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Capital Taxation and International Cooperation the Causes and Consequences of Automatic Exchange of Information

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Capital Taxation and International Cooperation the Causes and Consequences of Automatic Exchange of Information 7 Capital Taxation and International Cooperation The Causes and Consequences of Automatic Exchange of Information Leo Ahrens, Fabio Bothner, Lukas Hakelberg, and Thomas Rixen 7.1 Introduction Internationally mobile capital is hard to tax. Wealthy individuals can evade taxes by investing in secretive tax havens and (illegally) failing to report their capital income to their home tax administrations. Multinational corporations can avoid paying taxes by (legally) shifting their (paper) profits to low tax countries. Public scandals such as the Panama Papers, Paradise Papers, and Lux Leaks, combined with significant deficits in public budgets in the aftermath of the financial crisis, have raised the political salience of these practices. Enjoying a significant boost due to increased public pressure, the OECD, coordinating the international com- munity’s actions against international tax flight since the 1960s, (re)launched two policy processes. First, it revived the OECD Harmful Tax Competition initiative, first launched in 1998 (OECD 1998) that aims at improved financial transparency to fight international tax evasion of (mostly personal) portfolio capital. Second, it launched a new policy process against ‘base erosion and profit shifting (BEPS)’ in 2012 (OECD 2013) that aims at international tax avoidance by multinational corporations (MNC). The first policy process culminated in the adoption of automatic exchange of taxpayer information (AEI). In 2014, 51 countries adopted the so-called common reporting standard (CRS) by multilateral agreement (OECD 2014), and a further 58 have joined since, including all countries formerly notorious for their financial secrecy.¹ This agreement was widely hailed as a breakthrough in the fight against international tax evasion (Christensen and Hearson 2019). According to most observers, however, the BEPS project has so ¹ OECD (2019a). Leo Ahrens, Fabio Bothner, Lukas Hakelberg, and Thomas Rixen, Capital Taxation and International Cooperation: The Causes and Consequences of Automatic Exchange of Information In: Combating Fiscal Fraud and Empowering Regulators: Bringing Tax Money Back into the COFFERS. Edited by: Brigitte Unger, Lucia Rossel, and Joras Ferwerda, Oxford University Press (2021). © Oxford University Press. DOI: 10.1093/oso/9780198854722.003.0007 . 113 far failed to deliver substantial progress in the fight against (legal) tax avoidance (Büttner and Thiemann 2017; Lips 2019).² These developments raise interesting questions of high policy relevance. In this contribution, we provide an overview of the questions and the answers we found in our research and in that of other international tax scholars. First, how can we explain the different outcomes of the initiatives against tax evasion and tax avoidance? Why was the international campaign against tax evasion successful, whereas the campaign against avoidance failed? We argue that the difference is explained by domestic politics in the hegemonic state (USA), enabling credible sanction threats against governments providing financial secrecy, but not against governments abetting corporate profit shifting. Second, having investigated the causes of these policy outputs, we focus on their consequences and effectiveness. In the ecosystem metaphor of the ‘Combatting Fiscal Fraud and Empowering Regulators (COFFERS)’ project (Chapter 2), we analyse the impact of a Darwinian shock on national jurisdic- tions. Has AEI really made a difference for nation states? Specifically, has AEI led to changes in the pattern of international investment? Have tax evaders shifted their investments out of tax havens?³ There is a small body of literature addressing the impact of various instruments of information exchange on investment flows. We review this literature and describe our contribution to this debate. We find that AEI did indeed lead to the expected shifts in inter- national portfolio investments. We also investigate to what extent potential loopholes in the AEI regime identified by critics, have been used by tax evaders. We find scattered evidence for their increasing relevance, suggesting that loop- holes should be closed swiftly before they begin to undermine the regime (see e.g. Meinzer 2017). Going beyond the impact on investment flows, we improve upon existing literature by investigating an indirect effect of the Darwinian shock of AEI on national jurisdictions. We ask: Does AEI impact domestic tax policies? The hypothesis we investigate is that AEI removes the pressure of international tax competition and thus enables governments to regain ‘room to manoeuvre’, allow- ing them to increase taxes on internationally mobile capital. Indeed the data suggest that tax hikes on portfolio capital income have recently occurred across OECD countries. Can we attribute these domestic tax policy changes to AEI? How does AEI relate to or interact with other factors—most importantly, domestic political factors—that influence tax policy decisions? Leveraging the differential ² Recognizing the shortcomings of the BEPS project, the OECD has initiated a further policy process, often referred to as BEPS 2.0. Proposals include far-reaching reforms of the international tax system. At the time of writing this chapter, it is too early to tell whether BEPS 2.0 will bring significant reform or not. ³ Chapter 14 sees this shock through an agent based model. 114 success of cooperation against evasion and avoidance as a quasi-experiment, we find that the average tax rate on dividends in OECD countries is 4.5 percentage points higher in 2017 than it would have been absent international tax cooper- ation. Further, the results of a panel regression show that financial transparency, in conjunction with budget deficits, leads governments to increase taxes on dividends. These findings lend support to the notion that international tax cooperation increases the domestic policy space of governments under conditions of economic globalization. The rest of the chapter is structured as follows: We first provide a brief primer on the international taxation of capital income and how tax evasion, avoidance and competition work (Section 7.2). In Section 7.3, we address the question of the differential success of the campaigns against evasion and avoidance. After that, we address the link between AEI and international investment (Section 7.4) and domestic tax policy (Section 7.5). Section 7.6 concludes the chapter and derives policy recommendations. 7.2 A Primer on International Capital Taxation and Its Deficiencies According to the principles of international taxation enshrined in the OECD’s model tax convention (MTC), passive income from cross-border investment can be taxed where the investment is made (source country) and where the investor resides (residence country) (OECD 2017, Art. 10 and 11). To avoid double taxation, governments enter into bilateral tax treaties (BTTs) in which they agree on lower or zero withholding taxes applicable to investors from the partner country. Most OECD countries grant tax relief for taxes paid abroad but assert the right to tax households on their worldwide receipts of passive income (OECD 2018b, p. 24ff.). Otherwise, the government would advantage the recipients of foreign income over the recipients of domestic income, thereby violating the equal treatment and ability to pay principles underpinning most income tax systems (Scheve and Stasavage 2016, pp. 25–40). Owing to the financial secrecy offered by tax havens, this is precisely what happened in practice. While households are legally obliged to include their worldwide capital income in their income tax statement, tax authorities tradition- ally had a hard time detecting underreporting. If at all, BTTs provided for information exchange upon request, which conditioned the dissemination of account data on prior evidence for tax evasion and the domestic availability of requested information (Rixen 2008, p. 75ff.). Even if a foreign tax authority provided the required evidence, tax havens could refuse to share data by referring . 115 to domestic banking secrecy provisions. As a result, foreign account holders paid no or very little tax on unreported capital income.⁴ The available evidence suggests many made use of the opportunity to evade taxes. According to the most conservative estimate, 8 per cent of global household financial wealth was held unrecorded in tax havens between 2001 and 2008 (Zucman 2013, p. 1323). Further, tax evasion contributes massively to income and wealth inequality as it is mostly the very rich engaging in such activity (Alstadsæter et al. 2019). Tax evasion on this scale does not only cause immediate revenue losses and distributive concerns, but it also creates indirect losses by pressuring residence countries into tax competition. In the absence of meaningful tax cooperation, most OECD countries chose to cut taxes on capital income to prevent capital flight to tax havens (Ganghof 2006; Genschel and Schwarz 2013). Peer Steinbrück, the former German minister of finance, summarized the general logic when introducing a special tax rebate for personal capital income in 2006. From his perspective, ‘25% of X [was] still better than 42% of nothing’ (Handelsblatt 2006). With a lower premium on tax evasion, he hoped, fewer taxpayers would risk criminal charges for underreporting returns to their foreign accounts. In contrast to passive income, the MTC assigns the exclusive right to tax the business profits of a foreign-owned enterprise to the source country. In principle, the branch of a multinational group
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