Taxing the Corporation: Home Depot and the State's Claim of Right

The Arizona Court of Appeals recently issued a decision in the Home Depot case, which involves determining when the state has jurisdiction to tax a corporation. The case is about a domestic multi-state business but it has interesting implications for the taxation of multinationals. In brief, Home Depot (a Delaware corporation headquartered in Georgia) formed a subsidiary in 1991 to hold its trademarks. It then entered into a licensing agreement with the sub, Homer, under which it paid a royalty for the use of the trademarks. The royalty started at 1.5% of gross sales, and increased to 4% in the years at issue. The Arizona Department of Revenue decided that Homer and Home Depot constituted a unitary business for Arizona state tax purposes, the Arizona Tax Court agreed, and the Court of Appeals affirmed.

So here we have a Delaware corporation, headquartered in Georgia, doing business in Arizona through retail stores, but stripping its income out of the state in order to avoid the state level corporate income tax. That is, of course, the basic modus operandi of Google, Apple, Starbucks, GE, Amazon, et al, each of which sells products and services around the world yet pays low single digit corporate tax rates in each jurisdiction by stripping out its income in the form of license fees, interest, and other inter-company payments to subsidiaries located in low-tax jurisdictions.

Internationally the defense that countries employ against this behavior is the arm's length standard, under which each government that claims jurisdiction over any part of the multinational treats that part as if it was an independent party acting at arm's length with respect to the rest of the company. Indeed Home Depot raised its compliance with the arm's length standard as a reason for the court to dismiss the Arizona revenue authority's jurisdictional claim over Homer. But the Court points out that compliance with arm's length is not the issue in a question about establishing a jurisdictional claim:

Home Depot, nevertheless, argues its transactions with Homer have been at arm’s length, and points out that the Department has not challenged the appraisal establishing the legitimacy of the royalty it pays Homer. [Under prior case law] the principle [is] that unitary treatment will be imposed or allowed whenever the activities of the affiliated organizations affect the other(s) in ways that are "so pervasive as to negate any claim that they function independently from each other."

Under a statutory regime that allows for unitary taxation, in other words, the state can claim jurisdiction to tax with respect to any corporation anywhere, if it can establish pervasive links among affiliated corporations, or "operational integration." And what are the marks of such operational integration, such that the state's jurisdiction to tax is established? The Court lists fifteen, pursuant to Arizona state law:

1. The same or similar businesses conducted by components;
2. Vertical development of a product by components, such as manufacturing, distribution, and sales;
3. Horizontal development of a product by components, such as sales, service, repair, and financing;
4. Transfer of materials, goods, products, and technological data and processes between components;
5. Sharing of assets by components;
6. Sharing or exchanging of operational employees by components;
7. Centralized training of operational employees;
8. Centralized mass purchasing of inventory, materials, equipment, and technology;
9. Centralized development and distribution of technology relating to the day-to-day operations of the components;
10. Use of common trademark or logo at the basic operational level;
11. Centralized advertising with impact at the basic operational level;
12. Exclusive sales-purchase agreements between components;
13. Price differentials between components as compared to unrelated businesses;
14. Sales or leases between components; and
15. Any other integration between components at the basic operational level. 

Not every listed factor must be present in order to establish operational integration. Having established its jurisdictional claim, the state does not claim all of the income of the entire multistate operation, but rather applies its own internal formula for determining what portion of the whole is attributable to the group's Arizona operations. 

Herein lies the lesson for international taxation: corporate taxation of a multi-state group is possible on a unilateral basis--a state need only stake its own jurisdictional claim and have the werewithal to enforce it. Arizona's Court of Appeals seems to be suggesting that the state's jurisdictional claim need not be hampered by any artificial constructs, whether these be rules assigning corporate residence or contracts allocating rights. Presumably the allocation formula cannot be 100% but also relies on some decision about the extent of the jurisdictional claim--although this has not been argued or established here. The decision further implies that enforcement is possible as a practical matter, presumably on the basis of the operations and assets that are currently in the state. The question raised is whether the Arizona market will continue to be attractive to Home Depot, such that it will accept unitary taxation by the state in order to continue to do business there. These are empirical questions, and the economic evidence I have seen so far suggests that the business will not leave solely as a result of the tax (especially if there is no alternative market that would deliver the same profits at a lower tax cost: here is a short summary that covers some of the bases on this question).

Substituting nation-state for state in these assumptions, these are big normative claims about the right of the state to assert a jurisdictional claim to tax, as well as its ability to follow through once the claim of right has been established. These assumptions raise even bigger normative claims about the fairness and efficiency of any system that fails to exercise a jurisdictional claim where it exists, since failure to exercise a claim in one sector forces the other sectors to take up the slack thus distorting tax outcomes on the basis on noneconomic factors. 

FATCA Q&A--A Work in Progress

Just a few questions I get a lot, together with some of the answers I typically give. This is not an exhaustive account of anything, nor is it legal advice. If you have or think you have FATCA-related problems, you need to consult legal counsel.

What is FATCA?

• FATCA is the Foreign Account Tax Compliance Act. It is law in the United States, enacted as part of the Hiring Incentives to Restore Employment Act, (HIRE Act), which was signed into law by President Obama on March 18, 2010. (It is found at §§ 501-531, Pub. L. No. 111-147, 124 Stat. 71 (2010). It has been codified in scattered sections of the Internal Revenue Code.
• In brief, the law requires foreign financial institutions (broadly defined) to identify any of their accounts (also broadly defined) held by "US persons" (expansively defined) and then furnish the US with periodic reports on those accounts including identifying information and amounts of transfers in and out of the accounts. Targeted institutions that fail to comply are to be penalized with a 30% toll charge on all of their US-source payments (again expansively--not just payments connected to targeted accounts).
• There are numerous rules and exceptions and exceptions to the exceptions applicable to the above statement.
• "US person" includes everyone in the world who is a US citizen, whether or not that person lives or has ever lived in the US and whether or not that person is also a citizen of somewhere else. The US is the only country in the world that taxes its citizens on this basis. Citizenship-based taxation violates the membership principle as well as the global standard of residence-based taxation, and has therefore been denounced as unjust or bad economic policy or both by most academics, including Reuven Avi-Yonah and myself among others.
• The US considers any account to be foreign if it is not in the US, so for people who live in other countries, their neighbourhood bank where they have their checking account in the local currency is "foreign."

Why was FATCA part of the HIRE Act?

• The HIRE Act was a jobs bill that included payroll tax holidays and other credits for employers. FATCA was unrelated to this purpose, but was included in the form of revenue-raising “Offset Provisions”. The Chair of the House Budget Committee claimed that the HIRE Act was a responsible piece of legislation that “was fully paid for… by cracking down on overseas tax havens." Congressional Record (4 March 2010) page H1152 (statement of Sen. Allyson Schwartz). However, no cost-benefit analysis appears to have been undertaken, and pursuant to CBO projections, the sums to be raised under FATCA could do little by way of offset, even if they were fully implemented (see below, What is the cost/benefit of FATCA).
• The placement as a revenue raiser tacked onto a bill aimed at unrelated objectives has been viewed by opponents of FATCA as a sign that its passage was undertaken with some degree of stealth. See, e.g., Recovery Partners, “FATCA: The Empire Strikes Back” (4 July 2011); Koshek Rama Moorthi, “FATCA: Obama’s New Year Surprise Against American Expats” (30 November 2012), The Examiner; American Citizens Abroad, “ACA’s Voice in the News” (October 2012) online. The addition of unrelated riders and last minute addenda, especially revenue raisers, is a standard feature of US lawmaking, though it may appear anomalous to observers from other countries. For a brief discussion of how reconciliation and pay-as-you-go rules and standards affect tax policymaking in the US, see Center on Budget and Policy Priorities, “Policy Basics: Introduction to the Federal Budget Process” (3 January 2011).
• Presented as a revenue offset at the tail end of a long, complex, and contested piece of legislation did allow FATCA to pass with minimal debate or discussion in 2010. But the seeds for FATCA had been sown in earlier (failed) legislative attempts, both in Senator Levin’s Stop Tax Haven Abuse Act of 2009 and Senator Baucus’ stand-alone FATCA Act of 2009. See Carl Levin, “Summary of the Stop Tax Haven Abuse Act” (2 March 2009); H.R. 3933 (111th): Foreign Account Tax Compliance Act of 2009 (27 October 2009); See also Douglas Shulman, “Prepared Remarks of Commissioner Douglas Shulman before the 22nd Annual George Washington University International Tax Conference” (10 December 2012) (stating that “the Administration and the IRS are focused on a multi-year international tax compliance strategy…to put a serious dent in offshore tax evasion” and expressing support for the FATCA Act of 2009).

Why was FATCA created in the first place?

• The clear impetus for FATCA was the UBS scandal, involving thousands of bank accounts held in Switzerland by Americans living in the United States. It seems clear the target was rich tax cheats who live in America but don't want to pay taxes there, and who have been helped in that quest via unscrupulous sales pitches by offshore bankers offering banking secrecy as a shield against taxation by the USA. The legislation failed twice as stand alone bills (see above), and was tacked on to another, unrelated bill in 2010 (the HIRE act) as a revenue raiser, without any discussion or much analysis by US legislators. Many appear to have never even heard of FATCA.
• A lot of people seem to think FATCA was intended to smoke out and punish Americans who live permanently in other countries and who have not kept up with their US tax obligations out of ignorance or otherwise. I do not think that is the case. I think these Americans have become collateral damage of FATCA.

What is the cost/benefit of FATCA? 

• To my knowledge, no cost analysis has been undertaken with respect to FATCA.
• Amounts expected to be raised by FATCA were projected to be $343 million, $448 million, and $710 million, for 2010, 2011, and 2012, respectively. See Congressional Budget Office (18 February 2010) “Letter and Table Outlining Budgetary Effects of HIRE Act” ). The HIRE Act was expected to produce a revenue deficit in the amount of $4,380,000 despite the bold claim that it was "was fully paid for… by cracking down on overseas tax havens." See Congressional Record (15 April 2010) page S2368 “Budget Scorekeeping Report: Table 2: Supporting Detail for the Current Level Report for On-Budget Spending and Revenues for Fiscal Year 2010, as of April 9, 2010. 
• This precarious budgetary situation was aggravated by the fact that while the spending provisions of the HIRE Act were apparently immediately implemented, most of the FATCA provisions have yet to be enforced. For example, the disclosure of US accounts by foreign financial institutions was, according to the statute, to begin after December 2012, but the enforcement has been delayed more than once. See IRS, “Notice 2012-42” (24 October 2012) (which delayed the implementation of information reporting until 31 March 2015 and gross withholding until 1 January 2017); see also chart of initial and revised implementation times, DLA Piper, “Comparison of FATCA Timeframes” (October 2012).
• I have not found any information about whether any amount of taxes or penalties has been collected pursuant to FATCA to date.

What is an IGA?

• An IGA is an "intergovernmental agreement." The US has been signing these with some countries and is looking to sign a lot more with a lot more countries. 
• There are two categories of IGAs. In one category, the foreign country agrees to change whatever domestic law exists that might bar their financial institutions from complying with FATCA (e.g., consumer privacy protection laws). In the other category, the foreign country agrees to act as intermediary, collecting the info the US wants and handing it over as a government-to-government exchange. This typically bypasses any privacy protection regimes that might exist as people don't generally have privacy protection as against their own government's tax authority.
• IGAs are not treaties from the US perspective, in fact, just what exactly they are is a mystery. Treasury has implied that to the extent the US undertakes anything in these IGAs (in fact, precious little), they are "interpretive" in nature that is, they interpret existing tax treaties. Hence perhaps some confusion: if a country wants an IGA which involves the US providing anything in return, Treasury is suggesting a treaty will be needed for the IGA to "interpret." In my own view the idea that IGAs are interpretive in nature is a stretch: IGAs look like sole executive agreements to me. Treasury will not be putting them through any ratification procedures. Other countries have been typically (but not universally) treating these as they are, which is to say they are new treaties that require internal ratification procedures to place in force.

What are the IGAs for?

• In general the purpose of the IGA is to override the statutory structure of FATCA, making the unilateral statute less onerous than it otherwise would be, and to overcome domestic consumer privacy protections to enable institutions in other countries to pass personal financial information to the IRS. Thus, IGAs are a way of reducing both the administrative and the political burden Congress created for Treasury with FATCA. 

How does or will FATCA impact non-US financial institutions? 

• I can only speculate on this as I am not a compliance expert. However, it is to be expected that at minimum, compliance costs and risk of penalty from the US goes up, and if other counties implement their own regimes as the UK is currently doing, the costs and risks will be multiplied. 
• It seems to me possible that financial institutions face litigation risk with respect to customers who are mistakenly identified as having US indicia and whose information is turned over to the IRS, or whose accounts are closed, or who are asked for personal information that is not required to be asked or not allowed to be shared with third parties under domestic banking laws, whatever those may be. It seems possible that this risk might make an IGA seem more palatable than direct compliance with FATCA, from the perspective of a financial institution.

How will FATCA impact consumers? 

• Again I can only speculate, based on what people tell me. 
• First, a generalized fear seems to be setting in about US surveillance and a powerful and determined IRS that is interested in imposing, anywhere it can, enormous penalties all out of proportion to any taxes that might have been owed. The US Taxpayer's Advocate has expressed dismay at this state of affairs.
• Second, it is likely that everyone will see increased costs for financial services across the globe, even for those with no ties to the US of any kind, as compliance will have to be done on every account and institutions can be expected to pass on these costs in the form of higher fees and charges. 
• Third, it seems that data security risks rise as bulk data including social security numbers, account numbers, financial transactions, and other personal information is collected and shared with the IRS. If the info will be shared with other US federal agencies, as Senator Levin has suggested ought to be the case, this seems to compound the data security risk. 
• Fourth, there appears to be no remedy for error, compounding the problems noted above. If an institution flags a person as a "US person" in error, that person seems to be caught in a system with little or no review mechanisms in place. I am not sure how a person manages a case of mis-characterization. 
• Finally tax compliance is extremely costly when you live in another country, so as more Americans try to get compliant the global personal compliance industry (e.g. tax accountants and lawyers with US expertise) stands to profit handsomely. This is another payoff in the form of rent seeking courtesy of the regulatory state. This is also a boon to the institutional compliance industry, i.e., software and systems designers, auditors, risk assessors, and so on, who will benefit from selling their products and services to financial institutions. It also seems to be a boon to people who know how to help one expatriate from the US--which is neither a straightforward nor cheap option.

What should people who are worried about FATCA do? 

• I cannot and do not give legal advice on this. I urge those who are or may be harmed by the injustice of US citizenship-based taxation on themselves, their children or parents or other loved ones, to contact their local government representatives and the senators and congress members of any state to which they have any ties in the USA, to tell their stories and ask why the USA wants to tax their children's education savings plans or other government-sponsored savings plans in the countries where they live, why it is in the interest of the US to make life so difficult for Americans and dual citizens who engage in small businesses in other countries, why the US is so hopelessly out of step with international standards which impose taxation based on actual residence rather than inherited nationality, and why the US expects all of its citizens no matter where they live to fulfill tax obligations yet withholds tax benefits that help the poorest, such as the earned income tax credit. 

Send me additional questions in comments or by email and I will update this post.

Call for US Citizenship-based tax/FATCA stories

If you are in the Montreal area and would like to speak to the media about your experience as a Canadian who is or was affected by US citizenship-based taxation, whether or not you are or could be impacted by FATCA, and whether you wish to speak anonymously or not, could you please get in touch with me either in the comments to this post (moderated, so just indicate if you do not wish publication) or through my contact info, here?

Monday at McGill: Diane Ring on Sovereign Harmony, Domestic Discord

The 4th Annual Tax Policy Colloquium at McGill Law concludes Monday with a presentation by Professor Diane Ring of Boston College on her paper, Sovereign Harmony, Domestic Discord: Democracy and the Gap Between International Tax Cooperation and Domestic Politics (draft not yet available). Professor Ring explores how to understand the interplay between domestic tax politics and the need for nations to speak with one voice on the international stage. She argues that the more fractured internal politics, the less hope there seems to be for the kind of international cooperation that would make the tax system more coherent both nationally and internationally. Here is the Abstract:

The challenges of the international tax system have become ubiquitous. Newspapers recount the tax exploits of multinational corporations that are household names and announce the jail sentences of the latest Swiss bankers and U.S. taxpayers to fall in the ongoing attack on tax evasion. The twin pressures on effective income taxation captured by these stories are those of tax evasion (typically engaged in by individual taxpayers) and tax avoidance (typically characterized by the planning and structuring undertaken by multinational corporations). In both cases cooperation between and among states plays a pivotal policy and enforcement role. That is not to say that cooperation (in its various iterations) is a universal or achieved objective. Rather, the question of whether states can identify a shared goal and move cooperatively toward that goal is an important focus of international tax policy discussions. With respect to the problem of tax evasion there have been some notable steps of cooperation through information sharing measures (including Tax Information Exchange Agreements) as well as domestic changes designed to increase transparency. Less agreement and coordination has been evident for the problem of tax avoidance. The current context in which these questions are being explored communally is the Organization for Economic Cooperation and Development (OECD) project on “Base Erosion and Profit Shifting” (the “BEPS” project). 

But regardless of the degree of current cooperation, agreement, and coordination achieved on these international tax issues, the focus on the status of state-to-state relations can obscure another critical factor in the international tax system: domestic politics. Even if and when states reach a shared understanding of a dimension of the evasion or avoidance problems, a resulting agreement by states is not the end game. Although states must act and negotiate as monoliths in their state-to-state interactions, there remains the ever-present constraint of democracy at home and the possibility that a deal struck on the global stage is undone in the domestic sphere. This dynamic between international relations and domestic “politics” is neither new nor limited to taxation. But the serious attention to and heightened expectations from cooperation among nations regarding major issues of international tax policy requires that comparable attention be directed at the domestic side of cooperation. 

The task of this paper is to explore how domestic politics can impact the heart of the international tax system – agreements among states on important issues of tax policy design and practice. Through a better understanding of the intersection of domestic politics with international debates and agreements, we can consider how and under what circumstances states might diminish the likelihood that domestic discord will ultimately undermine sovereign harmony (i.e. international agreement). Part I outlines three recent examples of international agreement or cooperation that risked rejection or at least significant undermining on the domestic front. Part II reviews the literature regarding international cooperation to develop a framework for approaching the case studies on domestic politics in international tax. Part III draws upon the theoretical work reviewed in Part II to develop a framework for understanding the intersection of international tax and domestic politics. In light of the increasing role that global cooperation and coordination plays in the development of successful international tax policy and practice, the Conclusion considers further research that could illuminate the domestic side of international agreements.

The McGill Tax Policy Colloquium features distinguished visiting academics and offers a forum for students, professors, and local practitioners to discuss issues of tax policy and theory, along with related issues of economics and social justice. Professor Ring's talk will commence at 2:30 pm tomorrow; members of the public are warmly welcomed.

Location: McGill Faculty of Law, 3644 Peel Street, New Chancellor Day Hall, Room 203.

Date and Time: Monday, 25 November, 14:30–16:30.

From John Prebble : Teaching Tax in a Sculpture Park

John Prebble (customarily at Victoria University of Wellington, New Zealand) sends over this post from Austria, where he is currently teaching a course on “Jurisprudential Perspectives of Taxation Law” in WU (Vienna University)’s doctoral programme in international business taxation. As you can see from his remarks below, this would be a very fun place to do a doctorate.

John Prebble

In September 2013, the Institute for Austrian and International Tax Law, together with all the rest of Wirtschaftsuniversität Wien, moved to an entirely new campus, on land on the edge of the Prater, Vienna’s equivalent of Hyde Park in London or Central Park in New York, between the Danube and the Danube Canal. The campus design and the buildings were the product of international competitions.

For gastprofessors like myself, it’s like teaching in a sculpture park: I was the first occupant of the study that projects from the fourth floor of the orange and yellow Law School, designed by Sir Peter Cook, architect of the London Olympic Stadium. The exterior timbers are purely a “poetic fancy”; from the inside your eye scarcely registers them as you focus on the view beyond:

Next is the teaching building, by Carme Pinós, of Barcelona, where I had first use of one of the new lecture theatres. The rusty look of the cladding is indeed rust, but a special sort of rust that protects its steel, so there is no need for paint:

Finally, below are the exterior and interior of the library, by Zaha Hadid, from her Hamburg office. The elevated wedge is the main reading room. Readers’ desks are in tiers and point roughly south-west, giving everyone marvellous views across the woodlands of the Prater. The atrium is an excellent example of the famous sinuous lines of Ms Hadid’s work.

Must read: @Salon on Lobbyists Posing as Think Tanks

This is a must read. My first reaction was: this is not new, this is old hat. But the intentional misleading might be categorized as new. I have been doing some work on the problem of uneven political influence and how that fits in with the narrative of tax compliance (i.e., when the lobbyists write the rules, is it any wonder that GE, Apple, Google, Starbucks, etc, can say with pride that they dutifully comply with all applicable laws), and I have suggested that what is needed is more policy input from those who do not themselves stand to benefit directly from promoting a particular policy direction, namely, academics who research subjects for the purpose of increasing human knowledge. This means that in my view academics--which includes anyone who calls herself a researcher in any capacity--should always provide detailed disclosure of funding whenever publishing anything, so that the public can distinguish between advertising/advocacy and information.*

This is getting increasingly tough in our uber-consumer oriented society but we must stay vigilant about this, hence the dire need for organizations around the world doing things like the Center for Media and Democracy did here. In this story Salon hits the target directly on why disclosing pecuniary interests is critical to ensuring that public discourse does not fall to the fate of political representation in a nominally democratic but factually plutocratic society, namely, pay to play.

The concluding sentence says it all:

Certainly corporations have a right to have their voice heard, but that voice should be their own, not that of a phony expert on retainer.

* Note that this doesn't in any way mean that getting funding for engaging in research is inherently bad. It means that it is relevant to the conversation because some people find it politically expedient to provide funding in order to obtain specific findings and disseminate those findings as credible on the facts, and as an academic you ought not to want to be associated with that sort of propaganda, so you want to disclose your sources of support. In my view the research question should attract the funding and not the other way around. 

I'm talking FATCA: Listen tomorrow morning on CBC's the Current

Tomorrow I'll be talking about how the US crackdown on offshore tax cheats via FATCA impacts ordinary Canadians with US ties by virtue of citizenship based taxation, on Anna Marie Tremonti's the current (CBC radio). I'll do my best to explain the intent versus the reality of FATCA within the time allotted.

Update: here is the story from CBC with a link to the broadcast. Lots of things I wish I would have had time for, but hopefully this at least sparks a national conversation about this important topic.

Tomorrow at McGill: Tillotson on the historical use of morality in tax policy

The 4th Annual Tax Policy Colloquium at McGill Law continues Monday with a presentation by Professor Shirley Tillotson of Dalhousie University on her paper, The moral worlds of fair taxation: a perspective from 20th century Canadian history (draft not yet available). Professor Tillotson examines the use of political rhetoric to advance tax reform. Marco Garofalo posted some thoughts on the topic earlier today.

The McGill Tax Policy Colloquium features distinguished visiting academics and offers a forum for students, professors, and local practitioners to discuss issues of tax policy and theory, along with related issues of economics and social justice.

Professor Tillotson's talk is scheduled to commence at 2:30 pm tomorrow; members of the public are warmly welcomed.

 Location: McGill Faculty of Law, 3644 Peel Street, New Chancellor Day Hall, Room 203.
 Date and Time: Monday, 11 November, 14:30–16:30.

Rhetoric as Intellectual Anaesthetic in Tax Politics: Guest post by Marco Garofalo

Advocates of tax policy reform use common rhetorical themes to link their preferred policies to desired descriptors. The most common of these are fairness, efficiency, simplification, and competitiveness. Most of the time these terms are used without definition or explanation and they are used indiscriminately to support policy proposals across the political spectrum. This can have a tremendously destructive impact on public discourse over time, as people use these words to mean virtually anything, and then begin to believe these words have no meaning at all.

In his 1946 essay, Politics and the English language, on using "language as an instrument for expressing and not for concealing or preventing thought," George Orwell warned that using rhetoric in this sloppy manner ultimately destroys our ability to engage in critical thinking:

[A]n effect can become a cause, reinforcing the original cause and producing the same effect in an intensified form, and so on indefinitely. A man may take to drink because he feels himself to be a failure, and then fail all the more completely because he drinks. It is rather the same thing that is happening to the English language. It becomes ugly and inaccurate because our thoughts are foolish, but the slovenliness of our language makes it easier for us to have foolish thoughts.

 Orwell argued that political actors use language to deceive their audiences. He writes:

The words democracy, socialism, freedom, patriotic, realistic, justice have each of them several different meanings which cannot be reconciled with one another. In the case of a word like democracy, not only is there no agreed definition, but the attempt to make one is resisted from all sides. It is almost universally felt that when we call a country democratic we are praising it: consequently the defenders of every kind of regime claim that it is a democracy, and fear that they might have to stop using that word if it were tied down to any one meaning. 

Political actors can easily exploit the different meanings of words by using them in vague and imprecise ways. The audience then assumes the word to mean what they think the word means, rather than whatever meaning might have been intended by the speaker. The popular use of the term "a fair tax regime" serves as a ready example. Each person projects their own, everyday understanding of fair onto this word, giving the phrase any number of meanings, probably few of which would survive scrutiny under close examination. Consequently, a political actor announcing a new tax policy can deceive her audience by calling it “a step towards a fair tax regime” without in any way attempting to define what such a regime might require to fulfill principles of fairness.

In a paper presented last month at McGill, Professor Lynne Latulippe presented the use and misuse of the term "competitiveness" in contemporary tax policy. This term, usually bundled with efficiency, frames contemporary tax policy discussions and often hides the fact that generous benefits are intended to be granted to certain political constituents thereunder.

On Monday, Professor Shirley Tillotson from Dalhousie University will add to this discussion by presenting her text, “The moral worlds of fair taxation: a perspective from 20th century Canadian history” at the McGill Tax Policy Colloquium. In an echo of Orwell's warnings, Professor Tillotson presents a striking example of the use and misuse of rhetoric in furthering political goals by examining the use of "patriotism" in the development of Canadian taxation. Patriotism served as a ‘moral exhortation’ in the interwar period, as Professor Tilloston puts it, to do one’s part for the national purse.

Professor Tillotson employs as a telling example a noted failure of the federal tax authority to enforce compliance with the tax law on judges in Quebec, on the grounds that exposing judges as tax dodgers would undermine “absolute confidence” in the system just as the government badly needed cash to address the fiscal crisis of the 1930s. The rhetoric ran thus: if people do not have confidence that the judiciary is acting patriotically, then why would they aspire to patriotism? By sweeping non-compliance under the rug and linking taxation with war, the authorities were able to convince people in the 1920s through to the 1940s that paying taxes is patriotic.

These days, we tend not to use the term patriotism to convince the public to comply with tax law. Instead, Professor Tillotson argues, discourse in the late 1950s and early 1960s revolved around different questions: which features are of the tax system are fair, economic, or moral? Deductible mortgage interest payments, child care expense deductions, expense account deductions are examples of policies that were in play. All of these succeeded or failed because they were fair or unfair; economic or uneconomic; or moral or immoral.

Free-riders in action.

The idea of the free-rider is the common denominator in tax reform politics, throughout the time period examined by Professor Tillotson and extending to contemporary tax discourse. Free-riders always have been, and always will be, the object of fiery hate. Words like patriotism and fairness may have elastic definitions, but free-rider is clear: someone who does not pay their fair share. And for some reason, people get really get riled up over other people not paying their fair share.

But a definition of free-rider depends on one’s definition of fairness. Multinationals like GE, Starbucks, Google, or Apple were easily painted as free-riders after media reports that they apparently pay very little taxes anywhere. Many people think that the fair share for these multinationals should be higher. Yet each company points to the other ways in which each contributes to social goals, and each lobbies vigorously for ever more tax reductions by arguing that these reductions would help them contribute even more to society or by falling back on a rhetoric of competitiveness.

Consequently, we will continue to "lob moral molotovs" at each other until we come to some definition of fairness. Maybe, as Orwell suggests, we do not want to find a definition for fairness, because then we will be tied to that definition. Self-interested parties want to continue hijacking this word, and others like it, to their own advantage. A consensus on fairness would put an end to that.

Reading Orwell alerts us to how important it is to pay close attention to the words used in tax policy discourse, and parse through any tax talk that is mired in political spin.  Orwell warned that the "invasion of one's mind by ready-made phrases … can only be prevented if one is constantly on guard against them, and every such phrase anaesthetizes a portion of one's brain.” As Professor Tillotson puts it: “[w]e should be able to do better”.

Corporate Tax Breaks to Which No One in Gov Pays Any Attention

It is quite extraordinary how much taxpayer money can be spent through expenditures that face no systemic evaluation on the merits. The GAO released a report dated September entitled Corporate Tax Expenditures: Evaluations of Tax Deferrals and Graduated Tax Rates. The main findings are not exactly news: deferral reduces tax on U.S. multinationals by delaying tax until repatriation, and we don't really know whether graduated corporate tax rates are accomplishing whatever purpose we think they serve. For both cases, maybe the most alarming point is the last one on each topic: no agency has evaluating these expenditures as a mandate. Here are the summarized findings:

On deferral:
1. some experts say deferral promotes competitiveness of U.S. multinationals, but others say this ignores the effect on other corporations that can't use deferral, as well as broader economic impact.
2. deferral could distort corporate investment and location decisions and we don't necessarily know who benefits; meanwhile, deferral adds complexity to the tax code.
3. no other federal spending programs appear to subsidize U.S. MNCs in the same way
4. estimates suggest deferral doesn't cost much budget-wise
5. no federal agency has been tasked with evaluating deferral.

 On graduated corporate rates:
1. graduated rates are supposed to support small business, but we don't know if they do.
2. graduated rates present little complexity, but they probably induce planning and their impacts on decision-making aren't well understood.
3. graduated rates may be related to (a.k.a. duplicative of) other federal spending programs targeted to small businesses.
4. estimates suggest graduated rates don't cost much budget-wise
5. no federal agency has been tasked with evaluating the graduated rates.

More at the link, but not dramatically so.

Tomorrow at McGill Law: Sagit Leviner presents on the Three Goals of Taxation

The 4th Annual Tax Policy Colloquium at McGill Law continues Monday with a presentation by Professor Sagit Leviner of Ono Academic College, Israel, on her paper, co-authored with Tali Nir, Contemplating on the Meaning & Attainment of the Three Goals of Taxation, forthcoming in Honoring Arie Lapidot (Hebrew University Press, 2014). Here is the abstract:

Why do we need a tax system? Do we want the tax system to only finance public goods and services or do we also intend it to redistribute wealth and regulate human behavior?  What are the different means available to advance each goal and the likely (as well as unlikely) tension that might built up when utilizing these means and pursuing  the different goals? This chapter seeks to address these questions in order to present the building-blocks for a clear and accessible analysis of the goals of taxation. Specifically, the chapter addresses these goals in the context of the Israeli tax system while placing the analysis in a broader theoretical and empirical setting.

In connection with the above, Professor Leviner will discuss her 2003 Tannenwald prize-winning paper, From Deontology to Practical Application: the Vision of a Good Society and the Tax System, 24 Va. Tax Rev. 406 (2006) [draft here]. That paper laid out Leviner's vision for thinking abut tax policy from the perspective of a community-rather than individual-oriented view of society, "drawn from an analysis of the role that individual and collective rights and responsibilities ought to play in contemporary tax policy-making." This innovative work laid the groundwork for her current research and should make for a lively discussion.

The McGill Tax Policy Colloquium features distinguished visiting academics and offers a forum for students, professors, and local practitioners to discuss issues of tax policy and theory, along with related issues of economics and social justice.

Professor Leviner's talk is scheduled to commence at 2:30 pm tomorrow; members of the public are warmly welcomed.

 Location: McGill Faculty of Law, 3644 Peel Street, New Chancellor Day Hall, Room 203.
 Date and Time: Monday, 28 October, 14:30–16:30.

OECD public meeting on tax-base erosion project: US MNCs hope to 'participate'

Reuters reports that the OECD will have a "public meeting" in Paris on Nov 12-13, at which "companies will get to voice their concerns about the OECD's 'base erosion and profit shifting,' or BEPS, project":

The United States Council for International Business (USCIB), representing about 300 U.S. multinationals, has asked to participate at the hearing, said Carol Doran Klein, USCIB's tax counsel, on Monday.

And here comes a parade of lobbying that will be designed to protect all that is favorable to their clients in the status quo. These are the moments when I really appreciate the amount of transparency we have in US politics thanks to organizations like Open Secrets, the Sunlight Foundation and Muckrock:

A number of U.S. companies, including E. I. du Pont de Nemours and Co, (DD.N) and Starbucks Corp (SBUX.O), have raised questions about the BEPS project with members of Congress and the Obama administration, according to corporate lobbying disclosures filed earlier this year.

Remember "raising questions' is like "raising concerns": it doesn't mean the speaker has either a question or a concern; instead it means the speaker has an agenda. The Reuter's story continues:

Under existing international standards, the fees charged [on an inter-company basis] are supposed to be set using an "arm's length" approach, meaning one that replicates market-level values. In practice, fees are often skewed so that profits can be shifted into the low-tax country where the assets are located and out of higher tax countries. 

These practices are legal, but tax fairness activists and some less-developed countries are complaining about them.

Interesting subtext there. The story doesn't give any more detail about the public meeting but here is what the OECD says:

On 12-13 November a consultation, open to the public and press, will be held at the OECD in Paris. If you wish to attend, please contact TPConference@oecd.org.

Is not public and press redundant? No matter: the point is, this is part of the public consultation portion of the BEPS program.Here is a draft agenda in pdf, and it is fascinating in lineup of both topics and speakers--namely, only two are named right now and one of them has been a long time and trusted voice of business interests against corporate tax transparency, and purveyor of norm framing exercises at the OECD, namely, GE's Will Morris; the other is Michelle Levac, noted as one of the 50 biggest influences in tax by International Tax Review, owing to her role in leading Working Party 6 on transfer pricing. These two get bookend treatment, opening and closing the consultation. All the other speakers are TBD, so this is where the USCIB seeks to gain a foothold. Here is the outline so far:

Programme  Public Consultation on Transfer Pricing Matters  12-13 November 2013  OECD Conference Centre  2 Rue André Pascal, Paris 16th, France  Tuesday 12 November  08:30-09:30 Registration   09:30-09:50 Opening remarks and Ground Rules    Speakers:
Michelle LEVAC, Chair of Working Party No. 6
William MORRIS, BIAC   09:50-11:15 I:  Implementing country-by-country reporting  The BEPS Action Plan directs the OECD to develop and implement a system of country-by-country reporting to tax authorities of high level MNE group financial information.  A large number of questions arise in connection with implementing such a system.  These include:  (i) what information should be reported; (ii) at what time should that information be reported; (iii) to whom should such information be reported; and (iv) how should such information be shared among relevant governments, taking into consideration concerns regarding non-cooperative governments, incomplete treaty information exchange obligations, and the need to protect confidential taxpayer information.
Speakers: to be announced
1.  Information to be reported
2.  Information to be reported
3. Mechanisms for reporting / to whom to report / information sharing   11:15-11:45 Refreshment Break      11:45-13:15 II:  White Paper on Transfer Pricing Documentation  The BEPS Action Plan calls for the OECD to develop rules on transfer pricing documentation.  To initiate that process, the OECD published a White Paper on transfer pricing documentation on 30 July 2013.  The White Paper raises a number of issues on which business has provided comments.  These include: (i) the implementation of a standardised two tier documentation system; (ii) the use and content of a global master file; (iii) mechanisms for limiting early reporting to information useful in risk assessment with subsequent opportunity for governments to obtain detailed information necessary for audit; (iv) the development of materiality standards; (v) implementing consistent documentation formats across countries; and (vi) mechanisms for minimising unnecessary compliance burdens.    Speakers: to be announced  1.  Two tier approach
2.  Contents of global master file
3. Establishing materiality standards  4. Mechanisms for simplifying compliance (1)
5. Mechanisms for simplifying compliance (2).   13:15-14:30 Lunch break      14:30-16:00 III:  Revised Discussion Draft On Transfer Pricing Aspects Of Intangibles – Definitional Issues And Comparability Factors  On 30 July 2013 the OECD published a Revised Discussion Draft on Intangibles.  In the RDD, the definitional section was changed in some respects.  In addition, a new section of the RDD addresses comparability factors including location savings, features of local markets, assembled workforce, and corporate synergies.   Discussion in the afternoon session will be devoted to definitional issues and to the new section on comparability factors.
Speakers: to be announced
1. RDD changes to the definition of intangibles
2. Usefulness of the term “marketing intangibles”
3. Treatment of goodwill and on-going concern value / Examples 16 and 18   16:00-16:30 Refreshment Break      16:30-18:00 IV:  Revised Discussion Draft On Transfer Pricing Aspects Of Intangibles – Definitional Issues And Comparability Factors  (Continued)    Speakers: to be announced
4.Treatment of location savings and local market features
5. Treatment of Assembled Workforce
6. Treatment of group synergies
7. The financing and guarantee examples / Examples 1 and 2     Wednesday 13 November     09:30-11:00 V.  Revised Discussion Draft On Transfer Pricing Aspects Of Intangibles – Section B Of The RDD Section B of the June 2012 Discussion Draft attracted numerous written comments and was the subject of much discussion at the last business consultation. It has been substantially redrafted.  The approach in the RDD is more transactional in nature, while still emphasising the primary importance of functions performed, assets used and risks assumed.  The morning discussion will focus on the changes to Section B and the related examples     Speakers: to be announced
1. The general approach of new section B.
2. Examples 1 – 3
3. The treatment of outsourcing arrangements
4. The treatment of important functions   11:00-11:30  Refreshment Break      11:30-13:15 VI:  REVISED DISCUSSION DRAFT ON TRANSFER PRICING ASPECTS OF INTANGIBLES – SECTION B    Speakers: to be announced
5. Examples 11 – 14 and footnote 5 on page 63.
6. Treatment of funding for intangible development
7. Guidance on the use of corporate trade names   13:15-14:30 Lunch      14:30-15:15 VII: Other Discussion Draft Topics    Speakers: to be announced
1. Treatment of valuation techniques
2. Guidance on transfer pricing methods
3. Options realistically available / Example 24   15:15-16:00 VIII: Transfer Pricing Aspects Of The Beps Action Plan
The BEPS Action Plan published in July will guide much of the OECD transfer pricing work in the next two years.  The Action Plan contains four substantive transfer pricing areas of work in Actions 4, 8, 9, and 10.   This discussion will provide business an early opportunity to comment on the transfer pricing aspects of the Action Plan and the approach that Working Party No. 6 should take to fulfilling its mandate under the Action Plan.    Speakers: to be announced
1. How should the BEPS Project approach the question of hard to value intangibles / particularly transfers of partially developed intangibles?
2. How should the BEPS Project approach questions of risk allocations that may give rise to separation of income from relevant economic activity?
3. What role should there be for approaches outside the arm's length principle in addressing BEPS issues?        16:00-16:30 Refreshment Break      16:30-17:30 IX:  TRANSFER PRICING ASPECTS OF THE BEPS ACTION PLAN (CONTINUED)    Speakers: to be announced
4. How should the BEPS project approach the topic of recharacterisation of transactions?
5. What should the BEPS project consider in connection with global value chains and profit split approaches?
6.  What should the BEPS work on financial transactions address?    CONCLUDING REMARKS   17:30-18:00 Speakers:
Michelle LEVAC, Chair of Working Party No. 6
William MORRIS, BIAC   18:00 ADJOURN

Perhaps there will be additional public consultation meetings, I do not know. As Lynne LaTulippe taught my tax policy class recently, the consultation process is an often overlooked and in general understudied aspect of norm diffusion and lawmaking. This is one of the many times I wish that I was geographically situated to attend these things. I will be very interested to see how the speaker lineup evolves and would be very grateful to hear about the discussion from anyone who attends.

Rosenzweig on Corporate Tax Incidence

Last week I posted the JCT paper that outlines their approach to measuring the incidence of the corporate tax, in which  Further on the question of who bears the in which the JCT explained its decision to assume that in the short run the incidence of corporate tax is fully on capital owners but in the long run (assumed to be reached by the end of a ten year analysis period), owners can shift 25% of the tax to domestic labor. Adam Rosenzweig recently posted a paper on this topic, entitled A Corporate Tax for the Next One Hundred Years: Incorporating Macro-Economic Conditions and Fiscal Policy into the Corporate Income Tax, in which he argues that that incidence can shift more onto labor during periods of high unemployment, so corporate tax rates should float in response to prevent this shifting of incidence onto labor at the worst time. Here is the abstract:

The United States has included some form of income tax on corporations at least since the enactment of the Sixteenth Amendment one hundred years ago. Notwithstanding this long lineage, however, surprisingly little is known about who ultimately ends up bearing the cost of the tax, or whether it even matters. Perhaps in simpler economic times such as 1913, or 1932, or even 1980, this might have been acceptable. But as the world confronts vastly different economic conditions than the ones faced in the past, finding new ways to understand and implement the corporate tax will become crucial to its survival. This Article will introduce one way to do so by taking into account how macro-economic conditions, such as high unemployment, can impact who bears the incidence of the corporate income tax. The lesson that can be learned is that conditions such as high unemployment can cause the incidence of the corporate income tax to shift from capital onto labor, at least as compared to periods of full employment. This insight into who actually bears the cost of the corporate tax can fundamentally alter the landscape of the corporate tax policy debate, from using corporate taxes to increase progressivity to abolishing the corporate tax through integration. By explicitly incorporating both macro and micro-economic realities into fiscal policy, policymakers can transform the corporate income tax from a blunt and uncertain fiscal tool to a more precise instrument robust enough to survive the next one hundred years. 

This Article will consider one specific example, proposing a Dynamic Self-Adjusting Tax rate, or DST for short. The DST takes the incentive of employers to shift the cost of the corporate tax onto labor through lower wages, increased layoffs, or otherwise during periods of high unemployment as a given. The DST then offsets this by charging employers (through higher marginal tax rates) when they do shift the cost of the corporate tax onto labor while, at the same time, rewarding employers (through lower marginal tax rates) when they make new investments in labor. In this manner, the DST could help reduce existing tax-induced distortions while also potentially generating positive macro-economic feedback effects. By incorporating both macro and micro effects into the analysis, the DST could prove pro-growth, pro-employment, and self-financing all at the same time.

Global Tax Expert Database?

I've been slowly working through a couple of manuscript reviews and in one of them I started thinking about the problem of fly-in expert consultation, i.e., the traditional model of tax experts from rich countries flying in to developing countries to assess the situation and provide advice for tax reforms. This was connected to a conversation I had on twitter last week about how to get needed research on technical tax policy alternatives accomplished, when donors and tax policy institutions like the OECD tend to focus on tax assistance that furthers rather than challenges the status quo. The dangers inherent in these paradigms include policy ossification helped along by ideological entrenchment, as well as the privileging of historical ideas about who ought to be considered an expert. Also relatedly, in a paper I am working on about tax governance and the problem of special interest group influence, I am thinking about how to create more policy space for alternative tax policy views from academics and non-governmental, non-industry groups--i.e., those without direct (pecuniary or otherwise) stakes in tax policy outcomes.

This brought me to thinking again that lending expertise upon demand (rather than pushing expertise onto others) is an appealing idea and I would like to see some sort of a matching program, through which interested academics, NGOs, and other non-industry, non-government experts could make themselves available to revenue officials, especially in poorer countries, to collaborate on reforms desired by the officials, for instance by reading reforms proposed by industry or legislators or commenting on drafts of proposed tax guidance and the like. It would be an interesting project in and of itself, mapping out and connecting areas of interest and expertise that are currently excluded from the established network of government-run tax policy institutions and otherwise fragmented by geography, resources, and institutions.

Coincidentally, after I recently posted a comment on twitter about how the US could take unilateral measures to curb global tax avoidance if it chose to do so, fellow twitterer @hselftax wrote, "the #AdoptanMP campaign aims to give tech tax info to UK MPs. Perhaps you need #AdoptASenator in US?" Fascinating idea! Here is a website that talks about it.

How might such a program be built transnationally and tailored to tax collaboration on request? It would need to be voluntary on both sides--i.e., folks who self identify areas they would be willing to consult on, together with disclosure of credentials and affiliations, and revenue officials who identify areas in which they are seeking outside expertise. Does such a platform already exist, i..e, on LinkedIn or elsewhere? Is there an app for this? I know that the OECD has created tax inspectors without borders, but what I have in mind is a slightly different model than official-to-official consultation.

Measuring Corporate Tax Incidence: Update from the Joint Committee on Tax

The JCT released a report yesterday laying out its new method for measuring corporate tax incidence, Modeling The Distribution Of Taxes On Business Income (JCX-14-13).  The paper begins with a nice summary of the literature to date, and lays out the JCT's decision to assume that in the short run the incidence of corporate tax is fully on capital owners but in the long run (assumed to be reached by the end of a ten year analysis period), owners can shift 25% of the tax to domestic labor. Current Treasury practice assumes an 82/18 split. JCT explains its methodology and provides "illustrative examples", so the report is worth reading in full, but here are a few excerpts of note:

The Joint Committee staff has refrained from estimating the distribution of changes to the taxation of corporate income.... Past decisions not to estimate the distribution of taxes on corporations and passthrough entities were the result both of uncertainties among economists regarding the appropriate incidence of business taxes and to data limitations which made it impractical to distribute such taxes in the timeframe necessary to fit the legislative schedule. However, the economic literature has continued to advance. The Joint Committee staff believes that public finance economists now have a better understanding of, and can more appropriately measure, the incidence of taxes on business income. ... In addition, more detailed data and faster computing speeds help make timely completion of such distributional effects more feasible. 

...The debate over the incidence of corporate income taxes is ongoing, with a range of estimates on the precise breakdown depending on the assumptions of underlying models. Nevertheless, the existing research has arrived on two clear points of consensus. One is that the burden of the corporate income tax falls largely on domestic individuals, and therefore the corporate income tax does impact the well-being of these individuals. The second is that the burden of corporate income taxes is not borne entirely by capital owners, and is instead shared between capital owners and labor with the share borne by each being the subject of ongoing debate. 

...In the very short run, the incidence of business tax changes should fall entirely on the holders of the existing capital stock and bond holders. ... [I]n the long run owners of domestic capital are more easily able to escape some of the burden of the tax so business taxes are at least partially passed on to labor. ... 

The new methods ... reflect the current understanding in the economics profession that domestic individuals ultimately bear the majority of the burden of these taxes. Given the general economic consensus that these taxes should be distributed to individuals, the Joint Committee staff believes that estimating the distribution is appropriate. In the short run the new method distributes 100 percent of both types of taxes to owners of capital. In the long run it distributes 75 percent of corporate income taxes and 95 percent of the taxes attributable to passthrough business income to owners of capital. 

A portion of capital’s share of the corporate tax burden is borne by international capital owners, so in both the short run and the long run the distribution of tax burdens borne by domestic owners of capital is less than the burden borne by all capital owners. The portion of the corporate income tax burden borne by foreign capital owners is not distributed to domestic individuals on tax distribution tables. The remainder of the tax burden that is not distributed to foreign and domestic capital owners is distributed to labor, reflecting the compensation adjustment that results from corporate income taxes reducing the after-tax revenue that each worker generates for his firm. 

Given no definitive economic literature on the duration of the short run, the Joint Committee staff generally assumes that the long run is reached by the end of the 10-year budget window. These distributions between capital and labor reflect the middle of the range of estimates for distributing business taxes in the economic literature. The Joint Committee staff will use the updated distribution methods in this report to estimate tax distributions for all future estimates of the distribution of Federal income taxes. The Joint Committee staff will continue to evaluate and refine this approach to be consistent with new research findings as they arise. 

The Shutdown and a Tea Party Tax Paradigm Shift: Guest Post by Marco Garofalo

One of the many benefits of hosting a tax policy colloquium is that the students become deeply engaged in grappling with tax policy principles through contemporary scholarship, and they apply these ideas to the world in which they find themselves. After our recent presentations by Reuven Avi-Yonah on the shifting pressures of globalization on the tax base, by Clifton Fleming on the politics of tax expenditure analysis, and by Lyne LaTulippe on the topic of tax competition, in which she introduced us to work by the political scientist Mark Blyth, one of my students came back with the following analysis of tax politics in the US, and he agreed to share it here.

Government Shutdown and a Tea Party-Induced Tax Policy Paradigm Shift in the United States

A paradigm shift in tax policy may be unfolding in the United States, as the Tea Party positions itself differently than either the Democrats or the Republicans when it comes to important aspects of tax policy processes and practices.  In a recent article, "Paradigms and Paradox: The Politics of Economic Ideas in Two Moments of Crisis," Mark Blyth investigated why we did not see a paradigm shift in economic policy after the financial crisis of 2008. He argues that paradigm shifts are usually:

1. triggered by failures in the current paradigm; 
2. accompanied by a new paradigm that is waiting in the wings to replace the current one; and 
3. driven by a change in who can speak authoritatively on the subject.

He concluded that “it is politics, not economics, and it is authority, not facts, that matter for both paradigm maintenance and change.” Consequently, he argues that we did not see a paradigm shift after the financial crisis for a few reasons. First, even though there was a failure of the current paradigm, there was no challenger waiting to replace it. To illustrate his point, Blyth suggests that it was inconceivable that the Washington Consensus would be replaced by the Beijing Consensus, “so complete was its initial victory.” Second, the sudden policy failure did not result in a change of who speaks authoritatively on the subject, as protagonists did not change (individuals in the US Treasury, the ECB, and the IMF all retained their authority) and thus their solutions did not either. Blyth calls this ‘disciplinary incentive’; in other words, “too many careers and institutions are at stake!” Thus the financial crisis did not spur a paradigm shift.

But consider the Tea Party and its crusade. Since 2009, the Tea Party has been an unavoidable presence in US politics. While the Tea Party story has many permutations, causes, and manifestations, only the current government shutdown is important for the purposes of the current discussion. The current shutdown is not about Republicans versus Democrats; it is about the Tea Party versus Republicans. The Patient Protection and Affordable Care Act passed in Congress, was upheld by the Supreme Court of the United States, and its funding was not seriously contested by the Republican Party. This is an artificial crisis, a main architect of which appears to be Jim DeMint, former US Senator and current President of the Heritage Foundation.  If non-Tea Party GOP members do not want to play along, the implicit threat, according to Joshua Green of Bloomberg Businessweek, is that the Tea Party will turn on them, such as by launching “attack ads calling [Republican Senator Mitch] McConnell a ‘turncoat’ who ‘surrendered to Barack Obama’ in the healthcare fight."  So far, the Tea Party is pulling off this political coup: the government is shut down and positions are becoming entrenched.

Now consider this political impasse as a paradigm shift. First, we have a failure in the current paradigm (even though it is artificial). Joshua Green argues that “What’s causing the malfunction is a battle within the GOP.”  Second, we have a paradigm waiting in the wings to replace the current one. In fact, the Tea Party is not so much waiting to replace the Republicans as forcing that to happen. Third, the loci of authority in the Republican Party are shifting, either to Tea Party members or to the remaining GOP members who agree to change their tune. Hence we may see a paradigm shift, in which the Tea Party becomes the dominant faction in the Republican Party, resulting in a recalibration of the Democrat-Republican relationship.

Such a paradigm shift would have serious implications for tax policy. At least two would arise immediately, in the areas of tax expenditure analysis and tax consultations. First, tax expenditure analysis may begin to play a greater role. While the Republicans and Democrats function largely by dressing government spending as tax credits and deductions, the Tea Party is having none of that. The prime example would be the current crisis. The current government shutdown is itself a tax issue: the Patient Protection and Affordable Care Act, SCOTUS cogently reminds us, is a piece of tax policy. If the Tea Party does become the dominant Republican faction, then tax expenditure analysis may take center stage as a tool to sniff out government spending in all of its forms.

Second, the structure and content of tax consultations could change. Professor LaTulippe argues that international tax policy is beholden to a discourse of competitiveness (draft forthcoming). While part of the competitiveness discourse is about low rates, which the Tea Party presumably likes, part of the discourse is about tax expenditures, which the Tea Party would not like. Currently, tax consultations perpetuate this discourse by giving short time frames for the private sector to contribute to proposed tax reforms, with the result that a certain class of participants (accountants and lawyers) is greatly advantaged in giving feedback and achieving client-favored tax policy results. With the Tea Party paradigm, that policy loop could be disrupted, as this recent article suggests.

A paradigm shift in US politics is not certain. Any number of things could happen, including the Republican Party standing up to and beating the Tea Party. If that were to happen, then tax policy commentators should be concerned about the issues described above. Maybe once the dust settles we will meet the new boss, same as the old boss. But the current government shutdown (and impending sovereign debt default deadline) exhibits signs of a paradigm shift.  Something fundamental does seem to be changing on the small government side of political discourse. As such, we should stay tuned to the implications for tax policy.

Morriss and Freyer: Creating Cayman as an Offshore Financial Center

Andrew Morriss and Tony Freyer recently posted an article, "Creating Cayman as an Offshore Financial Center: Structure and Strategy Since 1960," in which they trace the development of the fiscal regime that made the Caymans the tax haven everyone loves to hate. The authors document the regime's roots in intense and purposeful transnational collaboration between British and Cayman government officials and private sector professionals. Like Morriss' previous work with Craig Boise on the Netherlands Antilles, this is a well-researched account of the political, institutional, social, and cultural factors at work in tax competition, and a must-read for everyone working on international tax policy issues.  From the abstract:

The Cayman Islands are one of the world's leading offshore financial centers (OFCs). Their development from a barter economy in 1960 to a leading OFC for the location of hedge funds, captive insurance companies, yacht registrations, special purpose vehicles, and international banking today was the result of a collaborative policy making process that involved local leaders, expatriate professionals, and British officials. Over several decades, Cayman created a political system that enabled it to successfully compete in world financial markets for transactions, participate in major international efforts to control financial crimes, and avoid the political, economic, racial, and social problems that plague many of its Caribbean neighbors. Using archival sources, participant interviews, and a wide range of other materials, this Article describes how the collaborative policy making process developed over time and discusses the implications of Cayman's success for financial reform efforts today.

There is so much in the paper it is difficult to extract effectively but he conclusion sums things up well:

Understanding how constitutional structure shaped the history of the Cayman financial center offers a response to critics’ preoccupation with actual or imagined abuses. OFC critics generally ignore the role of the United States and European nations in tax avoidance policies used by multinational corporations and wealthy individuals and those nations’ own roles as tax havens. ...  

The Cayman global competitive advantage thus did not originate in corrupt practices; it grew instead, from a history of social and constitutional stability sustaining collaborative policymaking among elected officials, legal professionals, and UK and Cayman civil service authorities like CIMA. 

... There is no question that the UK, the EU, and the United States have the power to [eliminate Cayman's tax policy autonomy] if they chose to do so. But if international relations are more than the exertion of brute force, there are important issues that need to be addressed in the development of international financial law with respect to OFCs. This requires broadly inclusive international consultations, not narrow efforts at defining best practices through rich nations’ clubs like the OECD or unilateral, asymmetric measures like the United States’ efforts through FATCA to force other countries to comply with U.S. regulatory measures.