FRAMING THE QUESTION AS ONE OF AUTONOMY

What is the good that is endangered by tax competition? Why should we be worried about this practice? The short answer, which I will develop in detail in section 3 of this chapter, has two components.

First and foremost, and this is the core claim of this book, tax com-petition undermines fiscal self-determination. Second, tax compe-tition tends to widen the income gap both between capital owners and everyone else, and between rich and poor countries. As we shall see later, the exception to the latter rule are situations where small, poor countries manage to use tax competition to improve their lot.

The present section focuses on the first component. An evalua-tion of tax competievalua-tion and its impact on fiscal self-determinaevalua-tion can be conducted at different levels of abstraction. Starting at a relatively high level of abstraction, the instinct of political philoso-phers would be to provide a normative foundation for the desira-bility of the (fiscal) self-determination of states in the first place.

Why is a world of states with a certain level of autonomy desir-able? In answering this question, the ideal of giving individuals a

say in the decisions that affect their lives will have to be weighed against the potential injustices involved in granting a community the right to make autonomous decisions without taking into ac-count the situation of nonmembers. The outcome of a reflection of this kind might conceivably be that we should abolish the state structure in which tax competition happens in the first place in favour of some type of world government. Or we might conclude, more plausibly in my opinion, that a convincing justification for the state structure can in fact be formulated.¹ In either case, there will be considerable philosophical disagreement before we even get to the question of tax competition.

Alternatively, and starting at a lower level of abstraction, we can take a number of features of the world today as parameters rather than as variables of our normative reflection.² In the context of tax competition, the existence of states as political units with a consid-erable level of autonomy is an obvious candidate for a parameter of this sort. My book adopts this second, pragmatic approach. Even if, and this is an open question, a world carved up into states turns out to be a second-best world from a normative viewpoint, states will not disappear in the near future. From this perspective, a philosophical reflection that analyses a world without states would at best be prac-tically irrelevant. Worse, as Aaron James puts it, ‘abstracting away from the embedding international form of the global economy’

1. I propose such a normative justification of the state in Peter Dietsch, ‘The State and Tax Competition–A Normative Perspective’, in Political Philosophy and Taxation, ed. Martin O’Neill and Shepley Orr (Oxford: Oxford University Press, forthcoming). Cf. also Simon Caney, ‘Cosmopolitan Justice and Institutional Design: An Egalitarian Liberal Conception of Global Governance’, Social Theory and Practice 32, no. 4 (2006): 725.

2. Daniel Weinstock’s way of approaching ethical questions in this way has had an impor-tant influence on me over the years. In fact, any ethical evaluation takes for granted some features of the world; the only question is how fundamental the assumed features are.

For example, in imagining a world without borders, one would still rely on a battery of assumptions about human motivation and their impact on the feasibility of alternative institutional arrangements.

might ‘obscure the question of how a distinctive class of fairness re-sponsibilities could emerge from that kind of social relationship.’³ The goal of this book is to identify this distinctive class of fairness responsibilities in the context of international tax governance.

One might object to this framing of the normative question that it is philosophically unsatisfying not to push for the ‘ultimate’

normative justification of one’s position. Yet, this objection misses the point. The question ‘How should we design our fiscal institu-tions in an international context?’ is underdetermined. If the ques-tion refers to a scenario where we are setting up the instituques-tional framework from scratch, then it would indeed be philosophically unsatisfying to take states as given. However, if the question refers to our world today, then it might on the contrary be counterpro-ductive to draw the existence of states into question. Both of these projects are worth pursuing, but they are fundamentally different projects and this book is engaged in the latter.⁴

Having said that, taking states as political units with a consider-able level of autonomy as given does not imply writing them a blank cheque as to how they exercise this autonomy. First, states and their citizens may well have obligations of justice or of assistance towards others that trump their right to self-determination.⁵ For example, one might think that duties of humanitarian assistance trump the right to self-determination. This is an important qualification to self- determination, but one that I set aside for the purposes of this book.

3. Aaron James, Fairness in Practice (Oxford: Oxford University Press, 2012), 13.

4. I purposefully avoid the terminology of ideal versus non-ideal theory here because I agree with Laura Valentini that it needs to be specified further to be useful. See Laura Valentini, ‘Ideal vs. Non-ideal Theory: A Conceptual Map’, Philosophical Compass 7, no.

9 (2012): 654–64.

5. Considering that self-determination reigns supreme opens one up to what Simon Caney calls the ‘wrong priorities objection’, which holds that a polity cannot reasonably ignore what is going on beyond its borders. See Caney, ‘Cosmopolitan Justice’, 732.

Second, taking for granted the autonomy of states without looking into the forms through which this autonomy manifests itself would indeed be unsatisfactory from a philosophical per-spective. It does matter who exercises the (fiscal) autonomy of the state. More specifically, it makes a difference whether fiscal policy reflects the democratic preferences of the citizens of a country as opposed to being imposed upon them by a ruling elite. Even without delving into the normative foundations of the idea, the whole point of self-determination is to give people a say over the decisions that affect them. Democratic institu-tions, while imperfect, represent the best framework available to achieve this goal.

At least for part I of this book, I will therefore make the idealiz-ing assumption that governments track their citizens’ democratic preferences.⁶ I acknowledge that this is an unrealistic assumption, since government actions often are the result of rather messy and contentious political processes, in which different groups of citi-zens pursue different interests. It is, in reality, not necessarily true that differences in political preferences within the polity of a state are less important than differences between polities.

What is more, someone might observe that this is an odd as-sumption to make for someone like me, who aims at normative reflection with practical relevance. Am I limiting my analysis to countries with democratically elected governments? Could a par-tial regulation of tax competition between such countries ever be effective if big economies such as China are not on board? These are legitimate questions, and chapter 4 will take them up by relax-ing the idealizrelax-ing assumption made here. However, not makrelax-ing

6. For a discussion of the problems associated with this assumption, see Alexander Cap-pelen, ‘Responsibility and International Distributive Justice’, in Real World Justice, ed.

Thomas Pogge and Andreas Follesdal (Dordrecht: Springer, 2005), 220–22.

this assumption at the outset would render self-determination too weak a foundation to carry the normative weight of the regulation of tax competition I will defend.

To sum up, the scope of the normative evaluation of tax com-petition I will develop here is limited in two ways. First, it will take for granted the organization of the world into states with a consid-erable level of autonomy; second, I will assume that this autonomy is exercised through democratic decision making, an assumption that will only be relaxed in a later chapter. The regulation of tax competition I will defend is one that applies to democratic states in the first instance, but that can be extended to include non- democratic ones.

So, if we accept the existence of states as political units with a considerable level of autonomy, what exactly does this mean in the fiscal context? What is the content of fiscal self-determination that tax competition poses a threat to?

In the public finance literature, a stylized definition of fiscal self-determination covers two basic choices regarding the size of the public budget (the level of revenues and expenditures relative to GDP) and the question of relative benefits and burdens (the level of redistribution).⁷ Call these choices the autonomy preroga-tive. Importantly, they extend to the means selected to realize them, as for instance the calibration of the tax mix between direct and indirect taxes. The two elements of the autonomy prerogative will play a key role in my argument.

Before demonstrating how tax competition undermines the au-tonomy prerogative thus defined, I shall now turn to a more detailed description of the various forms that tax competition can take.

7. See, for instance, Avi-Yonah, ‘Globalization’.

2. UNDERSTANDING TA X COMPETITION . . . To assess its impact, it is imperative to understand how tax com-petition actually works.⁸ In the introduction, I defined tax compe-tition as the interactive tax setting by independent governments in a noncooperative, strategic way. For tax competition to exist there must be fiscal interdependence. This condition holds when the fiscal policy of one jurisdiction creates externalities for other jurisdictions in the sense that it affects their tax bases. While tax competition occurs at all levels of government, from competition between municipalities to competition between states, this book focuses on the latter. Tax competition takes a variety of forms. It operates not only through lower rates but also through the defini-tion of the tax base, preferential tax regimes for foreigners, loop-holes, or other regulative measures such as bank secrecy. Owing to its mobility, capital is the prime target of tax competition.⁹ Three types of capital can be distinguished to illustrate different aspects of tax competition.

First, states compete for portfolio capital. Investors have an incentive to shift their cash, security, and equity holdings to

8. Sections 2 and 3 of this chapter are based on Peter Dietsch and Thomas Rixen, ‘Tax Com-petition and Global Background Justice’, Journal of Political Philosophy 22, no. 2 (2014):

150–57. However, to ensure a consistent style throughout the book, I here speak in the first person singular even in co-authored passages. For comprehensive overviews of how tax competition works, see Avi-Yonah, ‘Globalization’; and Rixen, The Political Economy of International Tax Governance. Palan et al., Tax Havens, offers a wealth of insights on the workings of tax competition and provides data to illustrate them. As for models of tax competition in the economics literature, chapter 3 of this book will provide a detailed review.

9. States may, in theory, also compete to attract mobile individuals via taxes on labour income. Empirically, while there is some competition for individuals in very high income brackets, labour tax competition is insignificant; cf. Peter Schwarz, ‘Does Capital Mobil-ity Reduce the Corporate-Labor Tax Ratio?’, Public Choice 130, no. 3 (2007): 363–80.

countries where tax rates on their earnings are lowest.¹⁰ Doing so has not always been both possible and a financially attractive thing to do. Until the early 1980s, exchange controls were in place in many developed economies, limiting the ability of their citizens to shift their wealth to other countries. Moreover, with-holding taxes used to be common, meaning that one’s tax burden did not necessarily fall when moving assets abroad. However, after a unilateral move by the United States to abolish withhold-ing taxes in 1984 triggered a huge flow of portfolio investment into the United States, the governments of other developed na-tions were forced to follow suit and withholding taxes became unpopular.¹¹

Tax havens target individual and corporate portfolio capital through a combination of low or even zero rates with legal provi-sions such as bank secrecy or trusts that obscure the ownership of capital holdings. Often, this involves the setting up of a number of shell companies to make life difficult for fiscal forensics teams.¹² Now, if you are a ‘respectable’ person and you do not want to set up your tax avoidance structure on some little island, an innovative study by Jason Sharman has shown that a more comfortable and

10. For a more detailed account of the various assets that fall into the category of portfolio capital, see Tax Justice Network, Tax Us if You Can, 12–13.

11. See Avi-Yonah, ‘Globalization’, 1579.

12. Nicholas Shaxson provides a nice illustration of this kind of structure: ‘A Mexican drug dealer may have $20 million, say, in a Panama bank account. The account is not in his name but is instead under a trust set up in the Bahamas. The trustees may live in Guernsey, and the trust beneficiary could be a Wyoming corporation. Even if you can find the names of that company’s directors, and even get photocopies of their passports—that gets you no closer: These directors will be professional nominees who direct hundreds of similar companies. They are linked to the next rung of the ladder through a company lawyer, who is prevented by attorney-client privilege from giving out any details. Even if you break through that barrier you may find that the corporation is held by a Turks and Caicos trust with a flee clause: The moment an inquiry is detected, the structure flits to another secrecy jurisdiction’. Nicholas Shaxson, Treasure Islands—Uncovering the Damage of Offshore Banking and Tax Havens (Basingstoke: Palgrave Macmillan, 2011), 27.

even less risky alternative is available.¹³ In the wake of the crack-down on money laundering, corruption, and tax evasion by inter-national organizations over the last decade, Sharman set out to test how effective the adopted measures were. Contacting fifty-four fi-nancial service providers in twenty-two countries, he attempted to ‘found anonymous corporate vehicles without proof of iden-tity and then to establish corporate bank accounts for these vehi-cles.’¹⁴ Out of the seventeen providers who offered step 1, thirteen were firms not in a remote island tax haven but, rather, in OECD countries. As Sharman points out, the United States and Britain are among the countries that have chosen to leave their financial service providers unregulated, while imposing strict standards on so-called tax havens. While only five providers out of the whole sample offered step 2—the corporate bank account—this is still one in ten for a practice that is supposed to be strictly prohibited.

All of these practices make it impossible for the revenue agencies entitled to tax the capital in question to trace it.

Tax evasion of this kind is obviously illegal, which makes it hard to come up with reliable estimates of the magnitude of these activities. However, the figures that do exist suggest that it is signif-icant. Estimates for the annual revenue loss to governments from this kind of tax competition range between US$155 and US$255 billion.¹⁵ To add insult to injury, some of the wealth parked off-shore in this way is subsequently reinvested in the home country

14. Sharman, ‘Shopping for Anonymous Shell Companies’, 129.

15. See Jeffrey Owens, ‘Written Testimony of Jeffrey Owens, Director, OECD Center for Tax Policy and Administration before Senate Finance Committee on Offshore Tax Evasion, 3 May 2007’, accessed 9 December 2011, <http://finance.senate.gov/imo/

media/doc/050307testjo1.pdf>; Tax Justice Network, Tax Us if You Can.

13. Jason C. Sharman, ‘Shopping for Anonymous Shell Companies: An Audit Study of Anonymity and Crime in the International Financial System’, Journal of Economic Per-spectives 24, no. 4 (2010): 127–40; and Jason C. Sharman, ‘Testing the Global Financial Transparency Regime’, International Studies Quarterly 55 (2011): 981–1001.

of the tax evader as foreign portfolio investment (FPI). This phe-nomenon is called ‘round-tripping’ and has to be distinguished from tax havens acting as conduits for legal forms of corporate tax avoidance. Recent empirical studies suggest that round-tripping is an important phenomenon. In one of the first estimates of the effect of tax evasion by investors on cross-border investment in debt and securities, in this case for the United States, Hanlon et al. report two revealing findings. First, they ‘estimate that a 1%

increase in the top U.S. ordinary tax rate results in an approxi-mate 2.1% to 2.8% increase in inbound equity FPI from tax havens relative to non-havens.’¹⁶ Second, they show that the signing of TIEAs (tax information exchange agreements) with tax havens results in a decrease of FPI of up to a third from these countries.¹⁷ In developing countries, where the proportion of wealth held off-shore sometimes exceeds 50 percent,¹⁸ one would suspect round- tripping to be even more prevalent.

To complete the picture of tax-avoiding strategies for portfo-lio capital, another practice has to be mentioned, even though it falls outside the remit of international tax competition. The fiscal systems of several countries offer internal, and legal, loopholes for individuals to reduce their tax bills. They have recreated at home many of the opportunities of tax evasion that exist internationally, but in ways that are legal and therefore give the practices a veneer of legitimacy. A striking example of this is the trust industry in the United States. As documented by the ‘Artful Dodgers’¹⁹ series on bloomberg.com, the ways in which several U.S. states jostle

16. Michelle Hanlon et al., ‘Taking the Long Way Home: U.S. Tax Evasion and Offshore Investments in U.S. Equity and Debt Markets’, Journal of Finance 70, no. 1 (2015): 259.

17. See Hanlon, ‘Taking the Long Way Home’, 260.

18. See Tax Justice Network, Tax Us if You Can, 3.

19. Bloomberg News, ‘Artful Dodgers’, accessed 6 February 2014, <http://topics.bloomberg.

com/artful-dodgers/>.

for out-of-state wealth are multiplying, attracting vast sums of cap-ital and seriously denting fiscal revenues in other states and at the federal level. For example, by using incomplete non-grantor trusts possible in Delaware or Nevada, residents of states with a relatively high state income tax, such as California or New York (13.3% and 12.7% marginal tax rate, respectively, on taxable income exceed-ing $1 million), can avoid these levies altogether because Nevada does not have a state income tax and Delaware’s income tax only applies to state residents.²⁰ Another striking example are so-called dynasty trusts set up in South Dakota that allow rich Americans to shield, for generations to come, some of their wealth from the federal estate tax of 40 percent.²¹ Now, these are forms of intra-country tax competition, which is not the focus of this book.

However, it is plausible to think that states will be more tolerant towards this kind of tax avoidance in a situation where the alterna-tive is to see capital flow into tax shelters abroad. If the latter issue were addressed, pressure to tighten regulation of intra-country tax

However, it is plausible to think that states will be more tolerant towards this kind of tax avoidance in a situation where the alterna-tive is to see capital flow into tax shelters abroad. If the latter issue were addressed, pressure to tighten regulation of intra-country tax