The more I think about it, the more I like the idea of policy drift as a way to explain what might at times seem like perverse outcomes in the international tax system. This post is an attempt to road test this idea.

Policy drift seems to originate with this 2004 article by Jacob Hacker [pdf], which was then magnified by the seminal book he co-authored, Winner Take All Politics. It starts from two powerful insights. First: it is much easier for interest groups to defend the status quo than it is for them to change it. Second: if a policy does not adapt in response to changes in the economic or social world, then its effects may change. Combined, these insights show the effects of a policy may change over time because it is too difficult to make the changes needed to adapt it to changing circumstances.

Hacker discusses how economic and social changes in the US from the 1970s onwards, such as the decline in privately provided healthcare, exposed people to new risks. Efforts to adapt government social policies, which had originally been designed to protect people from such risks, were defeated in the political process, so that they no longer achieved the outcomes for which they had been created. As Hacker puts it, “formal policies have been relatively stable but outcomes have not.”

Policy drift is said to happen when it is hard to make formal and informal changes to a policy. There are two other concepts in the same literature that are worth considering. Where it is hard to make formal changes to a policy, but easy to ‘convert’ it by reinterpreting it, there can be an internal adaptation of a policy. Where it is easier to make formal changes but harder to convert existing policies, the outcome may be ‘layering’, in which a new policy is implemented on top of an existing one.

Let’s consider three taxation examples.

Property taxation

It’s 1991, and the UK government introduces a new tax to fund local council services. It is based on house prices, valuing every property in the country and putting it within eight price bands. 24 years later, all properties are still placed in a band based on an estimate of what their value would have been in 1991. There are many arguments for and against this approach, but you can make the case that it achieved a form of horizontal and vertical equity when it was introduced, especially compare with what it replaced.

But over those 24 years, the value of properties has not changed equally in different areas. People living in London, for example, where prices have risen much faster than the UK average, do very well out of a system that is based on what their property was worth in 1991. Successive governments have recognised this, but feared the electoral consequences of a reform that would increase the council tax charges of a large number of people.

It seems that an internal conversion – revaluation of properties – is a harder thing to achieve than a formal layering – the introduction of a new tax on the most valuable properties, which was proposed by some parties at the election just gone. Absent both, the policy has drifted, from a broadly progressive tax on property towards one that is flat at the higher levels.

Tax treaties

It’s 1970, and the government of a recently independent developing country wants to attract foreign investors, who will bring with them much needed capital and technical expertise. It offers them generous tax incentives, but it finds that these incentives are frustrated by the foreign tax credit system of the investors’ home country: the investor pays less tax in the developing country, but this just means they pay more tax in their home country instead. So the two countries conclude a tax treaty. The treaty requires the developed country to grant ‘matching credits’ so that firms can keep the benefits of any tax incentives, but in return the developing country must lower its withholding tax rates on dividends remitted by investors from the treaty partner. These lower rates transfer the burden of double taxation relief away from the developed country, which would otherwise have paid for it through its foreign tax credit, onto the developing country. Maybe that was a fair deal, maybe it wasn’t.

Now it’s 2014, and most developed countries have moved from a foreign tax credit system to a dividend exemption. The tax sparing credits are no longer necessary, because the developed country doesn’t tax its outward investors’ foreign profits. Meanwhile the lower dividend withholding tax rates no longer shift the burden of double tax relief from the devloped to the developing country, since the developed country has foregone the revenue either way. So now the agreement serves a very different function: it makes it cheaper for the investor to repatriate profits from the developing country, an effect that is paid for by the developing country. It distorts the market for inward investment by treating investors from this one country differently, and it might have become a conduit through which investors from third countries divert their investments to obtain the more generous treaty.

Maybe these present day effects are good for the developing country, or maybe they aren’t. But the policy has drifted, because the treaty certainly has very different effects from those intended when it was signed; furthemore, the original bargain between the two countries is no longer relevant, and the distribution of the costs and benefits between the two partners may have changed dramatically. There could perhaps be an internal conversion, by chosing to interpet the treaty in certain ways, but this would be difficult; formal change is tricky too, because it requires cancellation or renegotiation of the treaty, which might scare investors, and because if one country loses out from the shift in costs and benefits, the other country generally has no incentive to renegotiate!

International tax rules

For much of the 20th century, government representatives and technical experts sat in rooms developing the component parts of the international tax system. Let’s simplify and say that the purpose of this exercise was to reach a situation in which multinational companies’ tax bases were distributed among the countries in which they operated according to the contribution their operations in each country made to their overall profits. The deal was reached at a time when, broadly speaking, you needed a physical presence in a country to do that. (The arguments made for a withholding tax on management fees in the 1970s tended to be about preventing tax avoidance, not fair distribution of taxing rights). So the concepts and tools developed in the past all require some kind of physical presence.

In the 21st century, it’s become apparent that a physical presence is no longer a prerequisite for significant value-added in a country. So the system does not achieve this original purpose. Instead, it gives an advantage to those countries that are home to the physical establishments of businesses that generate a lot of value in other countries without one. Arguably, the source/residence balance has shifted in favour of residence countries. Certainly, the policy has drifted.

The OECD’s desire not to open up the source/residence discussion during its BEPS process illustrates the difficulty in achieving any formal change in these existing policies. That China and India have been attempting to re-interpret the core concepts that they’ve already signed up to, including through changes in the commentary to the UN model treaty, suggests that there may be some internal conversion afoot.

In any event, I think these concepts of drift, conversion and layering – and especially drift – are quite helpful in understanding the path-dependent development of national and international tax systems. There are, of course, proposals to rebuild both from the ground up. But such proposals need to take into account the political constraints and the economic and social developments that have moulded the status quo.

The Folketinget (Danish parliament) chamber

The Folketinget (Danish parliament) chamber

At the risk of turning this into a travel blog, here I am in Denmark’s parliament building, the Borgen, a treat for aficionados of the TV programme. I spoke yesterday at a hearing organised by the parliament’s fiscal affairs committee on Denmark’s tax treaties with developing countries. The hearing was provoked by ActionAid Denmark’s questioning of the Denmark-Ghana tax treaty, which was ratified recently by the Danish parliament.

The British Public Accounts Committee this was not, and there was some good natured discussion between the different sides. Everyone agreed that businesses prefer there to be more tax treaties in place. The MPs, business and NGO representatives all agreed that there should be more transparency in the negotiation process.

We all agreed that having a treaty might improve the prospect of Danish investment into a developing country. Denmark’s tax minister and the industry representatives all said that a key consideration – perhaps the main consideration – for Danish treaty policy was to help make Danish companies competitive in the markets in which they invest. All of these arguments fell short, in my view, of establishing a clear cut, generalisable and evidence-based case that this is to the benefit of developing countries themselves.

Another point that I took from the discussion was the need to untangle the main things that tax treaties achieve, in a world where the most significant forms of double taxation are generally relieved unilaterally in the absence of an agreement:

  1. Clarifying definitions, providing dispute resolution, and other technical matters that make double taxation less likely.
  2. Giving tax authorities the legal basis for cooperation in enforcement matters.
  3. Offering businesses the reassurance of a credible commitment to fair and ‘civilised’ (not my word) tax treatment in the future.
  4. Reducing the taxing rights of the developing (ie source) country.

The case that treaties are necessary to provide items 1, 2 and perhaps 3 is strong. There is a (debatable) economic case for reducing source taxation to attract investment, made well by Clive Baxter from Maersk yesterday. But why respond to that case through bilateral treaties, which are harder to alter if the facts change, and which distort the inward investment market by treating investors from different countries differently? Why should the quid pro quo for items 1-3 be item 4? The fallacy, it seems to me, is to conflate the case for cooperation through treaties with the case for lower source taxation.

Here is my presentation. I’ll update this post when the others are all online, but they will only be of use to Danish speakers!

Last week’s Global Tax Policy Conference at Maastricht University on “international spillovers in taxation” has got me thinking. In particular, I was fascinated by Belema Obuoforibo’s presentation on the IBFD’s methodology for ‘spillover analyses’ (here is a link to an IBFD Powerpoint describing it). The term ‘spillover’ comes from the IMF, a term they use in economic analysis more generally to refer to “the impact of policy actions in one country on others” and around which the IMF framed a whole policy paper. Since its mention in the famous international organisations’ report to the G-20 [pdf], spillover analysis has become a common civil society demand, and the Netherlands and Ireland have gone on to commission them, with a focus on the interplay between their tax treaties with developing countries and certain provisions of their domestic tax law.

But a ‘spillover analysis’ is not the same as an ‘impact assessment’, and I think it’s important to understand the distinction.

The IMF’s recent paper on spillovers in international taxation distinguishes between ‘base’ spillovers, in which an action by one country affects another country without that country doing anything in response, and ‘strategic’ spillovers, in which the change creates an incentive for the second country to change its own policies – tax competition being the obvious example. All very interesting, but I sometimes find it tricky to see how the IMF’s definition applies to the specific areas discussed later on the same report.

One reason for this is that a ‘spillover’ effect from one country on another implies that the affected country is a passive victim. This is not the only way in which one country’s tax system might affect another’s. The decision by a developing country to sign a treaty, or to adopt an international norm, makes it an active participant, but that doesn’t diminish the impact on it of doing so.

A second issue is that ‘spillover analysis’ in practice has tended to focus on how one individual country’s tax system might be different to the norm. Following the Dutch spillover analysis, the government noted that Dutch treaties with developing countries were generally on the same terms as those countries had secured with comparable treaty partners. The IBFD’s methodology is based on how aspects of one country’s tax system compare with similar countries. So the growing practice of spillover analysis, it seems, considers impacts relative to the international average, not absolute impacts. It is a way of finding out if a country is worse or better than average, rather than seeking out all positive or negative impacts.

Let’s consider some examples from the area of tax treaties, to illustrate how these limitations play out in practice:

1. Is it a ‘spillover’ if the affected country actively opened itself up to the vulnerability?

Ireland didn’t used to be a tax haven. It used to be a ‘high tax’ jurisdiction like most OECD countries. Its transformation into a hub used for base erosion and profit shifting is relatively recent, and many of its tax treaties predate this. The changes to Ireland’s tax system transformed its tax treaty network into a major headache for countries such as Zambia, and it seems quite right to describe these effects as spillovers: treaty partners could not have anticipated them when agreeing terms in their tax treaties.

The same could probably be said of the Mauritius-India treaty, which originally predates Mauritius’ generous offshore regime. But it couldn’t be said of Mauritius’ treaties with many African countries, which they signed up to at a time when the risk of treaty shopping through Mauritius would have been clear. This is not a ‘spillover’ of Mauritius’ tax system, because it was a conscious choice taken by the developing countries. But it would be a shame if any analysis of the impact of Mauritius’ treaty network didn’t consider these costs.

2. Is precedent in tax treaty negotiations a strategic spillover?

When Zambia signed a treaty with China containing much lower withholding rates than it had previously agreed to, it may not have anticipated the British reaction, which was to request a renegotiated treaty on similar terms. Zambia also wanted to renegotiate with the UK, mainly to seek improved powers for cooperation and information exchange with the British tax authorities. The implication of the Chinese treaty, however, was that the UK expected similar terms in return for Zambia’s demands, significantly lowering the Zambian tax take from British investors. It seems to me that this was a ‘spillover’ effect of China’s aggressive negotiating position…but I suspect it would be unlikely to be picked up in any ‘spillover analysis’.

3. Are most-favoured-nation effects spillovers?

In April 2003, Venezuela and Spain signed a treaty with a most favoured-nation (MFN) clause in its interest article, which would be triggered if either country subsequently signed a treaty with a lower maximum rate in the interest article. In May 2006, the bilateral MFN clause in its interest article was triggered through a kind of domino effect: Estonia and the Netherlands signed a treaty granting exclusive residence taxation rights over interest; this activated the MFN clause in the September 2003 Spain-Estonia treaty, which in turn activated the MFN clause in the Venezuela-Spain treaty. As a result, according to an article in Tax Notes International, “Venezuela’s treaty with Spain has undoubtedly become the most favorable tax treaty executed by Venezuela to date.”

This was a policy action by two countries that had ramifications for two other countries, but which they should have anticipated when they agreed to the clause. The inclusion of a symmetrical clause, which could be activated by Spain as well as Venezuela, may have been a negotiating error by the latter. But was the MFN activation a spillover?

4. Is it a spillover if a country is just an aggressive negotiator?

The countries that have tended to do spillover analysis so far are those facing accusations that they’re used for treaty shopping. And the main policy response, at least from the Netherlands, seems to have focused on adding anti-abuse provisions into its treaties. What if there is no treaty shopping, but instead just a set of treaties that take most of the taxing rights away from developing countries? As I noted in point 1, the developing countries actively signed up to these treaties at some point in their histories. The IMF spillover paper sounds a cautious note about tax treaties because of the fiscal costs to developing countries of limiting their source taxing rights, but it’s not clear (to me at least) how the plain vanilla impact of the source/residence split could meet the definition of a spillover.

5. Is it a spillover if it’s no different to the norm?

Consider many developed countries’ unwillingness to share the right to tax their shipping firms with the developing countries whose waters they use, and who are in some cases very keen to tax the profits from shipping. Developed countries have been relatively united on this, so even if we accepted that the case described in point 4 above was a ‘spillover’ effect, I think the implication of the IBFD’s methodology would be to find no negative spillover from the hardline stance taken by, say, the UK. But just because this ‘policy action’ is consistent with comparable treaties and with the model conventions, does that mean countries should not assess the impact on developing countries of the policy stance?

In conclusion, it seems to me there is a risk that the focus on the concept of ‘spillover effects’ might lead to an overly narrow analysis of the impacts of a jurisdiction’s tax policy actions on developing countries. Or, to put it another way, could the choice of terms used to discuss this issue have linguistic spillover effects?

Update: Joe Stead points out that I have slightly undersold the 2011 International Organisations’ report to the G-20:

The [corporate tax] system allows countries to compete with one another in a manner that destabilises the system itself. Countries compete to attract economic activity and to favour ‘domestic’ companies…Such a goal is not easily reconciled with another goal often explicitly held by governments: ensuring that companies should pay to some country or countries a fair amount of tax on their global profits.

– Michael Devereux and John Vella

The effective tax rates on multinational corporations are being pushed steadily downwards, allowing multinationals increasingly to free-ride on the public services that everyone else pays for.

– Tax Justice Network

My term’s teaching is over, which means a return to blogging. Conveniently, several new – and related – papers popped into my inbox this week. There’s “Ten Reasons to Defend the Corporate Income Tax” from the Tax Justice Network, and two from the Oxford University Centre for Business Taxation, “Business Taxation under the Coalition Government” [pdf] and “Are we heading towards a corporate tax system fit for the 21st century?” No love lost between these two organisations, so it’s interesting to see how much common ground they share.

TJN’s paper, written by Nick Shaxson, is typically polemical, smartly designed and peppered with quotes from authoritative sources in support of its case, which is of course that corporation tax is good, and under threat. Shaxson marshals an impressive battery of sources in support of his argument, although the polemical tone, natural from a campaigning organisation, often left me suspecting that the other side of the argument had not been done justice. For example, a lengthy footnote convinced me that “numerous independent bodies have concluded after exhaustive studies that the burden [of corporation tax] largely falls on the owners of capital — that is, predominantly wealthy people”, with a split between capital and labour of something like 75/25. The claim is that numerous, not all, studies find this, and numerous papers are indeed cited, but I still wish that the studies finding a different result had been included, too, even if only to debunk them.

This point came up at the launch event for “Business Taxation under the Coalition Government”, a collective publication of the OUCBT. Chris Wales from PWC, who was a special adviser to Gordon Brown and now advises Labour on corporation tax, was there to suggest what Labour might do in government. When the Treasury minister David Gauke asserted that the incidence of corporation tax falls predominantly on (small-L) labour, Wales retorted that the cut in UK corporation tax rates over the past five years does not appear to have been passed on to workers, given the stagnation in wages over the same period.

Tax cuts in the UK

“The UK’s tax-cutting corporate model since 2010 is a terrible model for anyone to copy – for all the evidence so far suggests that the experiment has been a disaster,” says TJN, citing Reuters research suggesting the creation of just 50 jobs. Because TJN’s argument is about growth, it doesn’t rely on the absence of a link between taxation and investment, and indeed Shaxson is happy to concede the existence of such evidence. His case is as follows:

Many of these studies focus on gross benefits stemming from a tax cut (i.e. they measure investment levels), without also considering all the tax and other costs as outlined in the rest of this document: lost revenue, damage to other parts of the tax system, steeper inequality, greater rent-seeking and externalities, and so on. From the perspective of those designing national tax policies – which is the perspective that matters most – it’s the benefits net of these costs that matter.

The OUCBT report agrees with TJN that it’s near impossible to isolate the effect of the UK reforms on investment, and seems to accept TJN’s point in a footnote to its discussion on the effects of different tax rate measures:

Such measures help in comparing the UK to other countries, but only relative to the costs associated to the corporate tax system: they tell us whether the UK corporate tax burden is low enough to attract and foster investment in competition with other countries, ceteris paribus. They are not suitable to derive conclusions on the broader welfare implications of tax policy measures or on the broader economic performance of the UK.

Earlier on, the report finds an annual tax cost for the next financial year of £7.5 billion, noting that “[b]y any standards, these represent large costs, which must be met either by other taxes raising more revenue, lower spending or a higher deficit. This represents a clear trade-off with the gains in competitiveness.”

Setting that to one side for a minute, the OUCBT discussion of the effects of different tax rate measures on investment was new to me and certainly interesting. The authors distinguish between three different tax rates:

  • the headline rate, which they say is what incentivises profit-shifting;
  • the effective average tax rate (EATR), which they say affects the number of investments (the extensive margin); and
  • the effective marginal tax rate (EMTR), which they say affects the size of investments (the intensive margin).

The UK is now very competitive in terms of the EATR, but not so much the EMTR. This should have a positive effect on investment into the UK, because,

There is strong empirical evidence that differences in the EATR across countries affect the location of investment projects. The EATR is relevant in a context where a firm needs to decide among a set of mutually exclusive projects. This is the typical decision faced by a multinational choosing to locate investment in one of the OECD countries.

In contrast, the higher EMTR might discourage investment from capital-intensive sectors:

The UK tax component of the user cost of capital (EMTR) has historically been higher than the OECD average and this has not changed under the Coalition. For large companies, the UK capital allowances regime remains one of the least generous in the OECD. This affects firms’ cost of capital negatively, especially for businesses with substantial investment in physical assets such as plant and machinery and buildings.

According to the report, the UK has actually tightened its capital allowance regime for large companies during the past five years. So pointing to headline rates alone is not enough to demonstrate the death of corporation tax. The tax base needs to be considered, and in the UK case changes here seem to have slightly mitigated the impact of the falling rate.

Effective Average tax RatesEffective Marginal Tax Rates

The nature of competition

“Tax ‘competition’ has nothing to do with competition but has more in common with currency wars or trade wars,” says TJN. “We prefer the term ‘tax wars,’ which is more economically literate and more accurately reflects the harm that the process causes.” The OUCBT is a common target for this vein of criticism from TJN (see for example this blog by Nick Shaxson on its origins), and its Business Tax report is certainly laced with the term ‘competitiveness’. But the new paper “Are we heading towards a corporate tax system fit for the 21st century?” by the Centre’s Michael Devereux and John Vella is actually much closer to TJN’s position than one might expect.

The paper examines the OECD’s BEPS process in the light of two criticisms of the current system. First, it argues that the “arbitrary compromise for the allocation of profit between countries first agreed in the 1920s is wholly inappropriate for taxing modern multinational companies.” That discussion is for another day. Its second argument, the relevant one for our discussion here, is that the international tax system is undermined by tax competition, and BEPS will only succeed if it “contain[s] the power of existing competitive forces”:

Recognising the power of this competition is key to creating a stable long-run system for taxing the profits of multinational companies. Even if existing governments were to reach an agreement to preserve the basics of the existing system, while tightening anti-avoidance rules, there will still be an incentive for future governments to undermine that system, as their predecessors have done in the past. A stable system must remove the incentives for governments to undercut each other.

Importantly, Devereux and Vella argue that tax competition is not merely about attracting foreign companies to invest into a country. It is also about giving domestic companies a competitive advantage over their foreign competitors. Both the UK’s Finance Company Partial Exemption and the US ‘Check the Box’ rules are seen in this light, as instruments that confer a competitive advantage on firms headquartered in those countries at a potential cost to the countries in which they invest. The paper even goes as far as to question the “underlying rationale for providing a competitive advantage to domestic multinationals,” since if the beneficiaries are shareholders, many or indeed most of them may be foreign citizens.

A final thought

I’ve compared here three papers, two from academics, who have academic freedom but are nonetheless funded by multinational firms, and one from campaigners who consider the behaviour of those same firms (and to some extent those same academics) to be a threat to democracy and prosperity. They all agree that corporate tax competition is a problem that should be tackled. But they all stand outside the system looking in.

What about those engaged in tax competition? At the OUCBT event to mark the launch of its Business Tax report, Michael Devereux tried and failed to identify some “clear blue water” between the British Conservative and Labour parties. The only difference – at a time when the Labour party is seeking to differentiate itself from the Conservatives as the champion of responsible capitalism and fair taxation – appeared to be a single percentage point on the corporation tax rate. No mainstream political actor in the UK is proposing to move away from the structural changes made to the UK tax system, some of which are characterised by Devereux and Vella as “state-approved base erosion.”

This week I am trying to help the undergraduate students that I teach to understand a range of scholarship that uses social constructivism to study the political economy. When you go back to first principles to teach something you often see some of your own work in a new light, and that is what I am going to write about today. I’m briefly going to sketch out some social constructivist thoughts about multinational firms’ tax behaviour.

For a side project I’ve been reading some of the academic literature on tax compliance. There’s a great summary of the different theoretical perspectives on tax compliance in this working paper by Odd-Helge Fjeldstad and colleagues. The authors divide them into five:

  1. Economic deterrance. This is the classic rational choice framework, in which taxpayers weigh up the incentives, essentially the tax rate versus the penalty and the probability of being caught.
  2. Fiscal exchange. This is where the notion of ‘quasi-voluntary compliance’ comes in. If taxpayers think they will receive something in return – public services, in other words – they are more likely to pay. Although the evidence for this, according to the ICTD paper, is weak.
  3. Social influences. The final three positions, which I am going to appropriate into the social constructivist field, have stronger evidence to support them than fiscal exchange. The first is that tax compliance relates to perceived social norms: if they think their neighbours are honest, people are more likely to be honest themselves.
  4. Comparative treatment. From this perspective, people are more likely to comply with tax rules if they think the system treats them fairly relative to their compatriots.
  5. Political legitimacy. The final constructivist view is that if people trust the government and the tax authority, they are more likely to comply.

There are loads of empirical studies looking into the determinants of tax compliance behaviour among individuals and small businesses. It’s fascinating, but I think I found a big gap: I didn’t find a single study explaining the attitude to compliance among large businesses (or, to clarify, I found studies about staff compliance with management decisions, but not about compliance with externally-derived rules and regulations).

What do I mean by compliance? Trying to define this could easily veer into a discussion about tax morality, but that’s not where I want to go. We know that multinational businesses have a degree of choice over how aggressive their tax position is, and I want to ask, empirically, “what determines this?” Most of the existing work examining multinational firms’ decisions about their tax affairs tends, I think, to be situated in the rational choice, economic deterrance framework. According to that view, the first theoretical position listed above just needs to be adjusted to reflect the additional risks faced by businesses, in particular the reputation risk attached to aggressive tax planning (here is a paper that tries to do this empirically). Current discourse suggests that this risk is increasing, and businesses are revising their positions in response.

John Maynard Keynes

It all starts with Keynes…

This is where my undergraduate class comes in. We could argue that large business decision-making is more likely to be rational than that by small companies and individuals, because a successful large organisation has to create systems that obtain the right information and use it effectively. But a growing trend of political economy work, especially since the financial crisis, has focused very much on the fact that behaviour in financial markets (often by actors who are part of very large companies) can’t be explained solely through rational choices. My students are reading Andre Broome’s excellent introduction to constructivist international political economy, which refers to work in this vein on capital account liberalisation, european monetary union, and behaviour within financial markets.

Economic constructivist thought is often traced back to John Maynard Keynes’ analysis of how actors in financial markets deal with their inherent uncertainty. According to another useful book chapter by Rawi Abdelal and colleagues [pdf]:

Keynes lists “three techniques” economic agents have devised for dealing with this situation, all of which are inherently constructivist. First, “we assume that the present is a much more serviceable guide to the future than a candid examination of the past would show it to have been hitherto.” Second, “we assume that the existing state of opinion … is based on a correct summing up of future prospects.” Third, “knowing that our own judgment is worthless, we endeavor to fall back on the judgment of the rest of the world … that is, we endeavor to conform with the behavior of the majority or average…to copy the others … [to follow] … a conventional judgment.” In short, Keynes’ macro-economy rests upon conventions, that is, shared ideas about how the economy should work.

As the works cited by Broome show, this insight has been applied beyond financial markets to many other processes involving decision-makers and market actors. So why not multinational taxation? If we decide to do so, we can come back round to the theoretical perspectives I set out at the start. Perhaps the calculation about how much uncertainty to build into a company’s tax position is subject to the kinds of conventions identified by Keynes. And perhaps, beyond just uncertainty, the social conventions that influence business decision-making about taxation incorporate perceptions of social norms among decision-makers’ peers, as well as notions of comparative treatment and political legitimacy.

Here is one example, a quote from a survey of corporate tax directors [pdf] conducted by Judith Freedman and colleagues back in 2007 (and which it would be interesting to repeat now). There are remarks here that might support the fiscal exchange, social influence and political legitimacy theories:

One respondent said that his firm’s CSR policy does not extend to paying more tax than is due under the law; they are not interested in ‘making donations to Government’. Others echoed this view, arguing that they could spend their tax savings more wisely than the Government could. At least two firms suggested that there would be a greater social aspect to taxpaying if the amounts collected were earmarked for particular public services, rather than going into general revenue.

Social constructivists devote a lot of time to identifying and analysing the different groups among which social conventions form. There will be overlapping communities within and across companies, including for example the Davos elite, the tax function, social classes, nationality, and so on. I’ve written previously about a paper that touches on transfer pricing practitioners as a social group.

Corporate decisionmakers will have different information depending on their membership of different communities, but they may also be influenced by different social norms within their communities. This morning, for example, Chris Lenon suggests that corporate tax advisers are frustrated by what they see as a lack of rationality on the part of their boards, reporting “a gap between [tax advisers’] perception of the direction of travel in this debate and the denial of this at Board level because of the impact on earnings.”

I understand the normative case against using social norms to make up for deficiencies in the law, as well as the populist argument to the contrary. But I wonder if that debate might be seen in a different light if we begin from a constructivist ontology, in which, like it or not, social norms of one kind or another have always conditioned corporate tax behaviour.

It’s been a bit quiet on here recently, the result of a busy term at LSE. At least I am at not the only PhD-student-and-tax-blogger whose blog has been suffering from the demands of teaching and research!

This week I’ve been at the International Centre for Tax and Development Annual Meeting, a chance to compare notes with other people working on tax and development, as well as with tax officials from a range of African countries. It’s a great environment to present in, because there is feedback on both an academic level and also from the tax practitioners present.

Here’s the presentation I gave based on my field research in Uganda earlier this year. This is just a taster of what will hopefully result in a couple of full length papers in the new year.

[Link to presentation on Slideshare]

I’m on my way to the UN tax committee’s annual session in Geneva. This year’s agenda contains quite a few interesting topics. I can’t write about them all, but I thought I might pick out three that seem particularly interesting. Since they are all discussions about the model treaty and its commentary, the common question that they pose is, “what is the purpose of a model tax treaty?” I think you can take three (not mutually exclusive) views about this:

  1. It tells countries what works technically. It combines the wisdom of some of the most experienced tax officials in the world to produce a technically sophisticated template that negotiators can rely on.
  2. It tells countries what is politically palatable. If a provision is included in the UN model, for example, a group of experts from developed and developing countries have all been willing to agree to its inclusion, so neither side is going to consider it too outrageous.
  3. It tells countries what is acceptable behaviour. The models sketch out the concepts and principles that committee members think should underpin a country’s international tax system. It conveys an expectation that a country’s tax rules should be compatible with these concepts and principles.

From an international relations side, we might say that the first two purposes are about reducing transaction costs for negotiations, by providing countries with information ahead of time. The last one, on the other hand, would suggest that treaties act as instruments through which norms about acceptable behaviour are established and diffused within an international community.

The status of the OECD transfer pricing guidelines

When the 2010 update to the UN model treaty was being finalised, there was some controversy around article 9, which deals with transfer pricing and the arm’s length principle. The commentary to the previous version of the UN model stated that the OECD’s transfer pricing guidelines were “internationally accepted guidelines” and recommended that countries should follow them. A minority of committee members didn’t accept this view, and so rather than resolve the conflict, the commentary now records that [pdf] “The views expressed by the former Group of Experts have not yet been considered fully by the Committee of Experts, as indicated in the Records of its annual sessions.” Unusually, the record of the discussion identifies the dissenters as the Chinese, Brazilian and Indian members of the committee. It is worth noting that none of these three individuals are still members of the committee.

The new committee is going to discuss a proposed wording to resolve those differences. This wording states only that the OECD guidelines “contain valuable guidance” and adds that

the Committee has developed the United Nations Practical Manual on Transfer Pricing for Developing Countries which pays special attention to the experience of developing countries, reflects the realities for such countries, at their relevant stages of capacity development, and seeks broad consistency with the guidance provided by the OECD Transfer Pricing Guidelines.

There is a furious letter [pdf] from the US Council for International Business, which seems to be targeted directly at India, China and Brazil:

It seems inconsistent for G20 countries and other non-OECD countries that are now advocating for their views to be reflected in the OECD Transfer Pricing Guidelines to accept concessions from others participating in the development of those Guidelines and then undercut the very outcome of those negotiations by arguing elsewhere for positions that were rejected in that forum. If any notion of “fairness” has relevance in international tax, surely it should include the concept that acceptance of an invitation to bargain on an equal footing over a set of rules carries with it the good faith obligation to live by those same rules.

The letter argues that the UN Manual was not produced with enough participation from businesses, that the OECD guidelines are now formulated with input from “a broad spectrum of countries”, and that the proposed UN aim of “broad consistency” will permit “multiple, inconsistent applications of that principle, will lead to multiplied disputes, increased double taxation, and ultimately to serious damage to the cross-border trade and investment that fuels economic growth and development.”

This might be an argument based on purpose 1, 2 or 3 above. On 1, USCIB is arguing that the changes will create technical problems. On 2, it is arguing that the political signalling effects of the OECD and UN models undermine each other when countries agree to one thing at the OECD and push a different position at the UN. Finally, on 3, it is clearly concerned about diluting the clear message sent by the treaty commentaries at present, which is that the OECD guidelines are the only internationally accepted authority when it comes to transfer pricing.

Capital gains

Both as a discussion in its own right [pdf], and through a paper for the Extractive Industries subcommittee [pdf], there’s a lot of discussion of “indirect transfers”, where a capital asset in a developing country is sold, but the transaction takes place through the sale of a holding company located in another country. I have written about an example of this recently, and it was highlighted in the recent IMF spillovers report. As I observed, it doesn’t look like the G-20/OECD processes are going to look at this problem in any depth, so this is an instance where the UN committee is examining an issue of clear concern and interest among developing countries.

The discussion focuses on article 13(4) which covers the sale of a company whose value consists principally of immovable property. This may include a mine, or a capital-intensive business such as a mobile phone network. The UN papers highlight a range of administrative issues: how a developing country can know if a sale taking place abroad falls within the scope of this article, how to value the gain, how to define “immovable property” since the model treaties are not as clear as they could be on this matter.

What interests me most is the question of how to actually collect the tax, when the payment is made outside the country, and when by definition the company making the gain may no longer have any assets in the country. As the extractives paper observes:

While both the UN and OECD Models now contain optional Assistance in the Collection of Tax Debt Articles for countries wanting to provide for this in bilateral tax treaties, and there is a multilateral OECD/ Council of Europe Convention on Mutual Administrative Assistance in Tax Matters on the subject, this is not yet something most developing countries have provision for in their bilateral or multilateral relationships.

This is something tax authority officials from developing countries are definitely seeking from renegotiations. In the meantime, the extractives paper describes alternatives, which include asking the purchaser (who by definition will have assets in the country) to withhold the capital gains tax when paying for the transaction, and refusing to grant export licenses until the capital gains tax has been collected.

I don’t know how controversial this is going to be, but insofar as it is about providing advice to developing countries, I think that makes it a matter of purpose 1.

Services taxation

The committee is going to discuss a draft article [pdf] that would allow developing countries to tax technical services. This is a provision that exists in some form in many tax treaties already, and has been introduced into models such as the East African Community’s new model treaty. But neither the UN nor OECD model treaties include it. From a technical point of view (purpose 1), this new addition should be a good thing: since these provisions are fairly popular among developing countries’ tax treaties already, having an international Committee of Experts formulate a model provision built on their collective wisdom is surely a good thing.

That’s not the view taken by the International Chamber of Commerce in a letter [pdf] that outlines the main arguments likely to be raised against a withholding tax on management fees. The ICC is opposed to such a tax per se, but it emphasises that it is even more concerned about the double taxation that might result if countries impose such a tax it unilaterally. Here is what it says:

Given that it is the unanimous view of OECD Member States that the source basis taxation is not appropriate for services performed by a nonresident outside that State, it is unlikely that the country where services are performed will give up its right to tax and therefore such a provision is unlikely to serve as an effective model for bilateral agreements. While the UN Model reflects different interests than the OECD Model and different rules are therefore appropriate in some cases, it should be considered if deviating from a rule in the OECD Model that reflects unanimous agreement among OECD member countries will inevitably lead to conflicts in treaty negotiations. Doing so will likely encourage countries to take aggressive unilateral positions (in the absence of a treaty). The adoption of this rule on a unilateral basis will increase double taxation, reduce cross-border trade and increase costs for local consumers.

This is an argument that really goes to the heart of what the UN model is for. I think the ICC’s concern is that including an article sanctioning withholding taxes on technical fees in the model treaty will embolden developing countries to insist on the right to levy such taxes, and that this will make it harder for them to reach agreement with developed countries. That’s purpose 3.

An opposite argument, of course, would be that the UN committee, with members from OECD and non-OECD countries, should be in a good position to formulate an article that reconciles the concerns of OECD members and non-members. That’s purpose 2.

Following the ICC’s argument cited above, the model treaty’s job is not to provide a template that is to be used where countries do agree to include a particular provision. It is about circumscribing a definition of what is considered reasonable behaviour by a developing country. Keep it out of the model, they are saying, to discourage developing countries from doing it altogether.