By: Leandra Lederman
On February 6, 2020, the Indiana University Maurer School of Law welcomed our second Tax Policy Colloquium guest of the year: Prof. Werner Haslehner from the University of Luxembourg’s Department of Law, who is currently a Global Research Fellow and adjunct professor at NYU Law School. Werner presented his draft essay titled “International Tax Competition—the Good, the Bad, and the Ugly.”
States of course compete for tax base. Werner’s essay explains that “States’ general freedom to act (which we may call sovereignty) and taxpayer’s freedom to choose (which we may call liberty) – although neither is without limits – inescapably lead to competitive pressures and reactions.” (p.4) And some of this competition has been labelled as “harmful” by the OECD, the European Commission, and others. Yet, the essay points out, there is no accepted definition of the phrase “harmful tax competition.” The essay briefly reviews the literature and points out differences in approach to defining this concept. This part of the essay draws in part on Lily Faulhaber’s compelling article, The Trouble with Tax Competition: From Practice to Theory, 71 Tax L. Rev. 311 (2018), which pointed out the lack of definitional consensus and offered a typology of tax competition.
Werner’s essay further argues that, as commonly understood, there is no economic standard that supports a distinction between “harmful” and other types of tax competition. The essay thus proposes to replace the phrase “harmful tax competition” with “unfair tax competition.” (p.13) The essay specifically proposes “to refer as a basis for such a constraint to one of the most salient principles of moral philosophy: Immanuel Kant’s categorical imperative. According to this norm’s first formulation, one is to ‘act only in accordance with that maxim through which one can at the same time will that it become a universal law’.” (p.16). The essay provides two examples of behaviors that would be considered “unfair” under this standard: (1) ring-fencing (the provision of a tax benefit only to foreigners, not domestic taxpayers) and (2) secrecy (which, in response to a question I posed, Werner clarified refers to “secrecy as a service”—assisting foreign taxpayers in tax evasion).
Those two examples seem pretty uncontroversial—and likely would also be picked up under most definitions of “harmful tax competition”—but how would the standard otherwise be applied? Werner explained that his idea is to have a principle that has moral content, not to create a legal rule that some agency or other entity could enforce. His argument is that each country should ask itself what the effects would be if a rule it is contemplating were adopted by all other countries. He clarified in the talk in response to a student question that the analysis would be conducted as if all countries were similarly situated. And although the standard may appear to be replacing economic analysis with moral analysis, he explained that the Kantian question (what would the effects be if all countries adopted this rule) would require economic principles to answer.
The essay’s argument that the current distinction between “harmful” and other types of tax competition lacks an economic foundation is an important step toward the proposed replacement of harmfulness with a new standard. The essay’s reasoning that the concept of “harmful tax competition” lacks an economic standard is that “the economic harm resulting from tax competition, while real, bears an uncertain relation to the variously proposed criteria to identify and regulate tax competition.” (p.12) In other words, the essay argues that some regulatory activity that is generally understood to counter harmful tax competition—such as requiring economic substance to obtain a tax benefit—can actually produce more global economic harm: “From the perspective of global welfare, forcing companies to shift actual economic activity or substance to a suboptimal location would be more damaging than allowing them to shift activity merely on paper, because of the real effects on production. The assumption might be that businesses will refrain from making such a shift, but from their perspective, it is merely a question of the proper pay-off.” (p.10) This is an interesting attack on what I think of as a fairly common anti-abuse approach in U.S. tax law—the imposition of frictions designed to prevent the targeted behavior. So, a possible empirical question here is whether a particular friction designed to prevent targeted tax competition actually backfires, increasing deadweight loss, and, if so, if there is a rule that could be better designed to achieve the intended deterrent effect.
As this all suggests, Werner’s essay is ambitious and wrestles with fundamental and important issues. I do not generally consider the application of philosophical principles to taxation, so the essay posed a very interesting thought experiment. It would be particularly interesting to see if there are some examples of tax competition that are generally deemed “harmful” that would not constitute “unfair” tax competition, or vice versa. I also asked whether the standard would boil down to disapproval of regimes that selectively treat some taxpayers (e.g., foreign taxpayers) differently, similar to Europe’s State Aid doctrine. However, Werner made clear that that is not what his standard is intended to do.
The essay and presentation sparked a lively and fun discussion. Thank you again to Werner for sharing with us his interesting and thought-provoking draft, and for an excellent talk!
Maurer’s Tax Policy Colloquium series will continue on February 20, 2020, with Prof. Zachary Liscow from Yale Law School presenting “Equality, Taxation, and Law and Economics in the 21st Century.” The rest of the schedule is available here.