The paper’s underlying concern is that global tax competition may undermine countries’ fiscal systems in two ways: by reducing (1) their tax capacity (how much revenue they can raise, and thus what sorts of spending policies they can afford, and (2) their ability to achieve distributional aims, in particular at the high end of the wealth or income distribution. (Obviously, some readers may view these limitations as good rather than bad – noted in the interest of completeness, although I am not in that camp myself.) One might reasonably posit that problem #1 is more likely to be binding for small and developing countries, while problem #2 is more likely to affect larger, wealthier, and more developed countries.
The normative framework that the paper applies to these issues is consequentialist, but not welfarist. The aim is to maximize aggregate fiscal self-determination, a country-level analogue to thinking about individuals’ autonomy. This is founded on accepting pluralism and countries’ having distinctive sets of policy preferences, and the concern is about effective de facto, not just formal de jure, powers of fiscal self-determination.
A simple example that’s drawn from the paper may help to illustrate this. Suppose Sweden has a preference for high taxes and a big welfare state; the UK for low taxes and only a small welfare state. Fiscal self-determination is advanced if both countries can do what they prefer.
With global capital mobility, capital will tend to flow out of Sweden and into the UK if each country simply implements its preferences (which one might think of them as having wholly without regard to global capital mobility – although, in fact, one might ask if there’s a kind of not-behind-the-veil issue going on here. So what the UK does potentially undermines Sweden’s ability to do what it likes. But suppose a global tax authority therefore told the UK: You need to have higher taxes, so that you don’t undermine Sweden’s ability to fund a large welfare state. This would aid Swedish fiscal self-determination, but at the cost of denying fiscal self-determination to the UK. So there is an inherent tension that makes it harder to decide how fiscal self-determination is best maximized.
Before turning to the paper’s proposed response to the dilemma or tradeoff, it’s useful to mention 3 well-chosen scenarios that it emphasizes:
CASE 1: An individual hides income from the national tax authorities by earning it through (and stashing it in) a bank in a tax haven jurisdiction that (still) offers banks secrecy. This is fraud by the taxpayer under domestic law. The haven jurisdiction, or people in it, might conceivably be thought of as enablers or even accessories to this fraud, but rather than use all those issues the paper refers to this as “poaching” by that jurisdiction at the expense of the residence jurisdiction.
CASE 2: A company uses transfer pricing and other tricks of the trade to divert taxable income from the places where it actually arose (perhaps an ambiguous concept, of course) to a tax haven jurisdiction. This is profit-shifting by the taxpayer, and the paper likewise calls it poaching by the tax haven jurisdiction. The key difference between Cases 1 and 2, other than individual vs. corporation, is that 1 involves straight-up fraud, while here the profit-shifting may be at least arguably, or even unambiguously, legally permissible under the tax rules of the “true” source jurisdiction (and perhaps also the residence jurisdiction).
CASE 3: A multinational firm places a factory wherever the effective tax rate on the production will be lowest. We can call this production-shifting, rather than profit-shifting, because here the “true” source changes – this is “real” rather than formal tax competition. The paper’s term for jurisdictions that seek to attract factories and other real investment via lower effective tax rates is “luring.”
An example of the paper’s shrewdness is its recognizing that cutting back on poaching may increase luring. Real tax competition may become fiercer if higher-tax countries can’t mitigate their headline rates via the availability of profit-shifting. But let’s go back to the central line of argument.
If we think of tax competition as a race to the bottom, poaching inevitably leads there, to the extent that it is feasible, since profits can in principle be placed wherever one likes. Luring also pushes in that direction, although it is more constrained since one has to place the factory somewhere where real production activity is not just feasible but cost-competitive with the alternatives on an all-in, after-tax basis.
The paper offers two main principles in addressing the challenges to fiscal self-determination that these three scenarios raise. The first is a “membership principle,” holding that one should be liable to pay tax wherever one is a “member” of the given society. This works in familiar fashion for individuals, who in the simplest cases are unambiguously residents of one country but not others. But the paper also argues that corporations – perhaps a better concept would be “businesses” – are members wherever they make significant use of local resources. Thus, if I (at least through a corporation) sat around in NYC writing books in Hindi that I then had printed in Singapore and sold in India, I’d have some membership in the US, in Singapore, and in India. As I’ll address shortly, it might seem a bit odd to say my corporation is a “member” of these three societies, but it would be unexceptional to say that all three have legal nexus permitting them to tax my activity of writing, printing, and selling books.
Second, the paper offers what it calls a “fiscal policy constraint” on how countries should decide on their tax rules. To simplify slightly, the idea is no poaching and no luring. In other words – but, to be fair, putting it in my words, not exactly those of the paper – they should set their tax rules (such as the corporate rate) under the counterfactual assumption that capital is geographically inelastic.
Back to the UK, with its lower tax rate than Sweden. It’s fine, and a basic exercise of their fiscal sovereignty, if they set a low corporate tax rate in part because they believe UK residents will save and invest more if this rate is low, rather than high. But if the elasticity on which they rely is cross-border, rather than internal – if they are setting their tax rate at least in part to “lure” capital away from other places such as high-tax Sweden – then they are acting improperly.
As an aspirational aim for the distant future, the paper envisions the creation someday of an “International Tax Organization” or ITO, by analogy to the World Trade Organization (WTO), or more distantly, say, the International Court of Justice. In a world where all this was in place, if the UK cut its tax rate (to keep things simpler, let’s leave aside preexisting low rates), Sweden could contest this in the ITO, which would rule against the UK if the Swedes sufficiently demonstrated that luring was afoot and that it had an adverse impact on Sweden.
I don’t consider the fact that (as the authors recognize) this is not very short-term practical or likely to happen as an insuperable objection to evaluating it normatively. Our underlying principles (and what they should be) are of interest even with relevant political, etc., constraints. But several main comments occur to me, even leaving aside the broader issue of whether one might view at least some aspects of tax competition as good rather than bad.
1) To what extent is multilateral cooperation necessary to preserve countries’ tax capacity and ability to achieve their distributional aims? A big part of the problem is that so much business income is taxed at the entity level, via corporate income taxes, thus causing corporate residence electivity plus source manipulability (through both real tax competition and profit-shifting) to have large effects. But, so long as Problem 1 (fraud) is being addressed – and I note that FATCA et al suggest that it is increasingly being addressed – countries might have other ways of getting to where they might want. A key aspect may be shifting effective taxation to be more at the owner level and less at the entity level. Some recent US academic tax reform plans that would have done this are (a) Toder-Viard (mark to market taxation at the SH level, tax rate is reduced to 15%), (b) Grubert-Altshuler (deferral charge for the receipt of dividends, plus realization at death for shareholders, with the corporate rate likewise being reduced to 15%), and (c) Kleinbard’s BEIT proposal, shifting taxation of normal returns to the owner level (among other changes). Adopting progressive consumption taxation (which I would want to supplement with something such as inheritance taxation) might also decouple achievement of the fiscal sovereignty aims from the issues around tax competition.
2) To say not just no poaching but also no luring is a rather demanding standard. In effect, nations are being urged to make tax policy around a counterfactual, and to overlook key empirical consequences of their choices that may be quite difficult to disregard. Note of course that, in well-governed countries, the legislators recognize fiduciary duties towards the wellbeing of their constituents, and that one may especially uneasy about disregarding important empirical issues if one is not convinced that legislators in other countries are doing this as well.
3) This may be as much a semantic as a substantive objection, but it seems inapt to me to say that my hypothetical Hindi book publishing and writing business makes me a “member” of Singapore’s and India’s polities under the above hypothetical facts. The paper invokes the notion of benefit. But the normative force of the concept is unclear to me, especially where the benefits that I’m getting impose no net cost (and perhaps even convey a net benefit) to the jurisdictions that provide them. Singapore is presumably better-off (rather than, say, predominantly more “congested”) by reason of my doing some basic manufacturing there, likewise India by reason of my hypothetical eloquence in Hindi. So the idea is really nexus with an associated notion of proportionality. (The paper anticipates, say, 3-factor formulary apportionment’s being used, so that Singapore & India merely get a share – they can’t over-grab merely because my company has nexus &/or is deemed a “member” of their polities.)
Nexus is a familiar legal concept, but hard to ground directly in clear normative terms. I think of it in this context in terms of what I like to call the “Monty Python tax principle.”
A silly Pythoneer in a bowler hat comments, in one of the old episodes, “To aid the British economy, we should tax foreigners living abroad.” Hence, under the Monty Python tax principle, every country in the world might like to tax my activity of writing books in the US that are printed in Singapore and sold in India. But this would lead in a rather chaotic direction, to say the least (even apart from the question of how all those countries could actually collect these taxes).
Nexus is clearly an important practical idea, but I myself wouldn’t ground it semantically in terms of “membership.” I also might not ground it normatively in terms of “benefit,” although admittedly I haven’t focused on nexus issues, more or less taking it for granted that, in the above scenario, the only 3 relecant players are likely to be the US, Singapore, and India. But it’s a topic that certainly merits attention.
Despite quibbling with some aspects of the paper’s analysis, I found it very helpful and interesting, and thought that it prompted a great discussion at both our AM and PM sessions.
Dietsch’s recently published book, Catching Capital: The Ethics of Tax Competition, discusses his views more broadly. Recommended & worth a look by all with related interests. Its multidisciplinary strengths are not often found in the biz.