Response to the OECD consultation on taxation of the digital economy: taking the politics seriously

Yesterday I was part of a group of political scientists who made a submission to the OECD’s consultation on taxation of the digital economy. The text of our submission, also available as a PDF document, is below, first published on Rasmus Christensen’s website.

The undersigned are a group of political science academics working on issues of international taxation. Such a coalition has rarely involved itself in the OECD’s technical consultations. This submission reflects two compelling factors. First, the global tax system and its governance stand at a critical junction. The current debate on solutions to the tax challenges of digitalisation has the potential to shape global tax policy and its outcomes for countries and citizens across the world for decades to come – and this has motivated us to prepare this submission. Second, our research offers important insights that can help the global tax policy community pursue sustainable reforms. Below, we offer some general comments before moving to specific responses to the consultation questions.

Vincent Arel-Bundock, Université de Montréal; Rasmus Corlin Christensen, Copenhagen Business School; Lukas Hakelberg, University of Bamberg; Martin Hearson, London School of Economics and Political Science; Wouter Lips, Ghent University; Thomas Rixen, University of Bamberg; Indra Römgens, Roskilde University and Radboud University; Leonard Seabrooke, Copenhagen Business School; Laura Seelkopf, Ludwig-Maximilians-Universität München; Saila Stausholm, Copenhagen Business School; Duncan Wigan, Copenhagen Business School

General comments

We wish to highlight three key considerations for effective and sustainable action on the tax challenges of digitalisation.

  1. The objectives of the consultation and the taxation of the digital economy policy discussion more broadly are as much political as they are technical. By ‘political’ we mean that the drivers of this consultation are rooted in the popular politics of taxation, and that the political implications of policy solutions are not incidental or secondary considerations. This includes the consequences for inter- and intra-national (re)distribution, for citizens’ experiences of fiscal systems, for the viability of global tax governance, and for the wider economic transformations occurring as a result of digitalisation, where tax policy will help determine winners and losers. Historically, the relative isolation of international tax policy-making from popular politics helped produce a remarkably stable cross-border tax system. However, isolation challenges responsiveness to political demands for change. In today’s context, international tax politics has become both more mainstream and highly politicized. The risks of not engaging proactively with diverse political stakeholder interests – including ordinary citizens, civil society, business groups (large and small), academia, etc. – are significant. For instance, one reason for the recent struggles of multilateral trade cooperation is that the trade agenda extended into areas where social and environmental concerns implicated new political actors. Yet, the multilateral regime continued to treat these issues through a narrow trade lens. Technical approaches to taxing the digital economy are unlikely to be sustainable unless their substance and the process by which they were produced are perceived as fair by a broad range of stakeholders.
  • The recent expansion of the OECD’s tax policy-making institutions to include non-OECD members brings important dilemmas. While this expansion represents an important step towards global inclusiveness and accountability, it also calls into question the balance between inclusiveness and the coherence of the global tax system itself. Global economic shifts are raising the profile and influence of historically marginalised countries in global economic governance. In some cases, incrementalism has been enough to satisfy ‘rising powers’; in others, dissatisfaction with the status quo has led to the pursuit of outside options or to stalemate over wholesale reforms. The balance between building on the work undertaken over decades and responding to these new challenges is critical for achieving effective and coherent global action on the tax challenges of digitalisation. Institutional expansion at the OECD challenges the historical division of labour between the OECD and other bodies for international tax cooperation (such as the United Nations), which allowed one group of like-minded countries to move quickly while the process of global consensus-building could take place at a necessarily slower pace. We believe that the success of institutional expansion is contingent on a serious reconsideration of policies and processes that were not historically designed to accommodate the interests of emerging and developing countries. To turn again to the example of international trade cooperation, developed countries’ unwillingness to respond to developing countries’ longstanding concerns about agricultural protectionism was a major contributor to the breakdown of the talks.
  • The move towards binding, global cooperation on taxation creates costs as well as benefits. The reluctance of governments to enter into binding cooperation has shaped the global tax system for a century, at times hindering effective action and enabling harmful tax competition. Commitments to strong cooperation on international taxation are a key prerequisite for governments’ abilities to make and enforce fiscal policies in their own interests. Moreover, given the significance of the tax challenges of digitalisation, and the increasing willingness of states to act unilaterally, the risks of furthering cross-national mismatches and unintended externalities (in the form of double taxation or double non-taxation) in the international corporate tax system are high. Nonetheless, setting the bar too high creates a risk of short-term failure, as the OECD experienced in the past with the Multilateral Investment Agreement, or long-term instability as countries defect from binding agreements. In this context, the sustainability of any policy option depends on managing effective cooperation that prevents harmful tax competition while recognising that it is contingent on meeting the interests and expectations of all its members, and limiting incursions into the design of national tax systems when such a balance is not feasible. Moreover, it is important that each government is open and transparent with its domestic stakeholders about the likely costs and benefits of entering such cooperation

Specific comments

What is your general view on the proposals? In answering this question please consider   the   objectives,   policy   rationale,   and   economic   and   behavioural implications.

  • Distributional considerations should be foregrounded. Discussing the three suggestions on revised profit allocation and nexus rules, the consultation document usefully acknowledges that while they all have the objective of recognising value created in market jurisdictions, their implications for shifts of taxing rights are different. These differences, which we take to be highly significant, have implications for the considerations on effective action outlined above. Of the three proposals, the ‘significant economic presence’ idea, given its greater sectoral scope, seems to offer the potential to shift taxing rights covering most profit, although this would naturally be contingent on the final design of the mechanics.
  • The emerging differences between taxation on the basis of source and residence vs. market/destination merit further consideration. The Inclusive Framework is committed to considering solutions that reallocate the tax base. In today’s economy, the distinction between source and residence taxation is indeed increasingly unhelpful; yet, there is a risk that a singular emphasis on ‘market jurisdictions’ may unduly disadvantage traditional source jurisdictions without sizeable markets and limited purchasing power. The interests of these jurisdictions – often less powerful and underrepresented at the OECD – should receive significant attention.

How would you suggest that the rules should best be co-ordinated?

  • Coordination design is contingent on meeting stakeholder expectations. A number of implementation measures are available to the Inclusive Framework, including standard-setting, peer review, blacklisting and sanctioning, which have proven effective to varying degrees. These measures differ in their balancing of binding ‘lock-in’, national flexibility to pursue government policy choices (especially as regards raising effective capital taxation), and international redistribution. All of these critical considerations are interrelated and must be taken into account together in coordination design. For instance, the reopening of the distributional debate on allocation issues has become necessary because of the challenges faced by the current international tax system in enforcing effective capital taxation. Thus, on the one hand, should a workable and commonly agreeable solution that matches all members’ distributional interests and national policy choices be found, strong and binding cooperation is preferable. If, however, and we see a real risk of this, the envisaged solution is unfavourable to emerging/developing countries (see previous paragraph), then strong and binding cooperation is undesirable.

What could be the best approaches to reduce complexity, ensure early tax certainty and to avoid or resolve multi-jurisdictional disputes?

  • The consultation should seek to refocus public debate away from ex post criticism of the outcomes of tax rules once they are implemented, and towards ex ante debate over rules as they develop. A core component of tax certainty is political stability – the certainty of a tax position given the likelihood of future political action affecting that position. Such action may be in the form of legislative initiatives that change tax results, changed administrative practice, or public pressure on companies to alter approaches to tax planning. The stability of any policy solution(s) on the tax challenge of digitalisation developed by the Inclusive Framework depends critically on engaging with the voices and objectives of a broad range of stakeholders, and on a reconsideration of entrenched interests. In this context, the limitations of the consultation to primarily consider ostensibly technical questions on ‘aligning value creation’ may hinder positive engagement with a broader range of stakeholders. Such consultation design erects barriers of language and expertise that limit diverse engagement, closing off stakeholder engagement. In turn, this may negatively affect the likelihood that its policy outcomes will be broadly seen as fair.
  • Deeper and broader stakeholder engagement. In this context, we encourage the OECD and the Inclusive Framework to pursue more proactive engagement with non-traditional and diverse stakeholders in relation to the tax challenges of digitalisation. At the national level, this should mean an active approach to education and consultation with stakeholders around national negotiating positions, and parliamentary debate over the adoption of new rules that moves beyond the rubber-stamping that has thus far characterised the adoption of BEPS outcomes by most countries. At the multilateral level, this would go beyond the currently institutionalised TUAC and BIAC partnerships and the few substantive consultation letters received from non-expert interests, and would include sustained interactions on questions of the political implications of the tax challenges of digitalisation, including the inter- and intra-national distributional implications. Inspiration could, for instance, be drawn from other policy domains of the OECD where non-state actors have been successfully integrated through increased voice and access channels, implementation partnerships, institutionalised reviews, etc. More generally, we suggest the Inclusive Framework could – at a minimum – set out its formal ambitions for the involvement and diversity of stakeholders in global tax policy-making, and specific initiatives to achieve these ambitions.

China’s challenge to international tax rules and the implications for global economic governance

Hearson, M & W Prichard, 2018. China’s challenge to international tax rules and the implications for global economic governance, International Affairs 94(6): 1287–1307.

In scholarship on international economic governance – areas such as trade, the monetary system and development assistance – a lot of attention is now devoted to the rise of China. This literature appears to be settling on a consensus that China is a cautious reformist rather than a supporter of more dramatic change, and that it pursues outside options where existing institutions do not serve its interests. Meanwhile, work on the politics of the international tax regime is still largely preoccupied with the power that the US, as a ‘great power’, wields on the international tax regime. Our view is that this underestimates the influence a rising power can wield, and so we try to link the two literatures up. We focus on the Arm’s Length Principle, which underpins OECD-led international agreement on the distribution of multinational companies’ tax bases through transfer pricing. This international regime differs from areas such as trade and aid, which have fragmented in recent years, because it is a cooperation regime characterised by strong incentives for states to find and follow multilateral agreement.

Interests: Chinese exceptionalism

We begin with China’s interests. They align neither with developing countries, despite official rhetoric to that effect, nor with OECD countries. This is partly because China is undergoing an economic transition, summarised in table 1: its past, present and future interests differ from each other. In bilateral tax treaties, China has been able to manage this situation by adopting different negotiating stances with developing countries compared to developed countries. It faces more of a challenge in multilateral negotiations.

china1

China’s interests are also different because of what it calls its location specific advantages (LSAs). As a tax administration document states:

China has a huge population and a fast-growing middle class that form a great market capacity and huge consumer groups. This factor is unique in the world and inimitable by other small and medium-sized developing countries.

By arguing that the LSAs firms obtain from operating in the Chinese market (roughly divided into location savings for manufacturing, and market premiums for retail) are unique to it, China avoids the need to choose between its old and new interests. It has simply begun to claim a larger share of multinational firms’ taxable profits. We quote from an article written by some staff of the law firm Baker Mackenzie:

Most multinationals do not realize that their strategy of allocating ‘routine profits’ to China is under severe attack. To quote a Chinese tax director who has negotiated extensively with the Chinese tax authorities, ‘[i]t became clear that the State Administration of Taxation believes China has unique factors, including location savings and market premiums, that are not addressed by the OECD Transfer Pricing Guidelines […]’.

Capabilities: often underestimated

China has a particularly strong position in international tax negotiations because the same economic transition that is changing its preferences is also strengthening demand from multinationals to access its markets. Previous work by Lukas Hakelberg and Wouter Lips has focused on absolute market size, where China lags behind the US and EU, but we think three other variables also matter:

  1. Growth. China is undergoing huge economic and social shifts that make it a uniquely attractive place to do business, whether measured by the exploding size of its middle class, or its ascendency towards the top of the patent registration league tables. China’s attraction to investors is thus about future potential as well as present performance.
  2. Profitability. Its fairly new and rapidly growing consumer market is relatively untapped in many areas, has a taste for foreign goods and services, and is more willing to pay a premium for higher-quality products.
  3. Value-chain positioning. Chinese manufacturing has become indispensable to the production of a huge proportion of products consumed in the West, most iconically the iPhone, and this position is becoming increasingly institutionalized.

For these reasons, China can afford not to take too seriously any threats from multinational companies and foreign governments if it differs from international tax norms, giving it the kind of autonomy that only the US was thought to possess.

Strategies: Janus-faced

LSAs allow us to analyse how China has interacted with the established institutions of global tax governance. We conclude that its approach is neither conciliatory nor confrontational, but both, simultaneously. China adopts a rhetoric of common cause with developing countries, but pursues an agenda that is designed to maximize only its own share of the tax ‘pie’. It flirts with outside options such as the United Nations, while enjoying a privileged position within the G20-OECD complex at the heart of international tax rulemaking, and diverging from existing rules when it finds this to be in its interest. “China needs to strike a balance between conforming to international conventions and acknowledging its unique situation in transfer pricing legislation and practice,” wrote Chinese officials in a United Nations document in 2017. In practice, however, its actions have been more aggressive than this might imply.

In particular, China’s implementation of LSAs chips away at a core norm of the international tax regime, the Arm’ Length Principle (ALP). OECD rules require that the ALP be applied to each subsidiary of a multinational in isolation, in comparison to a locally owned independent enterprise. By contrast, the Chinese position is that:

With more and more companies poised to conduct business as groups, economic activities are more and more likely to take place in the inner circle of MNE groups. It is nearly impossible to take out one piece of a value chain of an MNE group and try to match it to comparable transactions/companies

This has ruffled some feathers, as can be seen in this quote from the United States’ former international tax negotiator, Robert Stack:

The OECD countries all ascribe [sic] to the arm’s-length standard and to what they call the basic OECD principles. Other countries have not signed on to the full implementation of the arm’s-length standard and the OECD guidelines, even countries that are in the G-20. And the reason this is very important is the question of market premium and intangibles that relate to markets and things like location-specific advantages that are specifically talked about in the OECD guidelines … [China should] not pick a rifle-shot issue that favors a large-market country and try to gerrymander the debate from that narrow issue.

The destabilising effect of China’s actions could lead to one of two outcomes, we suggest. In the first scenario, China would behave very much like the United States, throwing its lot in with the G20-OECD complex. Its growing influence would allow it to use a combination of incremental changes at global level and selective unilateralism to adapt as its place in the global economy evolves. In the second, by design or by accident, China’s approach could destabilise the core norms of the international tax regime. By opening cracks in the existing system, LSAs may induce other countries—perhaps led by other large emerging markets—to seek their own accommodations, thus placing increasing strain on the multilateral foundations of the international tax system. It remains to be seen whether China’s successful challenge to the ALP will similarly prompt subsequent challenges from elsewhere.

“A gathering of international chatterers for the purpose of chattering.” The birth of the OECD’s Committee on Fiscal Affairs.

In my previous post I explored the United Nations’ brief post-war flirtation with a Fiscal Commission, which came stuttering to a halt in 1951 due, it seemed, to the lack of a compelling purpose that might have motivated states to fight to retain it. The United Kingdom had supported a Russian proposal to wind up the UN’s tax work, a position that seems consistent with its subsequent opposition to the creation of what is now the UN Committee of Experts on International Cooperation in Tax Matters two decades later. It’s perhaps more surprising that, as we will see, the British were initially opposed to the creation of a Fiscal Committee at the Organisation for European Economic Cooperation (OEEC), the predecessor of the OECD, as well. Today the UK is a strong supporter of the OECD’s position as the dominant site of international tax cooperation, but it did not start out that way.

We begin, as the League of Nations’ tax work did, with a resolution of the Executive Committee of the International Chambers of Commerce resolution, in 1954. The resolution identified double taxation as a “serious obstacle” to trade and investment in Europe, and for OEEC members to take steps to relieve it. It asked for unilateral measures, bilateral treaties and, ideally, a multilateral convention. The OEEC’s secretary general was sceptical that the organisation could add any value here, especially given that the UN had not at this point formally dissolved its Fiscal Commission.

He also set out another surprising objection to the ICC’s proposal. It is often asserted that the OEEC picked up the League of Nations’ London draft model bilateral tax treaty, which favoured the interests of capital exporters, rather than the capital importer-favouring Mexico draft. While it is probably true that the eventual OECD model is closer to the London than the Mexico draft, the ICC’s proposal that the OEEC use the London draft was actually a problem for the OEEC, because not all of its member and associate countries had endorsed it. “If an approach of this kind were to be adopted by the OEEC, therefore,” concluded the Secretary General, “it would be necessary for the Organisation to set up an expert body charged with the duty of attempting to produce a more acceptable draft.”

Extract from OEEC Secretary General's memo, 12 November 1954

Soon after this, Switzerland and the Netherlands began to circulate proposals for a fiscal commission. In a curious echo of the current debate around digital taxation, these proposals all expressly mentioned turnover taxes, increasingly imposed by states on the rendering of services, as the main new problem motivating their concerns.

The Dutch note circulated in 1955 noted that “the number and extent of problems relating to taxation has been steadily increasing, not only in the national field but also and especially, in connection with the gradual intensification of international economic relations, in the international sphere.” It advocated work under the umbrella of the OEEC because it was consistent with the organisation’s mandate, and because of the need to discuss in “a smaller circle than the United Nations.” In December 1955 the Netherlands and Switzerland were joined by Germany, publishing a joint memorandum proposing the creation of a expert committee of “specially qualified high-ranking Government representatives,” and in January 1956 an ad hoc committee was created to conduct a study into the matter. The ad hoc committee immediately recommended the creation of a full committee, citing “ample evidence that there are cases of double taxation which constitute obstacles to international trade and investment, and that action to remove these obstacles should be possible within a group of like-minded nations such as the members and associated countries of the OEEC.”

Extract from Dutch memo to the OEEC, 11 July 1955

In March 1956, the Fiscal Committee was created, against the judgement of the British and Scandinavians. Britain’s attitude throughout had been sceptical, but acquiescent. The British representative, Sir Hugh Ellis-Rees, “criticised the memorandum for being vague and for not revealing what the usefulness of the study would be, nor what were its precise objectives.” On the other hand, he told the Inland Revenue, “I think that in our position in the organisation it would be tactically unwise to try to suppress at this stage a movement which has some support however ill-founded it may turn out to be.” Two handwritten notes in the Inland Revenue files are worth quoting at length here. One is from Alan Lord, who eventually sat on the Committee for the UK.

We regard the whole idea as, if I may borrow the FO [Foreign Office] words, “futile and unrewarding” or, in cruder terms, as a gathering of international chatterers for the purpose of chattering.

We must, in the interests of international unity, agree to attend a meeting, which is [illegible] but if anything on this should turn up with Mr Daymond and [illegible] you will no doubt determine your answer by reference to our Policy of being Against It.

The author of the second note is unidentified, but it shows how the UK viewed the Swiss and Dutch proposals, as well as – in the third paragraph – a pessimism that seems rather anachronistic when compared to the kind of work conducted by the OECD today.

1. Insofar as I can discover from this rather Crazy Going file, the pace is being made by: (i) the Dutch, who seem to be resentful about the liquidation of the Fiscal Commission of UN (which we ourselves regard as a Good Thing) and so want to set up a new Committee or Commission to discuss, inter alia, fields, spheres and bases, & (ii) the Swiss, who seem to be engaged in a private brawl with the French.[…]

2. If this be so, the answer to (i) is that we regard this exercise, to use the FO phrase, as “futile and unrewarding” and (ii) that this is a private fight in which we do not wish to join.

3. There seems to have been later on a ganging up of Germans, Swiss and Dutch to give a regrettable academic flavour to the whole thing and to discuss domicile, “classification of income” and “localisation of income”, whatever these terms may mean. Presumably some attempt to reach, for example, agreement on whether interest should be charged by reference to origin or residence, an exercise which long experience has shown to be pointless.

The British concerns were, I think, unfounded, as the new committee raced through a list of five thorny areas within a year, finding consensus on topics such as permanent establishment and the taxation of shipping and airlines, which are recognisable today as core components of the OECD model convention.

The most recent document in this particular file is an interim report from the Fiscal Committee in 1957. It shows how within 18 months the committee was already consolidating its ways of working (Working Parties on each specific issue, just as the OECD has today) and forming a clear raison d’être. In the excerpts below, I’ve picked out three things that struck me from the committee’s interim report. First, how forcefully it began to make the case for tax cooperation, as European economies became more integrated. Second, the recognition that other countries might be incentivised to follow Europe’s lead, because of its “placement in the world economy.” It is interesting to reflect on how much this echoes the EU’s tax cooperation efforts today, perhaps more so than the OECD, for which the economic power of its members complicates its authority.

Extract from interim report of the OEEC Fiscal Committee, 3 July 1957

Finally, the committee members had already begun to “harmonise their views”, perhaps the first conscious expression of what would become a powerful driver of successful tax cooperation: the formation of a consensus about how to do tax among an international community of practitioners.

chattering4

The Panama papers and the OECD: re-reading Havens in a Storm

Last week I re-read Jason Sharman’s classic Havens in a Storm, described by Tax Analysts’ Martin Sullivan as “one of the best books out there for tax experts trying to make sense of big countries’ policies toward tax havens” (Sullivan’s review includes a length summary of the book). I was looking for a hook for this blog and, well, it was provided by Jürgen Mossack and Ramón Fonseca.

The OECD has published a curious Q&A on the Panama papers leak, according to which the problem is “Panama’s consistent failure to fully adhere to and comply with international standards”, which it contrasts with “almost all international financial centres including Bermuda, the Cayman Islands, Hong Kong, Jersey, Singapore, and Switzerland.” But the Panama papers story isn’t just about Panama, it’s about the other financial centres that were used by Mossack Fonseca (see the chart below), most of which are rated as “largely compliant” by the Global Forum, the OECD satellite body that peer reviews information exchange compliance.

panama

Arguably the OECD have a point: the Mossack papers show how the world was before the G20 got involved and these jurisdictions reformed, in which case there’s been a lot of unnecessary hot air on British TV news over the last few days. There is certainly some evidence on the ICIJ’s data page to support this view:

Mossack Fonseca’s clients have been rapidly deactivating companies since 2009, records show. The number of incorporations of offshore entities has been in decline for the past four years.

But the main groundswell of opinion, as anticipated by Rasmus Christensen (Fair Skat), is that it’s time to use some serious economic and (in the UK’s case) legal power to overturn haven secrecy. That’s Global Witness’s position. France has wasted no time in restoring Panama to its tax haven blacklist. According to Richard Brooks, with his typically powerful prose:

To tackle the cancer of corruption at the heart of the global financial system, tax havens need not just to reform but to end. Companies, trusts and other structures constituted in this shadow world must be refused access to the real one, so they can no longer steal money and wash it back in. No bank accounts, no property ownership, no access to legal systems.

Turn the clock to 1998…

Havens in a Storm gives us some important context about why we are where we are. The OECD’s Harmful Tax Competition project has come to be seen as the defining international political tax project of a generation of global tax actors – both OECD bureaucrats and governments – in the way that BEPS is for the current generation.  The initial 1998 report [pdf] is still a reference point, primarily for its classic definition of ‘tax haven’, and the list of ‘uncooperative tax havens’ published in 2000 has not ceased to be cited, even though the last jurisdictions were removed from it in a 2009 update.

The four characteristics of the OECD’s 1998 tax haven definition
1. No or only nominal taxes
2. Lack of effective exchange of information
3. Lack of transparency (i.e., bank secrecy)
4. No requirement that activities booked there for tax have economic substance

Yet the 1998 and 2000 reports are also anachronisms. They raised the spectre of sanctions against countries meeting the tax haven definition, but within a few years, the project had been dramatically scaled back and watered down. The initial threat of specific sanctions against jurisdictions that did not commit to comply by 31st July 2001 became a partnership approach accompanied by what Sullivan refers to as “a series of toothless pronouncements, a mixture of cheerleading and scorekeeping.” Furthermore, the OECD’s ambitious original aim of dealing with harmful competition for mobile capital was abandoned for a focus exclusively on the exchange of tax information on request.

According to Sharman, these failures came about because the OECD lost a battle of ideas and language, not an economic (or, for that matter, military) one. Central to this analysis is that “the technocratic identity of the OECD as an international organisation comprised of ‘apolitical’ experts” resulted in a battle waged in a rhetorical and normative space, rather than a political one dominated by the calculus of economic power. “The OECD made the struggle with tax havens a rhetorical contest, that is, one centred on the public use of language to achieve political ends.” The OECD is able to do this not because of the economic dominance of its members, but because of the secretariat’s use of “expert authority” to create influential regulative norms. The power of ‘blacklisting’ tax havens lies not in the economic might behind the implied threat of sanctions, but in the very act of labelling, with its reputational consequences (“the bark is the bite”).

Opponents forced the OECD to abandon key planks of the project by turning its rhetorical weapons against it. First, they portrayed the idea of sanctions as a contravention of the principle of fiscal sovereignty, suggesting that by its implied advocacy of sanctions, the OECD secretariat was breaching norms of reasonable conduct. Second, they turned the term ‘harmful tax competition’ back on the OECD, forcing it to defend its pro-tax competition stance and eventually to replace the term with ‘harmful tax practices’. Third, they alleged hypocrisy among OECD countries, pointing to Luxembourg and Switzerland’s (and later Belgium and Austria’s) refusal to be bound by the project’s outcomes. In the world of rhetorical power, such ‘rhetorical entrapment’ is a powerful tool..

If the project had been primarily a manifestation of raw state power, these rhetorical skirmishes would have mattered little to the eventual outcome. Yet Sharman makes a powerful case that they were its main determinants. One important example is that he attributes the decisive intervention of the Bush administration not to its being ’captured’ by multinational businesses with material interests in the project being scaled back, but to the ideologically-driven machinations of lobbyists from the Center for Freedom and Prosperity.

So what does it mean that, in 2016, language continues to be the OECD’s main weapon? As its Q&A on the Panama papers makes clear:

As part of its ongoing fight against opacity in the financial sector, the OECD will continue monitoring Panama’s commitment to and application of international standards, and continue reporting to the international community on the issue.

On one hand, the OECD’s normative claims are more powerful because of its claim to be the custodian of ‘international standards’, a claim that probably has more weight as a result of the increasing involvement of some non-OECD countries in its various tax projects. On the other hand, the peer review approach seems to implicitly concede a conservative notion of procedural fairness (reasonable behaviour, again) towards secrecy jurisdictions.

And the allegations of hypocrisy among its members don’t help its authority: the US’ ambivalence [pdf] towards sharing tax information automatically on a reciprocal basis is the standout example; there is talk about the use of US states as tax havens by Mossack Fonseca; the list of non-compliant jurisdictions that marked the G20’s entry into tax information exchange in 2009 gave Hong Kong and Macao special treatment.   This is perhaps also one sense in which the UK’s actions towards its overseas territories could have some bearing on how Panama behaves.

…now turn the clock forward to 2013

To finish, the parallels between the Harmful Tax Competition project and the Base Erosion and Profit-Shifting (BEPS) project on multinational corporate taxation are worth pointing out. Consider: an initial ground-breaking report from the OECD secretariat that has become an intellectual reference point, a whittling away of that initial ambition in intergovernmental negotiations, and an inevitable feeling after the fact that the policy reforms agreed won’t quite fix the problem so eloquently framed by the OECD in the first place. It would be too soon, of course, to judge how successful BEPS has been in comparison to its predecessor.

But it’s more interesting, I think, to look at the rhetorical battle. In inventing a new term, ‘Base Erosion and Profit Shifting’, the OECD succeeded in owning the construction of the problem just as it did by defining ‘tax haven’. ‘BEPS’ refers simultaneously to a set of corporate practices that, because they are brought under this umbrella, are hard to define, but it also refers to the OECD’s own project to tackle them. In using the term, critics and supporters alike endorse the OECD’s intellectual leadership. The rapid and widespread adoption of the term illustrates that in 2013, just as in 1998, the OECD knew how to operate in a rhetorical battlefield.

The hypocrisy concern applies here too: for example, several OECD and EU members are in trouble for providing selective tax advantages to multinationals. It’s quite noticeable that, from the start, the OECD secretariat has tried to neutralise this problem by tackling it head on. For example, its tax chief, Pascal Saint-Amans, told the Financial Times in 2012:

The aggressive tax planning of the last 20 years was achieved with the complicity of governments themselves to cope with tax competition

An interesting research question is whether Sharman’s analysis of why the Harmful Tax Competition project struggled can still explain developments in its successor, the Global Forum, or indeed the outcomes of the BEPS project. Do OECD tax projects always stand and fall on the secretariat’s skill at owning the rhetorical space, or do we need to acknowledge governments’ material interests and incentives to fully explain outcomes? (In their commentary on the Panama papers, Len Seabrooke and Duncan Wigan, political scientists who believe in the causal role of ideas, seem to emphasise the latter, how “big, powerful states…themselves may benefit from sheltering other countries’ hot money.”) Answering that question might help us resolve a second, prescriptive one: can the problem of offshore tax avoidance and evasion ever be fully addressed on the technical, normative and rhetorical terrain occupied by the OECD, or does it require an institution with a more political modus operandi? This is certainly an interesting time to be studying the politics of international tax!

What is the UN tax committee for, anyway?

In January, the UN tax committee sent out a call for submissions [pdf] to the update of its transfer pricing manual. The subgroup working on this update will be drafting additional chapters on intra-group services, management fees and intangibles, all topics that greatly interest developing countries and civil society organisations grouped around initiatives such as the BEPS monitoring group.

So who made submissions to the UN consultation? Four private sector organisations, two academics, the World Bank and the Chinese government. Not a single NGO. Meanwhile, considerable effort has been expended by civil society groups in drafting submissions to and reports about the OECD’s BEPS process, lamenting how issues of concern to developing countries are likely to be left by the wayside.

I think this is a pretty strange prioritisation. Why focus all your energies on a process that you suspect is not going to deliver results for developing countries, and ignore entirely a process with a specific mandate to do so? I debated this a bit on twitter earlier this week with, among others Alex Cobham of the Centre for Global Development, who told me he considered it “self-evident that BEPS is relevant to developing countries’ tax base in a way that UN Transfer Pricing Manual may not be.” (We were also discussing automatic information exchange, which I’ve discussed before).

I don’t agree with Alex on the detail. But let’s consider this from first principles. How do (or should) NGOs prioritise their campaigning resources? I suppose the equation is something like:

Importance = 1. Magnitude of potential impact x 2. Likelihood of success + 3. Effect on long term balance of power

In the short-to-medium term it’s important to take into account both the size of what is at stake and the capacity of civil society groups to influence it. But there’s a long term dynamic too that means it may be strategic (unstrategic) to work on something that is unlikely (likely) to succeed in itself but will contribute towards (undermine) a long term strategy.

When I ask them, NGO folks often suggest that they don’t want to prioritise the UN because it scores low on all three counts. That is:

  1. It’s just a talking shop, without the same influence as the OECD
  2. In any event, the UN’s track record shows that the OECD countries have got all the decisions sewn up
  3. And in the long term the UN would be too unwieldy and bureaucratic a forum to be a viable home for international tax politics

I’m going to try to explain why I think this calculation is wrong.

1. It’s just a talking shop, without the same influence as the OECD

Both the OECD and the UN are soft law bodies when it comes to tax treaties and transfer pricing. They set standards in the form of model treaties and guidelines, but these have no binding effect on countries unless they choose to use them in treaty negotiations and in their domestic transfer pricing rules. This applies to the outcomes of OECD deliberations just as much to those of the UN. (Nothwithstanding the OECD’s proposal for a mutlilateral convention to implement the treaty aspects of BEPS, which will presumably be offered as a fait accompli to developing countries, including negative as well as positive aspects for them).

To influence the distribution of the international tax base, then, you need to influence bilateral treaty negotiations and national lawmaking. When it comes to treaty negotiations, at the level of standard-setting you can do two things: influence the developed country position (the OECD model) and influence the developing country position (the UN and regional models). The former will be harder, but will it have a bigger potential impact than the latter?

As I mentioned in my post a couple of weeks ago, a recent IBFD study shows that, where the model treaties diverge, the OECD model seems to be used more often than the UN model, which seems like a logical outcome of differentials in negotiating strength. So before even looking at how the model treaties might be changed, the best outcome for developing countries is surely to increase the prevalence of UN model provisions in negotiated treaties. In any event, the UN model is by no means ignored. Some of its most distinctive provisions, such as the services permanent establishment and source state taxation of royalties, have been adopted quite widely..

Turning to transfer pricing, you might remember that the first edition of the transfer pricing manual created some waves. This was mainly because of its inclusion of a annex on the ‘country practices’ of China, Brazil, India and South Africa, which emphasised their points of dissatisfaction with the OECD’s predominant transfer pricing guidelines. It is perhaps too early to see how influential the UN manual will be.

Accept for a moment the view, propounded by NGOs and sketched out in Chapter 10 of the UN manual, that OECD transfer pricing rules deprive developing countries of tax revenue because of enforcement troubles and an inherent bias towards countries that can capture the intangibles and high-value services. In that case an official document written by government officials discussing these issues and articulating alternatives is clearly very useful. Some people have suggested to me that the authors of Chapter 10 might be using it mainly as a tool to influence the OECD, but on the other hand there’s definite interest in its content from developing countries. South Africa indicates in its contribution that it is considering some aspects of the Indian and Chinese approaches.

2. In any event, the UN’s track record shows that the OECD countries have got all the decisions sewn up

I realised last October that although OECD members are in a minority on the UN committee, once you include the G20 members who are full partners in the BEPS process, the figure rises to 16 out of 25. And many of the individuals in key positions on the UN committee are the same people who represent their countries in the relevant OECD committees. So it would appear that for the UN to articulate any kind of alternative to the OECD, some of these people would need to set aside narrow national interest. Cynics feel that this is unlikely.

And yet the UN is doing alright. In the face of stiff opposition from a number of developed countries and the private sector, it’s ploughing ahead with a new article in its model treaty giving source countries the right to tax technical service fees. Developing countries often want such an article included when they negotiate, and they’re more likely to get it if it’s in the UN model.

I noted above that the UN’s transfer pricing manual is quite critical of the OECD approach, if only in its annex. Early plans for the manual proper had included greater divergence from the OECD approach, including discussion of fixed margins and formulary apportionment. During the drafting process these points were largely eliminated or relegated to the aforementioned annex.

If NGOs feel let down by what they see as the timidity of the UN committee, they might do well to study how their own (lack of) engagement in processes like this contributes to the outcomes in which they express disappointment. Having sat in on several sessions of the committee, I’m in no doubt that when matters like this come up for debate they stand or fall on the strength of feeling among the committee’s members, who in turn listen to the views of lobby groups. Business groups certainly think so, as evidenced by their submissions to the transfer pricing manual consultation.

If UN committee members were being lobbied at committee meetings, held to account in their home countries, and barraged with written submissions, all on the basis of a coordinated and specific agenda such as NGOs have developed for BEPS, the outcomes really would be different. That more confident exploration of unorthodox approaches proposed for the UN transfer pricing manual, for example, might well have made it into the final draft.

3. And in the long term the UN would be too unwieldy and bureaucratic a forum to be a viable home for international tax politics

I have less to say about this, because my experience of the UN is limited to the tax committee we have today. Most international relations theories accord power to international organisations in their own right, not just the sum of their members. An organisation’s power might come from its technical dominance, by exerting social pressure as monitoring reports from the OECD and IMF do, and through agenda setting, which is also a power that NGOs have. How much attention NGOs show towards an international organisation most certainly affects that organisation’s capacity to set the agenda, and its authority to speak about developing country issues.

It’s only one part of a bigger picture, of course, but nonetheless, development NGOs’ propensity to engage in media battles with Pascal Saint-Amans, and to attend OECD meetings in force, even if making critical comments, reinforces the idea that the OECD is where the action is for developing countries too. Of course the OECD can make technical reforms that help developing countries, but, since international tax is also about political settlements, I think it’s a strategic error to focus the overwhelming share of NGOs’ resources there at the expense of the UN.

Oxfam goes for the full Tanzi…but is that far enough?

“Revenue is the chief preoccupation of the state. Nay more it is the state”
– Edmund Burke

I spent the weekend with some old friends from the development sector. One of them, it now turns out, is working for a public relations consultancy. There was an awkward moment when I explained that I was working on international tax and my friend asked, with a sheepish grin, whether I was following BEPS. We were both following it from, well, different angles.

The most interesting moment in our conversation came when my friend mentioned clients’ fear of the ‘Margaret Hodge effect’. I can understand that, I thought. No company wants to see its executives thrown to the wolves in the Public Accounts Committee. But I had misunderstood.

“What my clients are concerned about,” said my friend, “is political interference in corporate tax policymaking.” I found this quite startling. Is it possible that businesses consider corporate tax policy to be a matter for private negotiations between them and the government, rather than the subject of public (and even parliamentary) debate as part of the government’s budgeting process?

The UK’s corporate tax regime has been dramatically overhauled over the last ten years, with a plummeting corporation tax rate and vast swathes of the multinational tax base exempted. This is a serious structural change in our tax system, yet there’s been barely a peep about it in public debate. And we continue to sign tax treaties, with only a cursory discussion in parliament each time. The public attention is only ever caught by the ex post impact of policy decisions in the tax returns of multinational firms. Hence why Pfizer’s bid for Astrazenica, and not the policy reforms that encouraged it, has been front page news.

I had this in mind as I read Oxfam’s new briefing paper on “Why corporate tax dodgers are not yet losing sleep over global tax reform” and Duncan Green’s blog post discussing it. Oxfam’s entry into the tax justice campaign has brought some fresh and interesting perspectives, and this is no exception. The paper argues that developing countries are unlikely to benefit from BEPS, for two main reasons:

Firstly, the business lobby currently has a disproportionate influence on the process, which it uses to protect its interests. Correcting the rules that allow the tax dodging practices of global giants like Google, Starbucks and others that lead to tax revenue losses in OECD countries will be difficult, given the size of the corporate lobby. But worse, perhaps, is that the interests of non-OECD/G20 countries are not represented at all in these negotiations.

It goes on to analyse the contributions to OECD consultations to demonstrate the overwhelming contribution from wealthy countries and business organisations. The paper calls for a three-pronged solution:

  1. Fully engaging non-G20/non-OECD countries in BEPS decision making
  2. Working towards a World Tax Authority to improve governance of international tax, along the lines proposed many years ago by Victor Tanzi.
  3. Widening the scope of the BEPS Action Plan to incorporate tax competition concerns, the redistribution of taxing rights, and reconsideration of the arm’s length principle

Oxfam, like other development NGOs, is keen to fix the problems it has observed with the OECD’s way of doing things. It is looking to change international institutional arrangements as a way of achieving this. The paper’s only real discussion about what happens at national level concerns “helping developing countries strengthen their fiscal administrations.”

This is all important stuff, but it’s missing something: a strategy to increase political engagement with corporate tax policymaking. International institutions can shape countries’ preferences and strategies, but the decisions they take (and maybe even the ways they work) are still products of the different positions taken by their member states. National politics matters.

If, as Oxfam argues, the business lobby has a disproportionate influence at the OECD, that influence won’t only be exerted at international level: it must also be applied inside the member states, who ultimately make the decisions at the OECD council. Is it wise to open up the source/residence debate within the BEPS process, as Oxfam proposes, when businesses favour reduced source state taxation? There is certainly a case for re-examining the political settlement at the heart of international tax institutions, but the outcome of such a process will surely follow the distribution of power among its participants.

If, as Oxfam also argues, developing countries are not participating in the decisionmaking, that isn’t just because the space for them is limited. It is also because they aren’t making the most of the opportunities available to them. Many of the UN tax committee’s most developing country-friendly initiatives in recent years have been led not by its developing country members but by members from OECD countries putting themselves in developing countries’ shoes, or by members from emerging economies whose interests do not always coincide with developing countries. That’s fine so long as international tax is a technical exercise, but an inclusive political process would cast these conflicts of interest in sharp relief.

Developing countries’ failure to take advantage of the opportunities that are already available to them can be seen in the tax treaties they have negotiated, comprehensively studied in an IBFD report for the UN tax committee [pdf]. Many significant clauses from the UN model treaty, which would confer on developing countries greater taxing rights, are absent from most of the tax treaties signed by developing countries. There are some examples in the chart below. I don’t know (yet) why developing countries often get such poor outcomes, but what happens in bilateral negotiations would surely occur in international negotiations too.

Use of UN model provisions in tax treaties between OECD and non-OECD countries

Source: IBFD for UN tax committee

Duncan Green situates the BEPS process in the later stages of the “Policy Funnel” (below), when “the technical content gets greater, and the chance to mobilize the public declines.” But corporate tax policy has been at that end of the funnel since the 1920s. The aim should be to drag it back towards a public debate.

The Policy Funnel (Source: From Poverty to Power)

The Policy Funnel (Source: From Poverty to Power)

What Oxfam is proposing would lead to an even larger technocratic tax community at international and national levels (a world tax organisation, and more tax authority capacity in developing countries). That may well be necessary. But what we need even more is for politicans and the public in each country to hold the technocrats to account. It seems to me that this can be done more effectively by beginning at the national level, looking at domestic tax rates, tax incentives, and tax treaties. Until that happens, I don’t think that the politicians of developing countries will pay enough attention to BEPS or anything of its ilk to get stuck into the politics and shift the centre of gravity of international corporate tax policy.

Satellites in geostationary orbit: a new tax justice issue?

Side view of Geostationary 3D of 2 satellites ...

Side view of Geostationary 3D of 2 satellites of Earth (Photo credit: Wikipedia)

When I made an amused reference to item on satellites in the new UN tax committee’s agenda, I wasn’t really sure what it was about. Richard Murphy thought it might be a plan to create tax havens in space. But, now that the UN secretariat have released some preliminary documents for the committee meeting next month, I think it may be a very good example of the differing interests of developed and developing countries in international tax.

In the most recent update of the OECD’s model tax treaty, there’s a discussion about whether a satellite in geostationary orbit (that is, always above the same point on the earth’s surface) could be a permanent establishment (taxable entity) in the country over which it orbits, or to which it transmits signals. Here is the full quote from the OECD model treaty as given in the UN document [pdf]:

5.5 Clearly, a permanent establishment may only be considered to be situated in a Contracting State if the relevant place of business is situated in the territory of that State. The question of whether a satellite in geostationary orbit could constitute a permanent establishment for the satellite operator relates in part to how far the territory of a State extends into space. No member country would agree that the location of these satellites can be part of the territory of a Contracting State under the applicable rules of international law and could therefore be considered to be a permanent establishment situated therein. Also, the particular area over which a satellite’s signals may be received (the satellite’s “footprint”) cannot be considered to be at the disposal of the operator of the satellite so as to make that area a place of business of the satellite’s operator

The OECD position is unanimous and, so it suggests, inevitable based on other aspects of international law. But consider this: most of the world’s commercial satellites are owned by companies resident in OECD countries. Many (perhaps all) developing countries have satellites permanently orbiting over them and broadcasting signals onto their territory, while down at ground level they have no companies making profits from this industry. Under the OECD position, there is no possibility of developing countries raising corporate income tax from this sector.

There may be a philosophical discussion that is much broader than tax, as the OECD commentary suggests, about ‘how far the territory of a State extends into space’. But I imagine that the consequence of the point about the satellite’s ‘footprint’ is that a state has no right to treat a satellite as a taxable entity if it is, say, broadcasting commercial TV to its residents, or providing GPS positioning to people on its territory.

If my assumptions are correct, that makes for quite an interesting discussion. A quick hunt around online suggests, for example, that the fixed position of a satellite in geostationary orbit means that it is not considered as movable property as far as US state tax is concerned – which might imply that it is a fixed place of business for international tax purposes. What would be the positions of the BRICS, some of which have their own burgeoning space sectors? Already, an OECD consultation document [pdf] implies that there were disagreements on this issue among its members.

I would guess that smaller developing countries have not considered this matter at all. In any event, I will certainly look forward to the discussion in October!