“Tax, Law and Development”: recommended reading for campaigners

This spring, two academic books have come out that offer an opportunity to look at tax and development from different perspectives. “Critical Issues in Taxation and Development” edited by Clemens Fuest and George Zodrow is going to be the economists’ take, using “modern empirical methods” to answer a lot of “what is the effect of X on Y” questions. I haven’t got my hands on it yet, but in the meantime I’ve been reading “Tax, Law and Development” edited by Yariv Brauner and Miranda Stewart.

The contributors to Tax, Law and Development don’t follow a strict empirical approach, rather they give their own reasoned opinions on how various laws, policies and institutions in international tax affect developing countries, and how they might be changed for the better. This is a work of critical legal scholarship, a position staked out by its editors in the book’s introduction, which argues that “we cannot avoid the challenge of tax competition by calls to end taxation of mobile capital, even if this may be perceived to be a theoretical economic inevitability.”

The book covers “on the ground” issues such as tax expenditure reporting in India and fiscal federalism in China, as well as international tax justice topics such as tax treaties, information exchange and country-by-country reporting. Each reader will find different parts interesting, and so here I’m going to pick out a few chapters that were the most useful for me.

Quite a large chunk of the book covers tax incentives, reflecting how big an issue this is for tax and development policy. Brauner and Luis Eduardo Schoueri’s chapters demolish the idea that tax incentives are purely a domestic policy issue for developing countries, by looking at how they interact with tax treaties and national policy in developed countries.

A controversial mechanism through which this can occur is tax sparing, through which a developed country offers its tax residents a credit against its tax bill for the tax they would have paid in a developing country, even if that country waives the tax to encourage investment. This way the taxpayer gets to keep the benefit from the tax incentive, rather than it being captured by their home state. As Brauner points out, policy advice from developed country-dominated organisations such as the IMF and OECD has for some time been that tax incentives are a poor use of the money, yet by continuing to give tax sparing agreements in their treaties, these governments keep on encouraging it.

Schoueri’s paper also discusses matching credit, a quasi-incentive included in some tax treaties whereby a developing country agrees to lower its withholding taxes on inward investment, but the developed country at the other side continues to offer a credit as if withholding taxes were still levied at higher non-treaty rate. A mainstay of Brazil’s tax treaty network in the 1970s, this mechanism ensures that inward investors, rather than the treaty partner’s fisc, benefit from the lower rate.

Many countries – including, increasingly, the UK – exempt their residents’ overseas profits altogether, in which case tax sparing and matching credit may be less relevant considerations. Here Schoueri argues that the system currently has inbuilt a kind of distorting reverse tax sparing: when the residence country decides not to tax some of its residents by exempting their foreign income from taxation, the source country is prevented by tax treaties from claiming this untaxed income for itself. As described above, when it’s the source country that foregoes revenue, it can be captured by the residence state. Schoueri argues for a more symmetrical arrangement.

Tracy Gutuza’s chapter on the South African headquarters regime is also about the impact of a tax incentive on developing countries. This one was created by the South African government to compete with the tax haven of Mauritius as the base for multinationals’ holding companies when investing into the rest of Africa. Who can blame them, I wondered, when even the UK is joining in the race to the bottom? Nonetheless, it’s a cautionary tale about the need to look at the BRICS with a critical eye. The regime twice fell afoul of the OECD’s 1998 definition of harmful tax practices, and Gutuza argues that the resulting social pressure was enough for it to be withdrawn or modified in both cases…except that as of 2011 it’s back.

Towards the end of the book comes a series of chapters preoccupied with this kind of social pressure. Pasqual Pistone is concerned about the solidification of “a kind of global norm concerning the exercise of taxing jurisdiction” as legal fact, Heather Stewart the “hybrid mode of global tax governance” emerging from tax information exchange cooperation, and Allison Christians “whether awakening public attention to multinational tax planning will provoke sufficient political attention to compel paradigmatic change.”

The latter paper was an interesting read for me, because it devoted quite a bit of space to the drafting of a report within the OECD tax and development task force [pdf] in which I was a participant. It’s interesting that to the outside observer, basing her analysis on published documents, certain events in the process took on a much greater significance than they did to those of us involved at the time, while other occurrences that felt much more significant don’t get a mention because they took place in private. One could say that this demonstrates the limits of desk-based research, but actually it made me rethink my own understanding of what happened at the time, as well as of the importance of the written record.

This is another good reason for campaigners to read this book. Not just to expand their hinterland, but also to see how their movement and the issues they work on are seen from a different, and largely sympathetic, perspective.