Is it or isn’t it a spillover?

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:

‘Spillover analysis’ as a frame of reference for tax and development policy

Last year, when Parliament’s International Development Committee was conducting an inquiry into tax and development, ActionAid (where I worked) was calling on the government to assess the impact of changes to the UK’s Controlled Foreign Companies (CFC) rules on developing countries. At the time, we were citing a report from the IMF, World Bank, OECD and UN to the G-20 [pdf], which recommended that:

It would be appropriate for G-20 countries to undertake “spillover analyses” of any proposed changes to their tax systems that may have a significant impact on the fiscal circumstances of developing countries…in moving, for instance, from residence to territorial systems.

The term ‘spillover’ is hardly new, appearing in the OECD’s famous 1998 Harmful Tax Competition report [pdf], which notes a concern that “countries may be forced by spillover effects to modify their tax bases, even though a more desirable result could have been achieved through intensifying international co-operation.”

When ActionAid raised the spectre of spillover analysis, the British government was adamant that it would be a useless exercise. But that didn’t stop the International Development Committee recommending that,

there should be an administrative or legislative requirement for the government to assess new primary and secondary UK tax legislation against its likely impact on poverty reduction and revenue-raising in developing countries, and to publish that assessment alongside the draft legislation

Since then, the Netherlands has decided to review its tax treaties with developing countries in exactly this light. And a few other publications lead me to wonder if the tide is turning against the UK government’s position.

The OECD’s BEPS action plan, for example, echoes precisely the argument we made at ActionAid, when it notes that:

While CFC rules in principle lead to inclusions in the residence country of the ultimate parent, they also have positive spillover effects in source countries because taxpayers have no (or much less of an) incentive to shift profits into a third, low-tax jurisdiction.

A recent IMF paper [pdf], which sets out a workplan on international tax issues, goes further still:

The work plan is focused on macro-relevant cross-country spillovers from national tax design and practices. The issues of tax avoidance by multinationals and evasion by individuals that are the focus of immediate concerns and initiatives are important instances of such spillovers. But there are many others too, and issues would arise even in the absence of compliance problems: for instance, the current trend among advanced countries away from residence-based taxation of active business income arising abroad and toward territorial taxation can have powerful spillover effects, including for developing countries.

I think the IMF’s thinking builds on a working paper from 2006 [pdf], which explores the implications were the US to move from a worldwide to a territorial system. It asks four questions:

(i) Will the territorial system change the level and/or location of U.S. FDI?

(ii) Will the territorial system encourage other countries to more aggressively pursue tax competition (i.e., lower rates or increase tax concessions) to attract U.S. FDI?

(iii) Will other countries follow the United States lead and move to a territorial system?

(iv) Will there be an impact on the tax revenues of other countries?

Finally for now, the UK’s Liberal Democrat party seems to have adopted the spillover policy recommended by the International Development Committee (which it chairs). A policy paper [pdf] for the party’s autumn conference last week says that it “would assess all new primary and secondary UK tax legislation against its likely impact on poverty reduction and revenue-raising in developing countries.”

With such a range of voices arguing for this, I’m hopeful that it will become more widely adopted. After all, it says nothing about the content of tax policy, just about the due diligence that should be done when it’s made.

Some fascinating snippets from the IMF’s new paper on fiscal transparency

Today in my inbox is an blog post in which “Two Richards Talk Fiscal Transparency” – the Richards concerned being one current (Richard Allen) and one former (Richard Hughes) head of division in the IMF’s Fiscal Affairs Department.I’ve pulled out two interesting things from the blog post and associated paper [pdf]: the statistics showing how governments weren’t truly aware of their underlying fiscal positions before the crisis, and some of the IMF’s new proposals for its Code of Good Practices on Fiscal Transparency. NGOs take note: there’s going to be a consultation on the latter.

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Africa may be getting worse, not better, at raising taxes

That is the implication of an interesting blog over at the Guardian, which argues that African GDP statistics are woefully inaccurate. A couple of years ago Ghana revised its GDP estimates dramatically upwards, by 60%, and it seems Nigeria is about to follow suit.

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Tax can promote growth and equity, says the IMF…but how?

The relationship between taxes and growth is hardly an easy topic to resolve in a single blog. But the IMF has been saying some interesting things on this subject recently, not least in a paper I reviewed a couple of weeks ago, which had three notable findings:

  1. In middle- and high-income countries, there’s a negative association between economic growth and the share of personal income tax and social security contributions in the tax mix (and a positive one for value-added and sales taxes).
  2. The share of corporation tax in the overall mix doesn’t have a significant relationship with economic growth.
  3. The authors couldn’t find a significant association between growth and any particular kind of tax in low-income countries, apart from a negative one for trade taxes.

Now, via Mark Herkenrath, comes a note of an IMF conference “Taxation and Economic Growth in Latin America”.  The note asserts that “Tax Policy Can Help Spur Economic Growth”, so the question, in the light of the evidence from the previous paper, is how?

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Corporation tax has no association with GDP growth, says an IMF paper

This is a review of “Tax Composition and Growth: A Broad Cross-Country Perspective,” an IMF working paper by Santiago Acosta Ormaechea and Jia Yoo.

Here’s the assumption that I’m going to make in this post: it’s probably not too much of a stretch to say that the consensus among development practitioners is that economic growth in low-income countries is indispensable to development, but that the quality, as well as the quantity, of that growth matters. It follows from this that sometimes the most ‘pro-development’ policy change might be one that compromises on the quantity of growth in order to ensure that it’s good quality – for example that it happens in ways that benefit the poor and not just a small, wealthy section of the economy, and that it is sustainable. (I said ‘low-income’ countries, because some might argue that middle-income countries need to focus more on equality, and less on growth).

Anyone making recommendations about tax policy or administration, be it a campaigning NGO or the IMF, or indeed a government on the receiving end of this advice, needs to consider how the position they advocate will affect economic growth. But if my assumption above is correct, they need to do this in order to consider the balance between quality and quantity of growth, not just to evaluate a policy on how it affects the rate of growth.

With this in mind, I’ve been reading a new IMF paper which purports to be the most comprehensive empirical study of how different taxes affect economic growth. The paper focuses on the tax mix, that is the different sources from which income is raised, not the total tax that is raised as a share of national income. The logical use of this research for development practitioners in low-income countries is to answer the question “where should tax revenue come from in order to have the best (or least worst) impact on growth?”

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