruner also categorises offshore financial centres (in the conventional sense of small jurisdictions) based on a number of characteristics, but the one I will highlight here is (service) specialization. Bruner follows six case studies, noting Bermuda as an insurance specialist, Dubai as an Islamic finance specialist, Singapore as a wealth management specialist, Hong Kong as a mainland finance specialist, Switzerland as a cross-border banking specialist, and Delaware as a business entities specialist:

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Elsewhere, Cambridge professor Jason Sharman has also categorised offshore financial centres, but based on their strategic growth trajectory in the face of the post-financial crisis tax haven crackdown. He groups countries into five: leaders, stagnants, growing, exited and entering. The leaders, long-standing havens who have fared well in the post-crisis era, include the British Virgin Islands, the Cayman Islands and Panama. The stagnants include Montserrat, the Netherlands Antilles and Vanuatu. The growers include Belize, Mauritius, Samoa and the Seychelles. The exited include Nauru and Niue. And finally the new entrants include Anjouan and Somalia.

A little further back in time, Michigan professor Reuven Avi-Yonah proposed a 3-way typology of tax havens based on their market value proposition. Avi-Yonah distinguishes between production tax havens that attract production investment through tax incentives (e.g. Ireland), headquarter tax havens that attract (virtual) ownership relocation through lax permanent establishment rules or management exemptions (e.g. Belgium), and traditional tax havens that attract mobile capital with low tax rates or secrecy laws (e.g. Luxembourg).

On the quasi-academic front, there is also the Global Financial Centres Index, published twice a year by think-tank/consultancy Z/Yen with backing from the Qatari Financial Centre Authority, which categorises financial centres (not tax havens or offshore centres) based on connectivity (to other financial hubs), diversity (the breadth of service offering), and specialty (depth of service offering). This creates a complex typology, but we can draw out some examples. Singapore, for instance, is a globally connected centre, a leader with a broad and deep service offering. Meanwhile, Cyprus is an evolving, locally focused centre with a narrow service offering.

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Finally, there are all the crowd-sourced service specialisations noted by the kind people of Twitter, which has no particular systematic to it. I’ll just list them here for brevity: Jersey – real estate, Bermuda – insurance, British Virgin Islands – banking, Cayman – asset finance, Gibraltar – gaming, Delaware – shell companies, Panama – flags of convenience, Vermont – captive insurance, Ireland – tech giants, Mauritius – Indian/African assets, Cyprus – Russian assets, London – “we have favourable opinions from respected QCs” (I thought that was funny), Nevada – IP licensing, and Netherlands – holding companies.

The takeaway

So what can we take away from all of these typologies? First, while there are problems and absences in each of the analyses, together they allow us to draw out some quite comprehensive descriptions of countries. The Cayman Islands, for instance, features in almost all of the above contributions. Based on that, we can say that the Cayman Islands is:

  • A global corporate ownership conduit, in particular from and to Asian hubs (Taiwan, Hong Kong and China)
  • A leader in the offshore financial services centre pack
  • A traditional/headquarter haven type
  • … with an international (not global) specialisation and a relatively deep service offering, in particular asset finance.

Similar descriptions could be extracted for many other countries. In sum, these “varieties of”-analyses allow us to construct a more holistic picture of the characteristics and specialisation of various tax havens/offshore financial centres/etc. compared to conventional binary labeling.

However, the analyses also illustrate the reflection on structural inequalities and confusion surrounding “tax havens” that started this post. The North v. South or rich v. poor country element is prevalent, as most typologies focus on the latter while rarely reflecting systematically on structural inequalities. When discussing and analysing tax havens, these nuances are crucial to keep in mind if one wants to avoid wholesale propagation of global power and inequality dynamics. While existing “varieties of” can be useful to help us understand certain countries’ make-up, more work is needed that takes account of the dynamics underlying financial and tax-related national and local strategies and how they are shaped by political and economic constraints. And, importantly, what the global effects are. Some “tax haven” activities are more harmful to other countries than others. (On that, I lean towards Peter Dietsch’s ethical discussion of tax competition). The work is definitely cut out for researchers, practitioners and other stakeholders alike. So, I’ll get to work then…

The Great Rise of Corporate Tax Avoidance?

“Perception is reality”. A simple and yet powerful idea.

It came to mind this week after I had conducted a complete unscientific yet exceptionally telling Twitter poll on the evolution of corporate tax avoidance over the past decade. Thanks to those who voted and retweeted.

89%(!) – a crushing majority – of around 1400 voters believe that, in terms of the tax lost to nation-states, corporate tax avoidance has become worse since 2007. Caveats abound – as noted, this is not a scientific poll: it is based on a convenience sample of followers of myself and my followers (in particular barrister Jolyon Maugham, who was the most prominent retweeter of the poll), who I’d wager are, on average, more critical towards corporate tax avoidance than the general population – but I believe nonetheless that it is a useful result for starting a reflection.

One reason why this is a good starting point is that it is backed up by other (and more scientific) work. Corporate tax avoidance has, if nothing else, seemed to get worse to many. For instance, while in 2011 corporate tax avoidance did not feature as a key concern around UK business ethics (per lists published by the Institute of Business Ethics), it has been the top issue every year since 2013. Another recent study has also shown that the public salience of corporate tax avoidance exploded in the wake of the global financial crisis, around the same time as investigative media reports began regularly scathing the tax planning of major multinational corporates like Amazon and Starbucks.

Okay, so attention by the public and by the media to corporate tax avoidance has risen in the past years. That doesn’t mean that corporate tax avoidance actually has risen. Bingo! This is one element that fascinates me about this – there is very little, if any, discernible, tangible, hard evidence to suggest corporate tax avoidance has in fact “gotten worse” in terms of tax lost to nation-states. To the best of my knowledge, there exists no longitudinal academic research that sheds light on the evolution of corporate tax avoidance, in terms of tax lost, over the past decades. (If you are reading this and know of some, please let me know!)

A number of tax administrations publish annual estimates of tax gaps – the difference between the amount of tax that should, in theory, be collected, and what is actually collected – on corporation taxes (thanks to Heather Self for nudging me to include this point). The British HMRC is one such example, with its “Measuring Tax Gaps“. Although I generally believe that most tax administration’s tax gap estimates on corporate tax avoidance are woefully cautious and inadequate (they are generally based on limited random samples or simple models based on immediately available information, and they have strong political motivation to underestimate the problem), at least they are usually consistent over time. In the case of HMRC, their most recent estimates (2016) find that the CT (corporation tax) gap has been slowly declining over the past decades.

Udklip

More broadly, we have a vast range number of point estimates on corporate tax avoidance, with the OECD’s estimate of an annual global $100-240bn gap probably the most well-known. But in terms of longitudinal academic research, the only even remotely relevant hard indicators we have (that I know of) are studies by Niels Johannessen and Gabriel Zucman and Lukas Hakelberg and Max Schaub, respectively, which both use data from the Bank of International Settlements to investigate the evolution of offshore bank deposits. (I should note that I posted this blog just before Johannesen, Zucman and colleague Annette Alstadsæter published a new paper with more extensive and time series data in this vein.) The former conclude that the international crackdown on bank secrecy circa 2009 had no noticeable effect on offshore deposits; the latter conclude that the second crackdown a few years later had some effect, but only insofar as individuals shifted tax haven deposits to the USA. Importantly, these studies concern bank secrecy and individuals’ bank deposits, not really corporate tax avoidance. There are some arguments that the two might be correlated, but there are also arguments that they aren’t, and once again we have no systematic research to substantiate it either way. In short: we still don’t really know whether corporate tax avoidance has really gone up or down.

In the way of softer indicators, my own research has given some tentative answers. I spend a lot of time interviewing and observing tax professionals – corporate tax advisers, in-house counsel, policy-makers, bureaucrats and others. One sentiment that has been reoccurring is that recent developments, around the world, have effectively addressed many historical opportunities for avoidance – both in terms of purely legal innovations in shutting down loopholes and such, but also in terms of changing conventional understandings of what is and what is not acceptable corporate tax planning. This aligns with the indications given by HMRC above, whose staff of course fall into this category of professionals.

So what are we to make of these huge discrepancies? The general public seems to perceive corporate tax avoidance as a growing problem, media attention and political momentum is up, but research does not offer anything in way of substantiating this perception, and the perception is exactly the opposite among many professionals, who believe that corporate tax avoidance has been addressed effectively (although certainly not entirely).

Clearly, the varying sources of information play a key role. Rising media attention has correlated with political action and public concern, while increasing exposure to regulatory shake-up and criticism quite possibly shape practitioner views. Another factor is likely to be the post-crisis environment, which has been more open for political innovation, new ideas and new villains. But in general the massive divergence in perceptions is a very intriguing and somewhat perplexing state of affairs.

This polarisation of perceptions has a number of key implications. Most immediately, it draws attention to the monumental gap in the academic literature on the evolution of the scope and scale of corporate tax avoidance, where systematic longitudinal research is sorely lacking. More broadly, it has implications for the general debate on corporate tax and potentially for political progress. As I have written elsewhere with Maya Forstater (final paper coming soon), this kind of polarisation of perceptions amongst people is not necessarily conducive towards effective, sustainable, long-term progress in terms of policy and practice. Reality is perceptions, indeed, but massively diverging perceptions (and thus massively diverging realities) can create an unstable, conflictual and potentially counterproductive environment. If we are to really address the current problems in the international corporate tax system, there is a need for fundamental change to perceptions and material realities, which must encompass all relevant stakeholders, both inside and outside practice – and it is doubtful that polarisation of perceptions will contribute positively towards that end.

Why do people evade taxes?

A much talked-about recent paper by economists Annette Alstadsæter, Niels Johannesen and Gabriel Zucman has re-ignited popular attention to tax evasion and inequality.

While discussion of reliability and methodology have prevailed in some corners of social media, the broader questions raised by the fascinating new study should remain at the fore: Why do people evade taxes? Who evades taxes? How can they do so? And what are the effects – on our societies, institutions, political systems, and so forth?

In this post, I will look at what the existing academic literature has to offer on these questions related to tax evasion, in particular the former: Why do people evade taxes? And I’ll zoom in on how recent contributions, such as that by Alstadsæter et al. and others, adds to this scholarship.

What shapes tax compliance?

Existing work on tax compliance is abundant, in particular within behavioural economics, sociology and psychology (see reading list at the bottom of the post). This scholarship has highlighted five central factors that particularly shape tax compliance in the national context:

  1. Levels of wealth
  2. Tax rates
  3. Audit probability and penalty
  4. Tax morale
  5. Institutional environment

Firstly, wealth typically enhances the probability of tax evasion. Wealthy people simply have more ability to evade. They have more and more flexible sources of income, allowing for manipulating and escaping of national regulatory and administrative powers. Think of the Ultra-High Net Worth Individual (UHNWI), who can offshore his financial assets and the accruing gains or move artworks stealthily across the globe – as opposed to the carpenter or teacher, whose main income (salary) is typically taxed at source.

Second, relatively higher tax rates foster relatively more evasion. Because taxes are often perceived as an undue burden (rightly or wrongly), the willingness to evade rises with the tax burden. As I have written elsewhere, this is extensively discussed in the economic literature. Even though taxes also pay for public spending (the fiscal coin), there may be a reasonable expectation by wealthy taxpayers that any evasion on their part will not lead to a deterioration in public spending in relation to the public goods from which they benefit, or that the benefit received from corresponding taxes simply does not provide sufficient value.

However, it is worth noting that it is mostly large differences in tax rates, and at the margins, that foster tax evasion. As an indicator, a number of experimental studies have found that increasing tax rates e.g. from 30% to 50% had little or no effect on compliance, whereas raising from 5% to 25% or from 5% to 60% does have an effect. Related, recent economic modelling on optimal corporate tax rates also suggest that only very high tax rates inhibit growth.

Third, potential tax evaders assess the risk of getting caught through audit probability and penalties/punishment, adjusting their behaviour accordingly. If a taxpayer perceives a high risk of being audited (and thus caught) and/or a substantial penalty (economic or personal), they are simply less likely to engage in tax evasion. This is as much about the perception of audit risk and penalties (which can be fostered in various ways) as it is about the actual probability of audit and penalty.

Fourth, the individual taxpayer’s tax morale is a decisive factor in tax compliance. Tax morale encompasses the social and cultural norms, and individual allegiance hereto, shaping compliance motivation. Tax morale itself is a highly complex phenomenon, dependent on a host of factors. The ‘morale fibre’ of each individual – the dispositions one is ingrained with given a life history of events and perceptions – is obviously instrumental. The extent to which people perceive taxes as part of a valuable quid-pro-quo is also central. As noted above, when the cost of taxation is viewed as too high compared to the benefits received, people are more likely to engage in evasion. Finally, the social environment matters: where people trust each other and perceive high tax morale in each other, it will deter evasion.

Fifth, the institutional environment determines the taxpayers’ willingness and ability to comply. Formal (such as political organisations) and informal (cultural ‘rules of the game’) institutions associated with the tax system shape tax compliance. On the former, trust in public institutions is a well-known determinant of taxpayers’ willingness to pay; if we trust our democracy, if we perceive the tax system as fair, if we believe the political system is efficient, we are more likely to pay our taxes. This is why revelations of corruption or scandal are likely to negatively affect tax morale. For instance, in the Danish context, recent revelations of massive dividend withholding tax fraud have been found to harm societal tax morale. On the latter, socio-economic and psychological factors can help explain tax morale, such as interpersonal trust and belief in fiscal cost-benefits.

Recent contributions 1: Tax evasion and inequality

Now let’s circle back to the first paragraph of this post: the new Alstadsæter-Johannesen-Zucman paper. This is a contribution mainly to point 1 above, i.e. levels of wealth as a determinant of tax evasion. But it also raises questions more broadly about the structure of evasion and the effects on our societies. There have been plenty of media stories about the paper, so let me just highlight three particularly relevant contributions in the context here:

First, the AJZ paper illustrates the progressiveness of tax evasion by wealth more clearly than perhaps any paper before it. Using data from the HSBC SwissLeaks, Panama Papers, Swedish and Norwegian tax amnesties, as well as data from the Scandinavian tax administrations, they show a remarkably clear trend of increasing probability of hidden funds (which are likely to correlate with evasion, although this is an assumption up for challenge) with wealth. It indicates that it is the utmost wealthy, in particular the top 0.01% (owning more than $40m in assets), that evade taxes via offshore structures (which is likely to cover a similarly increasing proportion of evasion mechanisms by wealth due to fluidity of income and assets, as noted above).

Second, the paper indicates that tax amnesties may be a more effective tool to combat tax evasion than previously thought. While tax amnesties are typically criticised for merely offering a one-time free lunch to wealthy tax evaders, the study finds that tax amnesties in Sweden and Norway have had positive, lasting effect on tax payments, and reported wealth and income, by taxpayers using the amnesty. However, it is important to caution the interpretation with some key points. Firstly, the data utilised here relates largely to the mid-2000s, where we did not have FATCA, the CRS, or today’s levels of international tax administration cooperation. The presence of new modes of information exchange are likely to squeeze scope for tax evasion (and avoidance) by wealthy taxpayers, thus potentially eroding the benefits of tax amnesties. More broadly, while tax amnesties may have a positive effect on the tax compliance of individuals with a history of evasion, we know little about its societal effects. From the literature reviewed above, we might hypothesise that the presence of amnesties deteriorates trust in political institutions, belief in a fair tax system, and perceptions that others are compliant – all of which would decrease societal tax morale.

Third, AJZ touch upon the implications of their findings, in particular as it relates to inequality. Ever since Piketty, inequality has been at the top of national and global political agendas. This paper, alongside other work by the authors (and others), shows that unrecorded offshore wealth substantially skews national inequality and tax burdens, leaving national statistics incomplete. The paper estimates that the top 0.01% hide about 25% of their true wealth, and that counting hidden offshore wealth increases the wealth share of Norway’s top 0.1% from 8% to 10%. You can easily imagine what this does to national (and global) inequality statistics. Given that tax compliance is generally higher in Scandinavia than anywhere else, it is likely that the inequality skew shown from Scandinavian data provides a lower bound for the rest of the world.

Recent contributions 2: Comparative experiments in tax compliance

Another stream of scholarship that has contributed important recent insights is comparative experimental work on tax compliance. This scholarship provides insights mainly for points 4 and 5 above, i.e. tax morale and institutional contexts of tax compliance. Here I’ll highlight recent work by a group of mainly Italian-based scholars, with two recent pieces (1, 2), though I must also mention that my colleague at Copenhagen Business School, Alice Guerra, has embarked on a fascinating 2-year post-doc project to build on and strengthen this line of work. Using controlled experiments involving Italians, Swedes and Britons, the Italian-based scholars are able to gauge differences in tax compliance and its sources across national contexts. Here I’ll highlight two particularly relevant contributions for this context:

First, while Italians (and Southern Europeans more generally) are typically viewed as having low tax morale compared to Britain (Northern Europe) and in particular Sweden (Scandinavia), the studies in fact showed surprisingly little variation in the intrinsic motivation of subjects to comply, when facing similar circumstances. In fact, Italians were even showed to have higher propensity for tax compliance than Britons given identical institutional environments (simulated in the experiments). This is despite consistent measures of relatively lower trust and honesty (factors that we would think lead to higher evasion) in Italy, and a general perception of Italians as less moral. This indicates that it is not, as conventional wisdom holds, the lack of intrinsic motivation on the part of Italians that hinders tax compliance.

Second, the national “style” of evasion is important in determining tax compliance. While Swedes for instance are more likely to comply in full than Italians, they are also more likely to not comply at all. It seems that in Sweden, there is a “either or” dynamic to tax evasion. In Italy, in contrast, there is a much more significant propensity to fudge (i.e. “cheat by a small amount”). Although the overall effect is that Swedes and Italians’ tax morale is relatively similar, the structure of national tax morale varies significantly.

Policy implications

While these studies and all of their contributions are valuable in themselves, enhancing our understanding of tax compliance and evasion, we would be foolish not to look at potential policy implications. I would not recommend full regulatory overhauls based on individual studies, but taken in context of wider bodies of literature, we can sketch out some preliminary lessons.

From the tax evasion and inequality literature, it is clear that tax administrations and legislators must pay particularly close attention to evasion by wealthy people, designing and implementing targeted policies to combat offshore evasion. This realisation has not been lost; it is behind much of recent years’ surge for automatic exchange of information and tax transparency at the global levels. The emergence of FATCA and CRS, while shortcomings remain, are likely to make a substantial impact on offshore tax evasion by wealthy individuals, deterring some avenues of evasion whilst channelling illegal activity toward other vehicles (such as trusts), where new regulatory innovation must then focus accordingly.

It also points to tax amnesties as a potentially useful tool to instil lasting tax compliance in prior evaders. However, this must be balanced against any deterioration in wider societal tax morale due to perceptions of injustice. Perhaps a useful approach would be to utilise the revenue brought in from tax amnesties specifically to raise societal tax morale, such as via broad-based campaigns or strengthening the integrity of public institutions.

Finally, there is a need to recognise shortcomings in national wealth and inequality statistics. Putting offshore wealth in the spotlight provides an opportunity to gain a more real picture of inequality and wealth in national and international contexts, which should be to the benefit of polities and citizens alike – no one is better off with continuing concealment of actual wealth distributions, except for tax evaders.

Based on the experimental tax compliance literature, we would do well to start questioning prevalent narratives of a “moral North” and an “amoral South”, certainly as it relates to tax compliance. Italians are no less willing to pay taxes than Britons or Swedes.

Rather, recent studies tell us that we should focus on the institutional context in which tax compliance happens. There is no denying that tax evasion is more widespread in Southern Europe than in Northern Europe, but the literature indicates this is not due to varying individual intrinsic motivation. Instead, there is a need for policy-makers to focus on implementing policies that eliminate formal opportunities for evasion. As an example, 95.9% of Danish personal income taxes are levied based on third party reporting (from banks, employers, unions, etc.). This makes it difficult to evade taxes. Similarly, the development of expansive networks of automatic exchange of tax information is likely to contribute to this end.

Finally, we must recognise the differing national “styles” of tax evasion. For instance, given that tax evasion for Swedes is very much an “either or” question, there is a need to focus deterring efforts on the initial decision to evade or not, as compared to Italy where focus should rather be on the culture of “fudging” (‘cheating a little bit’). This may foster differing policy initiatives that emphasise intensive and extensive decisions to evade taxes, respectively.

As a very last note, I must also emphasise that, although tax evasion is certainly a serious problem in many countries, North and South, as evidenced by the literature reviewed here, all the studies discussed here found that most people are honest and want to pay their taxes correctly. While Alstadsæter, Johannesen and Zucman estimate that many of the wealthiest taxpayers hide substantial fortunes offshore, most taxpayers clearly did not. The cross-cultural experiments also found that the vast majority of people genuinely do not look to evade taxes, (almost) no matter the circumstances. This is a lesson not to be forgotten.


Reading list on tax compliance

Alm & McKee, 1998. Extending the Lessons of Laboratory Experiments on Tax Compliance to Managerial and Decision Economics. Managerial and Decision Economics, 19(4/5): 259-275. Link.

Cullis, Jones & Savoia, 2012. Social norms and tax compliance: Framing the decision to pay tax. The Journal of Socio-Economics, 41(2): 159-168. Link.

Cummings, Martinez-Vazquez, McKee & Torgler, 2009. Tax morale affects tax compliance: Evidence from surveys and an artefactual field experiment. Journal of Economic Behavior & Organization, 70(3): 447–457. Link.

Fonseca & Myles, 2012. A survey of experiments on tax compliance. HMRC Research Report 198. Link.

Hashimzade, Myles & Tran-Nam, 2013. Applications of behavioural economics to tax evasion. Journal of Economic Surveys, 27: 941–977. Link.

Onu & Oats, 2016. ‘Paying Tax Is Part of Life’: Social Norms and Social Influence in Tax Communications. Journal of Economic Behavior & Organization, 124: 29–42. Link.

Pickhardt & Prinz, 2014. Behavioral dynamics of tax evasion – A survey. Journal of Economic Psychology, 40: 1–19. Link.

Torgler, 2002. Speaking to Theorists and Searching for Facts: Tax Morale and Tax Compliance in Experiments. Journal of Economic Surveys, 16(5): 657-83. Link.

Torgler & Schneider, 2007. What Shapes Attitudes Toward Paying Taxes? Evidence from Multicultural European Countries. Social Science Quarterly, 88(2): 443–470. Link.

The new political economy and geography of global tax information exchange

The OECD has recently released information on the two most important recent global networks of global tax information exchange. They are, respectively, the networks of exchange of country-by-country reporting (CBCR) and exchange of financial account information (through the Common Reporting Standard, CRS).

These networks give a unique look into the new political economy and geography of global tax information flows. CBCR and CRS data are, arguably, the cornerstones of modern global tax information cooperation, providing crucial data on the foreign activities of national individuals and companies. The CBCR is an annual report for large multinational groups (revenue +€750m) that states their jurisdictions of operation, the nature of business in each country, the tax paid along with a host of economic activity indicators. The CBCR is typically filed in the corporate headquarter’s country of residence, then shared on request with other countries as needed. Through the CRS, each government compiles data from national banks on the financial accounts (balances, interest, dividends, and financial asset sales proceeds) of non-citizens, which is then exchanged automatically with those citizens’ home competent authorities.

Therefore, it is also highly interesting to look at the global network of these information flows – who has access, who doesn’t, and who is connected.

So I scraped the data off the OECD website and analysed it. And what I found provides a very interesting picture of the modern tax information networks.

At the time of writing, there were around 700 (CBCR) and 1600 (CRS) bilateral exchange agreements established. (I’m not sure why OECD say 1800 CRS agreements because there’s only 1600 unique agreements in their data). Given that the CRS was launched four years ago and CBCR only two, the discrepancy is natural. Taken together, the 2300+ agreements are a quite fascinating data set. Let’s look at each in turn, and then the two together.

First, however, a key caution must be noted. While the CBCR and CRS provide key recent mechanisms of tax information exchange, they are by no means the only mechanisms. Preceeding the new CBCR and CRS networks are established networks of bilateral “by request” exchange of information networks (the previous OECD standard), bilateral tax information exchange agreements (TIEAs) and tax treaties with info exchange clauses. Given that these have been in place for much longer, they are naturally more dense than the new networks. Still, CBCR and CRS are the frontier and are replacing these older standards exactly because of their limitations. Thus, the analysis below provides a picture of the emerging state-of-the-art within global tax information exchange.

The global CBCR exchange network

I tweeted out the network the other day, and it looks like this:

cbcr network

(Size by degree (number of links); node colour by region; and network layout by ‘ForceAtlas2‘.)

There are a few caveats to be noted before drawing lessons from this picture. First, the novelty of CBCR shapes the network look substantially. The picture is dominated by European countries, but that is understandable given 55% of all CBCR exchange agreements are formalised by EU Directive 2016/881/EU on automatic exchange of tax information (the rest are individually negotiated CBCR MCAAs). Second, the absence of the USA is noteworthy. While the USA has been reluctant to commit to reciprocal information exchange of bank account data, that is not the cause for CBCR. Simply, US CBCR filing requirements will kick in on 31 December 2017, as in most jurisdictions, but later. It is almost assured that the US will develop an extensive exchange network to protect US MNEs from local filing demands. Other countries with late filing requirements that will be expected to build substantial exchange networks as we go include Hong Kong, Japan, Russia and Switzerland. The whole network is expected to increase substantially over the next few years, as the remaining CBCR MCAA signatories (as of today, there were 57) conclude and report agreements.

That said, what we can see is that the current global CBCR network is all about Europe, OECD members, and a few small offshore centres. That picture likely won’t change too much. The almost complete absence of South America (beyond Brazil and Uruguay), Asia (beyond Malaysia), and Africa (beyond South Africa and Mauritius) stands out. This has attracted renewed criticism that the OECD tax policy-making processes are not inclusive of developing countries. However, it should be noted that the OECD has moved in the direction of bringing developing countries more closely in to its tax work, including through the BEPS Inclusive Framework, so there is potential for a broadening of the geographical concentration in the CBCR exchange network.

It is also worth noting that the picture indicates a very clear “you’re either in or you’re out” trend. There are currently 45 countries exchanging CBCR data, and none of these have less than 23 agreements (maximum of 43). If you are set up to exchange CBCR data, you are ready to exchange it with many partners.

More broadly, I think the network shows quite nicely the varying allegiance to the OECD international tax consensus. The European Union, in particular the European Commission, has become an increasingly autonomous player in international tax affairs but also a close ally of the OECD on many counts. The centrality of Europe in the global CBCR network is a representation of this position.

The global CRS exchange network

CRS exchange network.png

(Again, size by degree (number of links); node colour by region; and network layout by ‘ForceAtlas2‘.)

The global CRS network provides a somewhat more developed but not substantially different picture of the new political economy and geography of global tax information exchange. The fact that we have 62 countries (as opposed to 45) and more than twice the number of exchange agreements makes for a more pronounced illustration.

Again, it is worth noting some points on the data. Once more, EU is massively present. This is partly because of its speed in implementing effective CRS legislation. Thus, 35% of CRS exchange relation are down to EU instruments, including EU Directive 2014/107/EU. However, EU members have also been active in concluding agreements with non-EU members. The remaining 65% of exchange relations are concluded as individually negotiated CRS MCAAs, plus ten exchange agreements through the UK CDOT (Crown Dependencies and Overseas Territories International Tax Compliance Regulations). We can also see that, again, the US is absent. However, here we should not expect it to develop a network at a later stage. Due to the presence of FATCA, the US’ own financial account information standard, there has been no desire to also sign up to the CRS. Finally, the CRS network is also expected to increase and broaden its geographical scope over the coming years as the remaining of the AEOI-committed countries (100 at the time of writing) conclude and report on exchange agreements.

Beyond that, the political geography of the CRS network is notably similar to that of the CBCR network: It’s all about Europe and OECD members, with a few small offshore centres mixed in. Like the CBCR network, the absence of developing states has also contributed to criticism of the CRS standard. Once again, we can also see that it’s very much an “you’re in or you’re out” picture. 62 countries have CRS exchange agreements, and only one (Bonaire, Saint Eustatius and Saba) has less than 29 agreements in place.

Another nugget that I found quite interesting in the data: There are around 350 CRS agreements that are only reported by one of the two jurisdictions to the OECD. All other relationships are reported by both jurisdictions. For instance, Anguilla’s CRS exchange agreement with Argentina is only reported to the OECD by Anguilla, not Argentina. And there is a certain trend with these 350 agreements. They are all reported by the following countries: Anguilla, Bermuda, British Virgin Islands, Cayman Islands, Croatia, Cyprus, Korea, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Mauritius, Mexico, Monaco, Montserrat, Netherlands, Romania, Saint Vincent and the Grenadines, Turks and Caicos Islands. Most of these countries are small (island) states with noteworthy financial centres, or what some might label tax havens.

There are a few possible explanations, but my guess as to what is going on here is this: Countries most at risk of reputational damage and political wrath from non-compliance are making sure they report all of their exchange relations to the OECD as soon as possible. They simply want to make sure it is noticed when they are conforming to expectations, when they are “doing good”.

The global tax information exchange network (CBCR + CRS)

Total global information exchange network

(Size by weighted degree (number of links, weighted by strength); node colour by region; and network layout by ‘ForceAtlas2‘.)

Here, I’ve added the CBCR and CRS relationships together, giving us a picture of who is truly able to access modern global tax information flows. The bolder the link, the more weight it has, indicating access to both CRS and CBCR information from international exchange.

Having noted caveats to the data above, the picture that emerges here is, as we might have expected, more pronounced but similarly indicative as the individual CBCR and CRS networks. The observations barely need repeating, but for good measure: there’s EU/OECD dominance with a few financial centres mixed in, an absence of the US and developing countries, and a strong in-or-out dynamic.

Given the current structural factors contributing to this network layout, the main factor with potential to substantially change this picture is change in the overall political economy of global tax governance. This may yet happen, e.g. through the BEPS Inclusive Framework, but may also very well not happen due to geopolitics or other factors.

There will be more analysis to do on this data, and it will be interesting to follow the longitudinal development of these networks. I will certainly continue my work in this area, as I’m sure others will. For now, however, a very interesting picture is emerging of the new political economy and geography of global tax information exchange.

Are large firms really successfully lobbying for low tax rates?

My last attempt at a review of recent academic literature on a corporate tax income topic was well-received, so here’s round two in the “Are firms really…?” series.

This time, I’ll take a look at another paper out of Oxford University in the context of an existing body of literature. Here, we are looking at the topic of whether large businesses are successfully lobbying politicians for low corporate tax rates.

Now, the political economy literature is torn on the matter. On the one hand, the “political power” literature holds that, indeed, large firms become politically influential due to advantageous positioning, political access, abundance of financial resources, etc. On the other hand, the “political cost” literature holds that firm size comes with increased public attention and thus relatively higher cost levels incl. taxation.

The former hypothesis is probably well-known to most readers, given the popularity of “business influence” or “regulatory capture” stories in academia and the media. A recent example is a story from Vice, titled “Bigger corporations are making you poorer” (https://www.vice.com/en_us/article/bigger-corporations-are-making-you-poorer), citing an interesting study by economist Simcha Barkai at the University of Chicago, which provides a link between industry concentration and firm profits, indicating a size effect on the ability of companies to extract value from the economy. And that’s just the latest in a long line of research on the firm size-influence connection. This the mechanism at play in the “political power” hypothesis.

The latter, however, is probably not as widely known, even though a noteworthy body of literature indicates that this is actually the theory more aligned with reality.

A study from February 2016 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2697468) by a group of researchers at the University of Mannheim reviewed 46 papers dealing with the political cost/political power forces. Performing a meta-regression on the existing evidence, they conclude:

This analysis is interesting because the empirical results across primary studies are by no means clear-cut and no tendency can be observed towards either the political cost or political power. Generally, our findings confirm the political cost theory. (my emphasis)

In short, “it’s uncertain but we’re leaning towards the political cost hypothesis”.

Their overall findings conclude that, on average, a ten percent increase in firm size, leads to an increase in effective tax rate of between 0.5 and 1 percent.

However, just as I remarked in my previous post, the wide variety in methods, data and analyses across the literature make it difficult to conclude definitively on the superiority of the political cost theory. The authors specifically address this point, noting that key definitional variations of firm size, of effective tax rates and of the sample period significantly affect the estimation results. For instance, the size-cost connection is significantly larger when measuring size by total sales, compared to total assets.

There’s also the question of concluding “on the average”, which is what meta-regressions like this can tell us about, as opposed to “on the margins”. It may for instance be that an “on average” increase in ETR by firm size hides significant variations by firm size level, e.g. medium-sized firms paying relatively more than small-sized firms but mega firms paying relatively less than large firms.

We must also pay attention to the geographical coverage of the survey. Of the 46 papers in the Mannheim study, the vast majority sample only US firms, with only a handful focusing on Europe. Thus, there are questions of generalisability. (I note here that the studies that do sample European firms generally seem to have noticably lower correlations between size and ETR than US sample studies, perhaps indicating that ‘largeness’ in Europe is less likely to produce political costs than elsewhere – but definitive evidence remains elusive.)

That leads me to the recent Oxford paper (http://www.sbs.ox.ac.uk/faculty-research/tax/publications/working-papers-0/large-and-influential-firm-size-and-governments-corporate-tax-rate-choice), released in April 2016, which provides new and relevant evidence on the topic.

How so?

The Oxford study contributes to the geographical literature gap by utilising rich administrative micro-data for firm size and tax rates across German regions. The intra-national comparison provides an interesting and novel ground for study of these dynamics.

Moreover, the Oxford study looks at the relationships between firm concentration, a relative measure of largeness, as opposed to studies of absolute firm size. The underlying notion is that relative size advantage may be more important than absolute size in the political game, and/or that relative firm concentration within a community may foster collective benefits for businesses.

Finally, the paper studies the link with German local business tax rate choices, i.e. regional statutory rates, as opposed to effective rates, which most of the literature utilises. ETRs are notoriously subjective, difficult to measure, and a source of uncertainty in the literature (as noted above), so there is sense in using statutory rates. Of course, ETRs are an individual firm-level measure, whereas headline rates apply (at least in the first instance) to the community of local businesses as a whole. Each may be useful to study, but in the context of this paper, focus on statutory rates match the focus on firm concentration (also a community-level measure).

Based on the data, the Oxford crew carry out a number of econometric statistical regressions, arriving at the conclusion that:

 

(…) we find that higher levels of firm concentration in German communities are associated with lower local business tax choices. The effect turns out statistically significant and quantitatively relevant and prevails in various sensitivity checks. (…)

The results confirm prior descriptive and anecdotal evidence, e.g. suggesting that the German cities of Wolfsburg, Ingolstadt and Ludwigshafen, which host the head-quarters of leading car and chemical manufacturers Volkswagen, Audi and BASF, set considerably lower local business taxes than otherwise comparable jurisdictions with a more even firm size distribution.

The German evidence for the presence of a political power dynamic is a notable addition to the existing literature, which seems to have favoured the political cost dimension. Specifically, the Oxford authors find that a 0.1 point increase in the local Herfindahl index, a conventional measure of economic concentration (measured as the sum of squares of the market shares of firms in the defined community), reduces the local business tax rate by 1.7% on average. Again we must note all the caveats of above: definitions, “on average” vs “on the margins”, etc.

Although this seems contrasts with the Mannheim review, the Oxford study may actually align relatively well with this existing literature given its geographical emphasis (Germany). As noted above, European-focused studies seem to provide weaker evidence for the political cost hypothesis than US-sample studies. In any case, it is further evidence relevant to the sum of knowledge on the topic.

I don’t purposefully set out to end all of these blogs with the same conclusion: that there is competing evidence, all of which is valuable on its own, but provides no firm, universal takeaway. But that is where we seem to have arrived. The political cost theory does seem to have slightly favourable support, but only in the specific context of existing studies (e.g. US-centric.)

However, I do want to stress that we should take the particular context of each study into account when evaluating a coherent body of knowledge. Often, I think we do academic research a disservice by seeking easy generalisable answers from it, or falsely ascribing universal laws to it, when in reality it rarely, if ever, meets such lofty goals.

Are American firms really more tax aggressive?

Are multinational groups headquartered in the United States more aggressive in their tax planning compared to non-US competitors?

That is, at least, a very popular strapline in tax circles. Negative media stories about the tax affairs of major US firms such as Apple, Amazon and Starbucks are often described as contributing factors to the OECD/G20 BEPS project and the European Commission state aid investigations. Although of course, by critics these projects are described as undue crusades against American firms.

Given the notorious difficulty in measuring effective tax rates of multinational enterprises (MNEs), there remains little systematic cross-national comparative research on the topic. Studies have varied in approach and results. For instance, economists utilising the prominent Devereux/Griffith methodology have often found relatively high effective tax rates in the United States. However, the D/G approach is based on a hypothetical domestic investment example and is not attentive to international tax arbitrage. Using financial accounts data, legal scholars Reuven Avi-Yonah og Yaron Lahav concluded in a 2011 piece that US MNEs had systematically lower effective tax rates than European MNEs. Another 2011 report from PwC found relatively high book effective tax rates in the US.

However, recent years’ academic literature has provided indications on the stand-out role of American corporate actors in the world of tax avoidance. A 2015 study by Chris Jones and Yama Temouri from Aston University found that US MNEs were more likely to locate investments in tax havens compared to firms headquartered in continental Europe.

Drawing from existing economic literature, Jones and Temouri identify firm characteristics likely to relate to aggressive tax behaviour (in this case, measured as tax haven investments), including technology intensity (R&D and intangibles) and incorporation in Liberal Market Economies (LMEs), such as the US and the UK – as opposed to Coordinated Market Economies (CMEs), such as Germany or Japan. Both of these hypothesis are confirmed by the analysis. They conclude:

“We find that MNEs from the high technology manufacturing and services sectors with high levels of intangible assets are more likely to have tax haven presence. (…)

MNEs from LMEs are significantly more likely to undertake tax haven FDI compared with MNEs from CMEs.”

On the other hand, an interesting new paper by Katarzyna Habu from the Oxford University Centre for Business Taxation, draws these conclusions into question. While Jones and Temouri’s paper draws on financial accounts data, Habu utilises a fascinating new dataset of corporate tax returns, made available by the UK HMRC to researchers. This provides a more accurate gauge of corporate tax bases, although it comes with its own limitations, such as limited cross-country comparability.

In short, the paper compares the taxable profit levels of similar domestic and multinational companies operating in the UK (based on industry and level of total assets).

Buried at the far end of Habu’s paper, a compelling read, is the following table:

Udklip

Here we see the differential (ATT) between the taxable profits to total assets ratio of the two groups (domestic and multinational) for various ‘home countries’ of the MNEs.

The results indicate that, from the pool of MNEs with subsidiaries trading in the UK, MNEs headquartered in tax havens are most tax aggressive, followed by French, Asian, other European, US and German MNEs. Entirely contrary to Jones and Temouri’s findings, there is no evidence here that US firms are more aggressive than German or Japanese firms. In fact, it rather indicates that French and Asian headquartered MNEs are more aggressive than US MNEs.

There are various potential explanations for the discrepancies in the recent literature.  Tax haven FDI and UK taxable profits avoidance are not necessarily expressions of the same type of tax aggressiveness. American companies could indeed be more aggressive in locating investment in tax havens, while at the same time not being more aggressive in lowering taxable profits through tax avoidance in the UK. More broadly, the wide variety of empirical data sources, theoretical approaches, geographical scope and so forth do not allow for easy comparisons between the studies. 

And then there’s the question of the differential between effective tax rates of domestic and international economic activity – one that is substantial in particular for US technology firms due to the tax system design (thanks Heather Self for that point). Existing studies do not investigate this systematically.

We should also note, as Alex Cobham importantly pointed out to me, that the latter study expresses net numbers – the overall effect of tax aggressiveness, which may hide significant flows of profit shifting in or out of the UK. US firms could conceivably be shifting profits into the UK in a tax aggressive manner without it showing up here. However, the evidence can’t say.

Thus, we should be careful in drawing firm conclusions from this ascending literature, but we should take both studies as interesting results that shed light on our understandings of the dynamics of MNE tax planning. There may be continuing suspicions that US MNEs are generally more tax aggressive, but further research is needed in order for us to firmly confirm or deny such assumptions.

Technical politics, sovereignty and the prospects of tax multilateralism

International tax cooperation is hard. Especially when it challenges national sovereignty. Sovereignty is close to heart for politicians. Taxation remains a cornerstone of the nation-state and of the social contract. Governments are not liable to relinquish absolute authority on tax matters.

So, at least, the story goes. Indeed, the reality – and the associated perception – of taxation as the ultimate prerogative of sovereigns (alongside the use of force) has fundamentally shaped all kinds of analysis of international tax matters. In political science, for instance, the predominant approach to international taxation relies on realist models of inter-state power battles. When tax is the point of discussion, states are the relevant players and power is the game, with sovereignty at the core of the underlying dynamics.

That’s why, it is said, for instance, that the European Union has never been able to take control over direct tax regulation, although its powers span an otherwise extensive array of national legislative agendas.

Sovereignty is also cited as a key criticism of the European Commission’s recently re-launched proposal for a Common Consolidated Corporate Tax Base (CCCTB). The CCCTB, of course, is the Commission’s flagship initiative to harmonise calculation of companies’ taxable profits, ridding the private sector of having to deal with 28 (soon to be 27) different such rulebooks. The CCCTB would revolutionise the corporate income tax system in the EU, moving from one of tax base allocation based on the arm’s length and separate entity principles, towards one based on unitary taxation, with tax base allocation through formulary apportionment, i.e. divided between Member States according to local sales, labour costs and assets.

More importantly, the CCCTB would mean EU Member States surrendering national sovereignty on tax matters. Effectively, rules for deductions, incentives and so forth would come under the control of the EU system, with individual countries having to obey rules agreed at the supranational level, and going the multilateral EU route to any substantial changes.

Whereas the CCCTB has been lamented as largely ‘doomed’ because of the EU’s sovereignty-challenging, hard law, bargaining-based policy process, another major multilateral tax initiative, the OECD-led, voluntary, soft law, consensus-based Base Erosion and Profit Shifting (BEPS) project, has been praised for its speedy and effective solution-building.

However, both projects are indicative of increasing international tax cooperation. They have much more in common than usually discussed, and that tells us something about the general prospects for tax multilateralism. While national sovereignty and power politics are important barriers to tax cooperation, they have been overemphasised at the expense of alternative understandings of the lack of traction for the CCCTB and similar initiatives.

Here, I want to expand on this argument, drawing two key distinctions, namely between political and technical policy arenas, and between legal and effective sovereignty, in understanding the outlook for international tax cooperation.

Technical vs. political levels

Every policy decision, every policy process, develops at the intersection of two key policy arenas: the political arena and the technical arena.

At the political level, we see most clearly the distinctions described above. Hard law vs. soft law; sovereignty vs. cooperation; my country interests vs. your country interests; etc. The primary actors are states, embedded in distributional conflict.

The technical level, however, is different. I have written elsewhere on the topic so I shall keep it short. Suffice to note that the protagonists here are primarily experts and professionals, bureaucrats and advisers, working to build credible technical solutions, with country interests and high politics in the background.

Each level is important in a policy process, although one may weigh more heavily at certain points and in certain settings. But the relation is key. The technical level shapes the political level, and vice versa. Experts influence what can and cannot be proposed and discussed and accepted as policy issues and solutions; politicians influence the framework in and speed of which certain policy topics are taken up, and so forth.

At the same time, the ‘technical’/’political’ distinction should not be overemphasised. What is technical is political: a minor, seemingly technical addition to a policy recommendation may have enormous distributional consequences. And what is political is technical: politicians’ ability to promote technically authoritative arguments in proposing issue solutions is central to policy success.

While popular explanations typically highlight dynamics at the political level – country interests, national sovereignty and distributional politics – as the preeminent cause of policy success or failure, the technical level remains underappreciated.

The success of the BEPS project, for instance, has not merely been down to goodwill from the G20 and OECD nations, but, to a great extent, it is a consequence of dynamics at the technical level, as I have written elsewhere. Consensus around key technical BEPS provisions throughout a significant international community of professionals has played a central role in effective policy uptake. The delivery of technically strong, agreeable solutions from the technical level to the political level, while still needing to be ratified, was essential in inclining political decisions and a major contributor to widespread implementation.

Similarly, while the CCCTB’s difficulty is usually ascribed to power politics, I would argue that it may have as much to do with technical opposition. The Commission’s proposal faces a number of key technical-level barriers. Several specific provisions have received negative scrutiny, in particular the R&D superdeduction. More generally, the CCCTB is an attempt at wholesale replacement of 28 distinct corporate tax systems, each with vested technical stakeholders, along with the complete overhaul of the international tax system and demolition of entrenched, well-established and well-supported legal and economic principles. It is safe to say there is extensive technical-level resistance to the proposal.

Thus, technical-level entrenchment may provide a barrier just as significant as power politics to the CCCTB and EU tax multilateralism in general – even if the interplay of high politics and technocracy is decisively different in OECD and EU. Power politics may play a more significant role during policy formulation and decision-making in the EU compared to the OECD. But there are also important overlaps. For instance, there is significant similarities in the nature and make-up of the community of professionals involved in the technical levels in the EU and the OECD. Differences are, in my view, not so substantial that they undermine the importance of the technical arena in the EU.

Legal vs. effective sovereignty

Another underappreciated distinction in analyses of tax multilateralism is that between effective and legal sovereignty. Many analyses of international tax cooperation have highlighted governments’ aversion to surrendering (legal) sovereignty on tax, their desire to retain the full right to design policy, in explaining lack of traction for tax multilateralism. However, this argument unduly evades the fact that tax multilateralism may, and indeed does, effectively challenge national sovereignty even if it does not do so strictly as a matter of law.

Going back to the BEPS and CCCTB, from a sovereignty perspective, these projects again seem entirely different on the surface. CCCTB is hard law, requires formal pooling of sovereignty, is embedded in the complexities and frictions of the EU system, and has immediate and highly visible inter-nation distributional consequences. BEPS is soft law, based on consensus cooperation, born out of a flexible, technicised OECD process, and has fewer obvious ‘cui bono’ implications.

But although BEPS is seemingly of a softer nature, indications are that it actually behaves similarly to legally binding projects. Countries around the world are implementing key BEPS provisions in a way remarkably close to recommendations. As a matter of law, there was no imperative to do so, but as a matter of practice, there is. The technical-level consensus and dissemination of policy discourse plays a central role here, alongside national political commitments to the OECD and its tax policy processes. Indeed, OECD tax outputs have been known to take on legal ‘hardness’ (cf. 1, 2, 3). Formally, the BEPS recommendations retain ‘soft’ qualities – they can be unilaterally changed at political will – but in practice, there is a strong normative allegiance. As a matter of law, it is non-binding, but effectively… well, if not outright ‘binding’, then certainly something closer to binding than non-binding.

In the same way that international tax competition de facto undermines national sovereignty (effectively constraining national policy choices), while de jure leaving it untouched (nations formally retain the right to design policy), we might say that BEPS de facto is a pooling of sovereignty, although de jure it is not. National sovereignty has effectively been pooled or surrendered as a result of the BEPS process.

Of course, policy-makers may not perceive it as so. They may never articulate it. And they may rightfully hold that the distinction remains crucial. But the increasing trend towards tax multilateralism – indicated by both BEPS, CCCTB and a host of other international initiatives – may well be a result of increasing recognition that pooling of sovereignty is essential in order to improve the international tax system, whether that is effective or legal sovereignty-pooling. As German political scientists Thomas Rixen and Philipp Genschel have argued, countries can only curb tax competition by relaxing sovereignty or unilaterally engaging in double taxation:

Udklip

Thus, the emphasis on governments clutching to legal national sovereignty is perhaps somewhat overemphasised in accounts of tax multilateralism.

The Prospects of Tax Multilateralism

So what does this mean for the prospects of tax multilateralism more broadly?

In my view, the lack of traction for the CCCTB, due to continued challenges at the political and technical levels, should not be seen to crumble the overall prospects of tax multilateralism in the EU or beyond.

On the contrary, it seems to me that the underlying dynamic of political-technical interplay in international tax provides fertile ground for tax multilateralism, as both BEPS and the attempt at CCCTB testifies to. The lesson, rather, is that tax multilateralism has to happen under the right circumstances.

The CCCTB may be a dead fish, but this may be less about absolute adversity towards pooling/surrendering tax sovereignty than it is about adversity towards the particular modality and scope of pooling/surrendering tax sovereignty in the CCCTB case. It is the specific characteristics of the CCCTB – the extensive scope of the overhaul, the distributional implications, etc. – that explains its inability to get off the ground, while BEPS has shot out of a cannon. The long list of technical issues associated with the CCCTB regime, alongside the political squabbles, is not a recipe for success. In that sense, the CCCTB may be more fraught than BEPS ever was, asking for a more expansive and apparently unappealing pooling of sovereignty, underpinned by slow and friction-filled decision-making processes, compared to the perceived speediness and efficiency and technical OECD discussions.

Thus, while existing initiatives international tax cooperation may fall flat, we should not take that as evidence that tax multilateralism is failing. We should take it as evidence that we have yet to hit the right approach in the interplay of technical politics and political politics.

The fiscal coin and reasonable expectations: Taxes as business costs or intra-economy transfers?

Are taxes on corporations business costs or intra-economy transfers? This is a oft-discussed question in debates about corporation taxes – academic, political as well as layman debates. And it is one with significant implications for tax policy.

This blog is here to say: Both. Possibly. But mostly a transfer.

The fiscal coin and taxes as intra-economy transfers

Every so often, we’ll hear the argument that taxes are business costs. Simple as that. They reduce corporate profits by increasing expenditure. And the implications are straightforward: If taxes are merely costs, there is an imperative to minimise the cost, thus maximising profit, in order to generate value for shareholders and stakeholders, including society at large.

This view, however, neglects – deliberately or as an indirect consequence – the fiscal coin. A favourite concept of mine, which receives far too little attention, the fiscal coin is the equal and opposite mechanisms of taxing and spending. As a matter of economic reality, any tax must translate to an exactly equal expenditure or saving, and any spending must be based on an exactly equal tax (current or future). Taxes do not disappear into a black hole; they pays for something. We may not like how they are spent, but we cannot deny that they are indeed spent (or saved).

Thus, whether or not businesses perceive tax as merely a cost, it is, as a matter of economic substance, an intra-economy transfer. From corporate books to somewhere. And businesses act accordingly.

My old microeconomics textbook noted in its introductory chapter that, in the same way that pool players operate as if they were familiar with the basic laws of physics, economic agents act as if they are familiar with the basic laws of economics. I’m skeptical toward this as a universal assertion, but in this case I do believe it provides a helpful image.

Businesses do act as if they know that taxes are intra-economy transfers (at least to some extent). In making investment decisions based on the availability of local infrastructure, skilled workers, low political risk premiums, and so forth, there is a recognition that taxes, while they may be an initial cost, boost factors that ultimately contribute to profits. And indeed, there are many businesses that openly acknowledge this relationship, certainly in Denmark where tax norms are perhaps special.

Reasonable expectations and taxes as business costs

So, taxes are intra-economy transfers. But, there is an entirely plausible argument that taxes may in fact also be just business costs, although it is not the one often purported. It has to do with reasonable expectations.

If businesses have a reasonable expectation that corporation taxes, on average or on the margins, will not contribute to profits in any way, we can say there is a fair argument that corporation taxes are just business costs. If taxes do not contribute to local infrastructure, to skilled workers, to low risk premiums or to any such element, then there may be a point.

And while I am doubtful that assertion can be evidenced, the perception of such a situation may explain why the view of “tax as a pure cost” is prevalent.

Why might this perception emerge? I shall highlight two potential causes. First, businesses may reasonable expect that the overall tax burden and the associated level and content of public expenditure is not determined to any relevant extent by corporation tax payments. This view may in fact be reasonably substantiated given the structure and trend of overall tax revenues in developed countries over the past few decades. As corporation tax rates have steadily declined, many states have shifted tax burdens away from capital and towards individual income, consumption or property. In fact, this is the exact recommendation that the European Commission, along with the OECD, has been providing to member states over the past few years. So there may be a reasonable expectation from businesses that any reduction in corporation taxes, whether through avoidance/evasion or through tax incentives, rate cuts or base narrowing, would be countered by the state with a burden shift to other taxpayers, thus maintaining the overall level of public expenditure and thus profit-boosting institutions.

Second, businesses may reasonably expect that their marginal contribution to the overall tax burden has a non-existing or insignificant effect on any beneficial (for them) public spending. They may simply not perceive there to be a quid pro quo. This is the classic ‘tragedy of the commons’. Barriers to collective action will mean that businesses will seek to free ride. This goes for all taxpayers, but large, multinational companines in particular have a significantly greater ability to free ride, to selectively determine tax level and location, than the average taxpayer. In an age of declining societal tax morale due to increasing perceptions of injustices in the tax system, this may well be a phenomenon on the rise. Moreover, the general opacity of the tax-to-spend dynamic may worsen the dynamic. Politicians are largely skeptical towards earmarked public funding, and thus it is impossible to establish a specific link between the tax that businesses (or other taxpayers) pay and the associated spending. Finally, societal disinclination towards tax may also contribute: a general skepticism to taxation may mean taxpayers are less positive towards the fiscal coin.

Political implications

Thus, corporation taxes are, in substance, intra-economy transfers. But as a matter of perception and maybe reality, they may also be merely business costs. The political implications are crucial, I believe.

Whether or not corporation taxes – and indeed other taxes – are perceived as bearing effectively on taxpayers’ benefits deriving from public spending is essential to fiscal policy. If they are not, that is a major policy problem, both for the tax and for the spending system, and something that needs to be addressed by governments. Most definitively, we need to strengthen tax morale by ensuring tax compliance across the board. Perhaps we also need more transparency around the way in which average and marginal tax payments contribute to public spending and welfare benefits. More generally, perhaps we need a broader and more vocal discussion on the link between tax and spending. That is certainly a debate worth having…

 

Power in Numbers: How Data Shapes the Tax Policy Arena

Since the first number value systems were invented around 3400 BC, numbers have played a central role in human society. Arguably, though, they have never been more important than they are today. We fiend for data, quantities, statistics and numbers to an astounding degree. We live in an almost fetishised data-heavy society.

This applies to the tax world as well, of course. In fact, numbers and data are absolutely central to tax policy debates. We obsess over tax rates and the amount of tax lost to evasion and the percentage-growth effects of tax policy changes. We rank national tax regimes’ competitiveness and secrecy jurisdictions and tax avoiding companies. Etc. etc. etc.

Why? Because numbers allow us to quantify anything, communicate easily, analyse and conclude with simple outputs. And so, often times we absorb information and arguments construed as numbers over other types of inputs.

That’s why we play extra close attention when the hear that the European Union loses €1 trillion a year to tax dodging, that Estonia has the no. 1 competitive tax code in the world, that Apple is holding $215 million offshore. It’s also part of the explanation why mathematical models and econometrics is now the standard way to “do science” in modern economics (it wasn’t always like that, to be sure).

But numbers are not neutral. Numbers provide authority in a way that words or plain language sometimes does not. Numbers indicate “we did the math”, summoning ethos appeals that often provide instant credibility.

Thus, those able to produce, use and leverage numbers and data often hold greater sway, and they manage to be influential, impactful and effective in modern debates around tax. The point is similar to one I have made previously on technicisation of global tax policy processes and I think the two are related: This particular feature of the tax policy arena – an affinity for numbers – provides an environment where certain actors and arguments are often favoured.

How numbers rule

A recent paper by Hans Krause Hansen and Tony Porter in the journal International Political Sociology discusses the distinct features of numbers and how they affect transnational governance:

  • Mobility: As counting strips away meaning behind, numbers are mobile and travel easily across borders.
  • Stability: The meaning of numbers is less complex than words. 83 is less frequently interpreted in different ways than ‘democracy’ or even ‘house’.
  • Combinability: Numbers are easier to combine, also in different ways. 2+2 is always 4; five oranges and two bananas can be 7 or 5+2.
  • Order: Quantitative ranking is intuitive and comprehensible. 1 is higher than 2, etc.
  • Precision: Simple arithmetic allows for great precision in using numbers. One meter is exactly 100 cm, and so forth.

Hansen and Porter specifically analyse barcodes and radio frequency identification numbers in this light, but their insights are more broadly relevant, certainly in the tax world. A few real-world examples to illustrate this point:

Citizens of Tax Justice’s “Offshore Shell Games”

For the American tax think tank/advocacy organisation, Citizens of Tax Justice, the stated organisational focus is “federal, state and local tax policies and their impact upon our nation.” A wide span. And each year, they output hundreds of reports, blogs, analysis, etc. on these topics. Yet, since 2013, their most popular annual output has arguably been the “Offshore Shell Games” report, which surveys the deferred cash stock of US multinationals in tax haven subsidiaries. The vast amounts, up to $2.5 trillion per the 2016 report, and its “leaderboard” of offshore cash piles make for neat media stories.

The $2.5 trillion number is mobile, straight-to-the-point, easy to communicate, thus become widely cited, shared and discussed. The massive figure is also stable, eyecatching yet unmistakable, and leverages the combinability of numbers, being made up of similarly clear individual company numbers, plainly extracted from corporate accounts. Order is key: As we see the number go up each year, from $2 to $2.1 to $2.5 trillion, the simple narrative is one of growth, which CTJ firmly problematises. And finally, precision of the number provides strength: with the bottom-up data approach from corporate accounts readily accessible and the overall number down to a decimal point, the credence of the overall argument is enhanced. Together, these features make for a plain and intuitive case, allowing CTJ to successfully set out the argument that “big US multinationals are hoarding monumental cash piles offshore, avoiding billions in US taxes.”

Tax Foundation’s Tax and Growth predictions

Another American tax research organisation, the Tax Foundation, has been hitting the headlines recently. To be fair, it has been a lot since establishment in 1937. But arguably their current popularity has been driven primarily by data outputs. Of particular note is its “Tax and Growth Model” outputs, a macroeconomic dynamic scoring model used to evaluate economic effects of policy changes. The model is similar to macroeconomic models used by the US government (and other governments), though it allows for less conservative dynamic scoring, meaning behavioural and thus economic effects of policy changes are factored in to a much greater extent (a topic of much debate). (In Denmark, the centre-right/liberal think tank CEPOS works in similar ways, though they often rely on the independent DREAM model, and they work more broadly than tax issues). In short, the model allows you to input policy changes and receive a range of estimates about the consequent economic future. This is what allowed the Tax Foundation to ascertain during the American election campaign that Donald Trump’s tax plan would generate 10-year GDP growth of 8.2%, compared to Hillary Clinton’s -2.6%.

(The list of noteworthy data outputs also includes the Foundation’s US “State Business Tax Climate Index”, which compares and ranks each state’s business tax systems – garnering significant public and policy attention. Such rank comparisons are incredibly powerful, similar to PwC and the World Bank’s international “Paying Taxes” ranking – I’ll discuss why in the third example below.)

Again the numbers there are mobile and stable; they are ease to carry across debates and borders and simple for any recipient to comprehend. The order is central here, too: 8.2 is clearly superior to than -2.6. Combinality is a core component of the GDP estimates; they are made up of hundreds of assumptions and calculations on the effects of policy changes, possible only through such a massive scoring model. Finally, precision is paramount. We are provided with one single, definitive prediction of the GDP effects of a catalogue of tax policy changes, down to a decimal point, providing a true aura of conviction. Hundreds of assumptions, based on a vast economic theory and empirical research, boiled down. The final number provides the ultimate appearance of precision and certainty. In all, the number characteristics contribute to laying the ground for a simple conclusion: “Trump’s tax plan is better for the economy than Clinton’s”.

Tax Justice Network’s “Financial Secrecy Index”

The Tax Justice Network, another productive tax advocacy/research organisation, has been highly successful with its key number ranking output: the Financial Secrecy Index. The FSI compares jurisdictions around the world based on financial secrecy and size. The FSI, published first in 2009, then 2011, 2013 and 2015, surveys 15 key secrecy indicators (legal rules, administrative practice, etc.) and the overall national financial services market, which rolls up into a final global ranking of “secrecy jurisdictions”: 1, 2, 3, and so forth. The size feature was included in particular in order to challenge prevalent understandings of “tax havens” as small offshore island states. Instead, the USA, the UK, even Germany and Japan, have ended up high on the secrecy score, prompting headlines back in 2009 like, “Delaware – a black hole in the heart of America“.

Looking once more to the distinct characteristics of numbers, we can see the importance. The US being the number 1 (or number no. 3, in the 2016 report) most secrective jurisdiction in the world is a firm, easy-to-grasp statement, easy to transmit and hard to misunderstand. It provides a strong challenge to conventional wisdsom on tax havens. Combinability has also been central to one important FSI story. The anatomy of the FSI score is of course a combined number. Further, if you combine the scores for the UK, its overseas territories and crown dependencies, it would top the list – which has been one of the key media stories following the FSI launch. Order, of course, is the key ingredient to a ranking, and provides a powerful messaging tool. Number 1 is number 1, number 2 is behind, ahead of number 3, etc. The ability to say, based on an extensive data exercise, that “Switzerland is the top secrecy country in the world”, and “the US is (one of) the top secrecy jurisdictions in the world”, is highly impactful. Finally, the precise scoring on multiple indicators, allows for the appearance of a strong representation of reality: Switzerland’s 2016 FSI score is almost double that of Luxembourg – potentially a damning indictment.

Numbers affect tax policy, but not always

Numbers matter for tax policy. Much like the technicisation of international tax reform, the number-obsession creates participation barriers to policy debates and shapes politics and policies, with important democratic, economic and social implications. And much like the reliance of modern academic economists and indeed public and international economists on econometrics and mathematical modelling has become necessary and crucial in order to be taken seriously and impact economic policy debates, the ability of tax policy actors to draw upon quantitative support for tax policy arguments has become essential.

Indeed, numbers push arguments, emphasise issues and change perceptions. The $2.5 trillion dollar offshore cash pile guides attention towards US deferral reform and MNC tax behavioural norms. The 10%-point swing in GDP growth estimates tells us that one Presidential candidate’s proposals are significantly better for the economy. And the secrecy jurisdiction ranking persuade us that, despite conventional wisdom, the US and the UK are among the key enablers of ‘the offshore world’.

Policy actors able to produce, harness, manage and broker quantitative support for policy arguments thus stand at a potentially significant advantage in tax debates, with the possibility to effect real policy change.

However, it is important to recognise that not all numbers or data-based arguments are successful and influential. The datafication of policy debates is certainly just one part of the equation. Numbers are assessed and filtered through policy processes and debate arenas, and some are certainly less robust and authoritative than others. Maya Forstater, for instance, has done yeoman’s work to dispel the precision of certain ‘Wild Ass Guesses‘ within the tax policy area. When arguments with quantitative support are successful, it is often not entirely because of the quantitative element itself; often, it is because those proposing the data-backed arguments are also able to draw on strong expertise and key networks (as I have argued elsewhere). For instance, the ability of the Tax Justice Network to draw on credible expertise to build and push the Financial Secrecy Index as a global benchmark was a key success factor in changing the discourse around “offshore tax havens”.

Thus, the next time you observe a tax policy debate (or indeed other policy debates), pay attention to the use of numbers, data and quantitative support. And see how it is used, leveraged and combined with other factors, such as credible expertise and networks. Often, this is how policy arguments are won and lost.

 

Tempering expectations for the BahamaLeaks

Hey, ho. Another month, another exotic tax haven leak. Another political storm, another media circus, another rush to condemn. And maybe this time, it will lead to lasting change. Who knows? But my guess is the Bahama Leaks won’t quite live up to whatever hype it has attracted in its short life. There are two main reasons for that:

Scale and scope

Just like the Panama Papers, the Bahamas Leaks have been shared with German newspaper Süddeutsche Zeitung by a John Doe, from where it has been passed to the International Consortium of Investigative Journalists (ICIJ) and on to their partners. And just like the Panama Papers, the documents reveal previously secret ownership lines and corporate structures in an island haven famous for its tax haven usage. But unlike the Panama Papers, the largest ever such leak, which contained a massive 11.5 million documents on, the Bahamas Leaks features only a tenth of that, at around 1.3 million files.

While the Panama Papers stories led with stories of world leaders such as Vladimir Putin, the Saudi King, the Prime Ministers of Pakistan, Malta and Iceland (who eventually stepped down), and large banks across the Western world, the Bahamas Leaks have kicked off with rather dry stories on former EU Competition Commissioner Neelie Kroes’ and UK Home Secretary Amber Rudd. Not quite the same crowd.

Simply, there seems to have been more meat on the bone with the Panama leaks. Extensive documentation of under-the-table documents between banks, trustees and Mossack Fonseca certainly looks to eclipse “the names of directors and some shareholders” from the Bahamas company registry.

Leak fatigue

Ever heard about “donor fatigue”, the notion that people (typically in the West) get tired of hearing about third world disasters and crisis? I think we may be seeing a similar dynamic with tax haven leaks. In recent years, we’ve had a plethora of such leaks – Swiss, Offshore, Lux, Panama, Bahamas, etc. The novelty factor and the outrage decreases by each one (though counteracted by the scale and scope of revelations). Thus, we have “leak fatigue”, a situation where each new leak is afforded less attention, thus limiting the associated impetus for change.

We shouldn’t be entirely bearish on the BahamasLeaks outlook, though. As ever, it does contribute to some political momentum, even if it mainly serves as an occasion for policy groups to push their existing agendas (EU: the new CCCTB, NGOs: public BO registries, OECD: automatic exchange of information, etc.). And certainly it provides a very good case for discussion of our current global transparency system. But all in all, I am tempering my expectations for any consequent political initiatives.