Category Archives: Morality

ParadisePapers and guilt by association

The new leak is upon us. 13,4 million new documents from Appleby, an upscale offshore service provider headquartered in Bermuda, as well as 19 company registries have provided fodder for politicians, professionals and the public since the stories began to flood in late Sunday night.

Inevitably, the headlines will tell tales of the various offshore activities of the rich and famous, with extensive detail provided by corporate ownership documents, contracts, internal communications, and so forth.

However, the leaks illustrate a range of different activities which might usefully be segmented in terms of both law and broader societal concerns.

At the “very bad” end of the law spectrum, there is likely some outright evasion of taxation or regulation, corruption, and some highly dubious and opaque dealings involving problematic individuals and corporations. Although many more stories are to come, the lack of adequate anti-money laundering management on the part of Appleby points in this direction, as does the secret loans of Glencore, and the case of Mrs Brown’s Boys.

At the other end of the law spectrum, there will be relatively innocuous investments, holdings, etc. Queen Elizabeth’s offshore investment vehicle, for instance, appears in line with common investment practice. (I realise many will say these are not innocuous whatsoever – I’ll pick this up below).

And in between, in the “grey zone”, there will be instances of tax avoidance, structures established in unusual and unexpected locations and manners, secretive ownership set-ups that do not pass the sniff test, etc.

While these different issues vary in terms of their relation to the law, they are bound to be bundled together in stories from and in reactions to the Paradise Papers.

And the reason for that is broader societal concerns. From the perspective of many people, the mere association with “the offshore world” and with Appleby implies guilt in some sense, morally if not legally. No doubt this is partly caused by recent years’ rise in media stories and political rhetoric on “cracking down on tax havens”, which leaves little room for nuance.

But the broader societal perspective is no less important to take into account than strictly legal questions. Here we need to understand the association with Appleby and offshore in the context of the implicit or explicit support granted to “the offshore system” and the large system issues in the international order by such association.

The use of offshore structures bring with them increased risk – reputational risk certainly (as the leaks firmly illustrate), but also risk of exacerbating the problems of the international system (both in terms of tax, economy, investments, etc.) through financial and normative support to those profiting from these problems and/or to the offshore system as a whole, and even to the issues of the global economy as a whole, such as inequality. I stress risk here because offshore structures may well not lead to such a result but nonetheless they maintain the potential for it, even if that is not the intention.

Increased risk implies increased responsibility. In the same way that the corporate tax mantra may not suffice for the public when corporations are explaining their tax affairs, the reference to purely legal compliance (which in itself is difficult to impossible for journalists and others to challenge without detailed insight) may not be sufficient to really address broader societal concerns. There is a responsibility, whether you think it is fair or not, to address the broader societal concerns, to take them into account, not just in communicating actions but also in assessing those actions in the first place.

This responsibility to address claims of “guilt by association” simply comes with the territory of offshore investments. Some may not like it, but that’s reality.

And this responsibility is especially incumbent on high-profile individuals and corporations, who are figures of society, and who play a heightened role in shaping society-wide norms, e.g. the trust and belief in the tax system and the willingness of ordinary people to pay the correct amount of taxes.

And it is also especially incumbent in an era where there is widespread polarisation of debates on tax and the offshore, as well as widespread problems with the international tax system.

The answer to this responsibility, I hope, should not be to avoid entirely engaging with cross-border investment involving “offshore” sites, or to shy away from the discussions entirely in order to shield one self. Encouraging a total shutdown of the Bermudan economy, or a total shutdown of discussions on the offshore, is clearly not advisable. In order to fix the underlying structural issues, we need to continue working towards a better offshore system, better global cooperation, a better international tax system, a better global economy. This may sound like platitudes but really the root cause of many of the issues we are faced with, and the issues people perceive today, run deep.

In the short term, we should be able to move discussions and policy forward by paying attention to and responding to both legal concerns and the concerns of a wider societal nature. We should not accept outright claims of “guilt by association”. But we should also not accept outright claims that this boils down exclusively to an issue of legal compliance.

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 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…

 

Catching Capital: Thoughts on Dietsch and tax competition

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

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

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

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

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

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

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

1: Tax competition harms fiscal sovereignty.

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

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

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

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

Tax competition harms fiscal sovereignty

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

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

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

“No strategic harm” and an International Tax Organisation

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

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

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

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

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

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

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

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

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

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

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

Tax cooperation is not inefficient

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

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

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

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

Tax cooperation enhances, not erodes, national sovereignty

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

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

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

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

Udklip

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

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

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

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

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

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

Transitional justice

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

A diligent, normative, and also non-normative book

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

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

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

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

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

 

History, politics and corporate tax aggressiveness shape national debates on responsible tax

The immediate reaction when companies are asked about their tax policies is often somewhere along these lines (hat tip @SoongJohnston):

However, that’s not always the case. In particular, some countries have more open debates on corporate tax policies and responsible corporate tax. I am fascinated by these differences in the nature and content of national debates on responsible corporate taxation in the policy arena and the media. And also fascinated by the reasons for these differences.

So, I want to take a look at the responsible tax debate in a few selected countries – namely Denmark, Norway, the UK, Australia and the US, which I am most familiar with. And I want to try to understand why the debates differ.

First, however, I must note that my knowledge of national tax debates is, naturally, limited. Barriers of geography, language, time, resources and so forth constrain my ability to accurately detail every aspect of tax debates in various countries.

(I also note that I will not touch upon the question of whether or not tax is or should be a CSR/responsibility/morality issue at all. For that, I recommend reading this (by @taxpolblog), this, this or this (by @judithfreedman).)

And now on the analysis:

National responsible tax debates

Denmark

To start with the most immediate country from my perspective: Denmark. The current Danish debate on corporate responsible tax is, well, largely non-existent.

On the one hand, it has been a priority for civil society organisations over the past few years, with both ActionAid Denmark and IBIS (now part of Oxfam) launching CSR related tax projects. And certainly, the Danish public, when surveyed, find responsible tax an important issue.

However, the topic has failed to gain wider media and political traction. Briefly in 2014, the government supported a Danish Fair Tax Mark equivalent, but generally, the public attention to responsibility in corporate tax affairs has been sporadic. One reason for that may be the reluctance of Danish companies to engage in any such debate. I highlighted a few tax policies from Danish companies the other day, but these are exceptions rather than the norm. Danish businesses rarely discuss tax responsibility in the open, and the top business associations see no relationship whatsoever between tax and responsibility. Attempts to open up the debate in private and public forums have been largely unsuccessful.

Norway

My sense is that Norway and Denmark are very similar in this respect, though with certain differences. Both are high-tax countries, high-end welfare states, with high social trust and international companies at the forefront of the social responsibility agenda. Still, the responsible tax debate is rather silent. However, my impression is that the Norwegian responsible tax debate is somewhat more open than in Denmark. There seems to be a greater tradition for it. Historically, Norway is an exceptionally open society. Personal tax records are publicly available. And on the corporate side, the Norwegians have been closely involved in transparency initiatives such as EITI (whose Secretariat is located in Oslo) and PWYP. It is also the only Scandinavian country to have a formal Tax Justice Network branch, whose people are very active in fostering debates and partnerships on the responsible tax agenda.

UK

Given the Danish drought on the responsible tax front, interested Danes (like myself) often look to the UK to quench their thirst. As I have remarked previously, the UK tax debate is unique:

Arguably, the UK public, politicians and businesses emphasise and engage in the responsible tax debate to a greater extent than anywhere else. Besides civil society organisations highly active on and attentive to tax issues, key actors and forums such as the CBI, KPMG UK, ICAEW, the Parliament PAC and Responsible Tax Group all contribute to an open and thriving room for debate. The UK also has the Fair Tax Mark, supported by many businesses. And UK actors are among the most active in debating international tax policy and reform initiatives. To my mind, there is no doubt the UK debate on responsible tax is the most extensive – whether that is considered good or bad.

Australia

If any country should give the UK a run for its money, however, it might be Australia, as I have been informed. Similarly to the UK, Australian politicians, government and the media are certainly keen on transparency and a responsibility debate, with the Parliament conducting several inquiries into corporate tax practices and enacting extensive regulation to deal with corporate tax avoidance. However, I have not seen Australian businesses engage in the debate to the same extent as in the UK (do they?), which is a key difference from my perspective. Businesses are often at the end of the criticism around tax avoidance and corporate tax practices, and thus it signifies an important gulf in the debate if they are not active participants.

US

In my view, the US debate is similar to Australia, although perhaps with an even greater chasm between businesses and others engaged in the debate. As elsewhere, American public attitudes to corporate tax practices are skeptical, the media is critical of corporate tax avoidance (lately in particular tax inversions), and there is a number of active civil society organisations campaigning for tax justice and responsible tax. And the US has done much to advance international tax transparency and combat tax havens. But although comprehensive corporate tax reform is high on political agenda, it probably remains a pipe dream. Meanwhile, US corporations are among the most aggressive in utilizing tax avoidance strategies, holding more than $2 trillion offshore, prompting the Senate to question US companies’ tax conduct. However, like Australia (though perhaps to an even lesser degree), US companies largely do not engage in the responsible tax debate. They are active in tax policy discussions (behind closed doors, mostly), but there is little engagement with the media and the wider public on questions of responsibility in tax.

I am not sufficiently familiar with Central European, Asian, African or South American responsible tax debates to provide detailed thoughts, so input here is welcome.

Why these national differences?

Now, the real interesting question flowing from all this, is, of course: Why? If true, why is the UK debate so extensive? Why is the Danish debate so quiet? Why are the US and Australian debates distinct?

To my knowledge, there are no systematic studies of these national differences. Historical, political, institutional, economic, social and cultural factors all play a role, certainly, but more specifically what the causes are, we don’t know.

I will not attempt an exhaustive list of explanations, but I propose that at least the following two factors provide some explanatory power:

Historical role in allowing ‘irresponsible’ corporate tax practices

One important element in the current nature of national tax debates is, I believe, the national historical role in corporate tax practices perceived as being ‘irresponsible’. My hypothesis: The greater the national role, the more national public and political attention, and thus a more extensive/open national debate.

In the UK, politicians and private actors have played a key role in fostering corporate tax avoidance and secrecy through the early Euromarkets, the City of London, and legislation in its overseas dependencies and crown territories. In the US, the finance and banking communities were central to the formation of Caribbean secrecy jurisdictions, and US check-the-box rules have been one of the most (if not the most) important legislative facilitators of corporate tax avoidance over the past half century.

In both countries, politicians and political bodies have been aggressive in leveraging that history to put the tax responsibility of corporations on the public and political agendas over the past decades. The UK PAC and the US Senate Subcommittee on Investigations have been particularly important here. And the same is true of the Australian political arena.

On the other hand, Denmark and Norway, for instance, have comparatively insignificant historical roles in facilitating ‘irresponsible’ corporate tax practices, which may support the explanation of comparatively silent national responsible tax debates in the Scandinavian countries.

Tax aggressiveness of national companies

Another element is the aggressiveness of national companies in exploiting tax avoidance opportunities. My hypothesis is: The more tax aggressive a country’s corporations are, the more attention and thus more debate.

Research has shown that that companies from liberal market economies, e.g. UK, US and Australia, are more tax aggressive than coordinated market economies, e.g. Germany, Denmark and Norway.This is also the impression most people will get from reading the media in general. It could be part of the explanation of the more pronounced responsible tax debates in the former three countries.

There is (to my knowledge) rather limited work on the tax tendencies of different countries’ companies (of which the study linked above is part), but the comparative capitalism (CC) literature of political science tells up plenty about different national institutional set-ups and behaviours of economic actors. The study cited above e.g. uses the Varieties of Capitalism (VoC) framework to distinguish UK/US/AUS from DE/DK/NO. Almost every CC framework, incl. VoC, finds the Anglo-Saxon countries as a distinct grouping, with a greater affinity for unregulated market and capital competition than elsewhere, which may also hint at the greater tax aggressiveness of these countries’ companies.

The comparative capitalism literature can thus assist us in understanding why US, UK and Australia firms are more tax aggressive than, e.g. German, Danish or Norwegian. And, I contend, this plays a key role in the make-up of national debates on responsible tax. When companies are more tax aggressive, politicians, the media and the public will be more likely to perceive irresponsibility or injustice, and thus there will be a greater impetus for public debate on corporate tax responsibility.

Now, while these factors do certainly not provide the whole story, in my view they are important when we are trying to understand the nature and cause of different national debates on responsible corporate tax. Other factors could also be discussed, such as the general nature of debates on responsibility and transparency, or the public attitudes toward taxes. That said, I welcome comments or inputs that might shed further light on these topics!