The market, taxation, and redistribution Peter Dietsch, Philosophie, Université de Montréal Presented at the Cérium summer school 2 nd and 3 rd July 2010.

The market, taxation, and redistribution

Peter Dietsch, Philosophie, Université de MontréalPeter Dietsch, Philosophie, Université de Montréal

Presented at the Cérium summer schoolPresented at the Cérium summer school

22ndnd and 3 and 3rd rd July 2010July 2010

The market, taxation, and The market, taxation, and redistributionredistribution

Two central questions:Two central questions:1)1) What are the distributive consequences of the international What are the distributive consequences of the international

fiscal landscape?fiscal landscape?2)2) To the extent that this landscape generates inequalities we To the extent that this landscape generates inequalities we

should consider unjust, what institutional responses are called should consider unjust, what institutional responses are called for?for?

Several subsidiary questions:Several subsidiary questions:1)1) Fiscal systems represent a corrective of the market. What is Fiscal systems represent a corrective of the market. What is

the justification for the distributive outcome of the market in the justification for the distributive outcome of the market in the first place?the first place?

2)2) How do we justify and implement redistribution?How do we justify and implement redistribution?3)3) What is the relation between the normative principles of What is the relation between the normative principles of

international taxation put forward here and the sovereignty of international taxation put forward here and the sovereignty of states?states?

4)4) Why not rely on corporations rather than states for a solution?Why not rely on corporations rather than states for a solution?

The market as a means of The market as a means of social interactionsocial interaction

Two traditional justifications for the market:Two traditional justifications for the market:1)1) The maximisation of social welfareThe maximisation of social welfare

but consider: 2but consider: 2ndnd Best Theorem Best Theorem(RG Lipsey, K Lancaster, “The General Theory of Second Best”, (RG Lipsey, K Lancaster, “The General Theory of Second Best”, The Review of Economic The Review of Economic StudiesStudies 24/1 (1956), pp. 11-32) 24/1 (1956), pp. 11-32)

2)2) The guarantee of individual libertyThe guarantee of individual libertybut consider: externalitiesbut consider: externalities

Two insights:Two insights:

1)1) The market is contingent on the stateThe market is contingent on the state2)2) The market should be judged by its resultsThe market should be judged by its results

(Amartya Sen, “The Moral Standing of the Market”, (Amartya Sen, “The Moral Standing of the Market”, Social Philosophy and PolicySocial Philosophy and Policy 2/2 2/2 (1985), pp.1-19)(1985), pp.1-19)

The distributive outcome of the The distributive outcome of the marketmarket

Important:Important: Evaluating a distribution requires a theory of justiceEvaluating a distribution requires a theory of justice Justice ≠ EqualityJustice ≠ Equality

Three ways to redistribute:Three ways to redistribute:1)1) Ex post Ex post (eg through income taxation)(eg through income taxation)

but: effect on efficiency?but: effect on efficiency?2)2) Ex ante Ex ante (eg through estate tax)(eg through estate tax)

but: utopian + undermining the rule of lawbut: utopian + undermining the rule of law3)3) through institutional design (eg through anti-trust policy*)through institutional design (eg through anti-trust policy*)

=> central to my argument today=> central to my argument today

* * (see Peter Dietsch, “The market, competition, and equality”, (see Peter Dietsch, “The market, competition, and equality”, Politics, philosophy, and economicsPolitics, philosophy, and economics 9/2 (2010), 213-44)9/2 (2010), 213-44)

Taxation as a means to Taxation as a means to reredistributedistribute

Definition:Definition:A tax is a financial duty levied either on the basis of A tax is a financial duty levied either on the basis of certain economic activities or in virtue of holdings of certain economic activities or in virtue of holdings of wealthwealth

Objectives:Objectives:Raising revenue, redistributing income, influencing Raising revenue, redistributing income, influencing behaviour, smoothing the economic cycle behaviour, smoothing the economic cycle

Some clarifications:Some clarifications:1)1) Taxation does not conflict with property rightsTaxation does not conflict with property rights

(see Murphy / Nagel, (see Murphy / Nagel, The Myth of OwnershipThe Myth of Ownership, OUP, 2002), OUP, 2002)

2)2) Does taxation imply a conflict with efficiency?Does taxation imply a conflict with efficiency?3)3) When is a tax progressive or regressive?When is a tax progressive or regressive?

Central questions for todayCentral questions for today

A descriptive and a normative question:A descriptive and a normative question:1)1) What is the impact of tax competition on the distribution of What is the impact of tax competition on the distribution of

income and wealth both domestically and globally?income and wealth both domestically and globally?2)2) To the extent that this impact entails injustices, what To the extent that this impact entails injustices, what

should we do about it?should we do about it?

A definition of tax competition:A definition of tax competition:Interactive tax setting by independent governments in a Interactive tax setting by independent governments in a non-cooperative, strategic waynon-cooperative, strategic way

Why is tax competition a problem?Why is tax competition a problem? They undermine the fiscal prerogatives of the state: (1) They undermine the fiscal prerogatives of the state: (1)

size of the state & (2) level of redistributionsize of the state & (2) level of redistributionWhy is it often ignored by theories of justice?Why is it often ignored by theories of justice?

StructureStructure

1)1) How tax competition works and what its How tax competition works and what its distributive effects aredistributive effects are

2)2) How to regulate itHow to regulate it

Discussion of two objections:Discussion of two objections:

1)1) What about sovereignty?What about sovereignty?

2)2) Why regulation? Why not rely on socially Why regulation? Why not rely on socially responsible behaviour of corporations?responsible behaviour of corporations?

Various forms of tax competitionVarious forms of tax competition

A multitude of ways to create a favourable tax environment:A multitude of ways to create a favourable tax environment:

Lower rates; preferential rates for foreigners (“ring-Lower rates; preferential rates for foreigners (“ring-fencing”); loopholes; regulation (eg bank secrecy)fencing”); loopholes; regulation (eg bank secrecy)

Tax competition (mainly) targets 3 forms of capital:Tax competition (mainly) targets 3 forms of capital:

1)1) Portfolio capital; eg through low rates combined with Portfolio capital; eg through low rates combined with secrecysecrecy

2)2) Foreign direct investment (FDI); eg through ring-fencingForeign direct investment (FDI); eg through ring-fencing

3)3) Paper profits; eg through transfer pricing or thin Paper profits; eg through transfer pricing or thin capitalisationcapitalisation

Some figuresSome figures

Estimates for wordwide yearly revenue losses to Estimates for wordwide yearly revenue losses to governments due to governments due to individual individual tax evasion or tax evasion or avoidance: US$ 155 to 255bnavoidance: US$ 155 to 255bn

““Developing countries are estimated to lose to tax Developing countries are estimated to lose to tax havens almost three times what they get from havens almost three times what they get from developed countries in aid.” (Angel Gurria, Secretary-developed countries in aid.” (Angel Gurria, Secretary-General of the OECD in November 2008)General of the OECD in November 2008)

Estimates for the US tax gap by the IRS: US$ 345bnEstimates for the US tax gap by the IRS: US$ 345bn(= 20% of total revenue)(= 20% of total revenue)

At the height of its preferential corporate tax for At the height of its preferential corporate tax for foreigners, Ireland received 60% of US FDI in Europeforeigners, Ireland received 60% of US FDI in Europe

60% of world trade is intra-firm60% of world trade is intra-firm 70% of individual wealth in South America is held 70% of individual wealth in South America is held

offshoreoffshore

TheThe theoretical theoretical consequences of tax consequences of tax competitioncompetition

A “race to the bottom”:A “race to the bottom”:

A sequence of mutual underbidding of capital tax A sequence of mutual underbidding of capital tax rates, which eventually leads to an under-rates, which eventually leads to an under-provision of public goods in all jurisdictionsprovision of public goods in all jurisdictions

See H.-W. Sinn’s See H.-W. Sinn’s “selection principle”“selection principle”::

If the state intervenes to correct for market failure If the state intervenes to correct for market failure by reintroducing competition between states / by reintroducing competition between states / systems as the alternative, this alternative will fail, systems as the alternative, this alternative will fail, tootoo(H.-W. Sinn, “The selection principle and market failure in systems competition”, (H.-W. Sinn, “The selection principle and market failure in systems competition”, Journal of Public Journal of Public EconomicsEconomics 66/2 (1997), pp. 247-74) 66/2 (1997), pp. 247-74)

TheThe empirical empirical consequences of tax consequences of tax competition Icompetition I

For developed countries:For developed countries:1)1) Fall in average OECD corporate tax rates and top income Fall in average OECD corporate tax rates and top income

tax rates over the last decadestax rates over the last decades2)2) Compensated by base broadening (‘tax cut cum base Compensated by base broadening (‘tax cut cum base

broadening’)broadening’)3)3) More precisely, we see a shift of the tax burdenMore precisely, we see a shift of the tax burden

… from multinationals to nationally organised SMEs… from multinationals to nationally organised SMEs… from capital to labour… from capital to labour… towards indirect taxes… towards indirect taxes… away from high incomes to preserve ‘backstop function’ … away from high incomes to preserve ‘backstop function’ of personal income taxof personal income tax

In sum: In sum: Developed countries are able to maintain the size of Developed countries are able to maintain the size of the budget (1) but only at the expense of compromising the budget (1) but only at the expense of compromising the desired level of redistribution (2)the desired level of redistribution (2)

TheThe empirical empirical consequences of tax consequences of tax competition IIcompetition II

For developing countries:For developing countries:Largely similar impact with two notable Largely similar impact with two notable

differences:differences: The strategy of ‘tax cut cum base broadening’ The strategy of ‘tax cut cum base broadening’

is usually not open to developing countriesis usually not open to developing countries Effect of ‘Washington consensus’Effect of ‘Washington consensus’ Example: BrazilExample: Brazil

In sum:In sum:Developing countries lose both fiscal Developing countries lose both fiscal prerogatives of the stateprerogatives of the state

What has been done about it?What has been done about it?

OECD:OECD: Report on Report on Harmful Tax Competition Harmful Tax Competition (1998)(1998) Several follow-up reportsSeveral follow-up reports

European Union:European Union: Code of conductCode of conduct Savings DirectiveSavings Directive Discussion of a consolidated corporate tax baseDiscussion of a consolidated corporate tax base

G20:G20: Blacklist of tax havens (April 2009)Blacklist of tax havens (April 2009)

OneOne problem of all these initiatives: problem of all these initiatives:

Their scopeTheir scope

Background justice for international Background justice for international taxationtaxation

Two approaches to deal with tax competition:Two approaches to deal with tax competition:

1)1) A palliative approach focused on distributive outcomesA palliative approach focused on distributive outcomes

2)2) A preventive approach focused on just institutionsA preventive approach focused on just institutions

Two proposed principles:Two proposed principles:

1)1) Membership principle:Membership principle:Natural and legal persons should be liable to pay tax in the Natural and legal persons should be liable to pay tax in the state of which they are a member.state of which they are a member.

2)2) Intentionality principle:Intentionality principle:Suppose the benefits of a tax policy change in terms of Suppose the benefits of a tax policy change in terms of attracted tax base from abroad did not exist, would the country attracted tax base from abroad did not exist, would the country still pursue the policy under this hypothetical scenario? If yes, still pursue the policy under this hypothetical scenario? If yes, the policy is evidently not motivated by strategic considerations the policy is evidently not motivated by strategic considerations and therefore legitimate. If not, then the policy is illegitimate.and therefore legitimate. If not, then the policy is illegitimate.

Fitness clubs and free-ridingFitness clubs and free-riding

Consider the analogy between a fitness club Consider the analogy between a fitness club and a country…and a country…

Tax evasion and tax avoidance represent Tax evasion and tax avoidance represent forms of free-ridingforms of free-riding

Those who do pay for public services have a Those who do pay for public services have a legitimate complaintlegitimate complaint

The membership principle (see above)The membership principle (see above)Individuals and companies should be viewed Individuals and companies should be viewed as members in those countries where they as members in those countries where they benefit from the public services and benefit from the public services and infrastructureinfrastructure

Challenges and implications of the Challenges and implications of the membership principlemembership principle

Challenges:Challenges:

1)1) Overcoming differences in the definition of Overcoming differences in the definition of membershipmembership

2)2) Enforcing the principleEnforcing the principle

Implications:Implications:

1)1) For individuals: self-selection into For individuals: self-selection into jurisdictions according to political preferencesjurisdictions according to political preferences

2)2) For multinational enterprises (MNEs): For multinational enterprises (MNEs): realreal instead of (merely) instead of (merely) virtualvirtual tax competition tax competition

The insufficiency of the membership The insufficiency of the membership principleprinciple

Consider two scenarios:Consider two scenarios:

1)1) Country A lowers a certain tax rate, because Country A lowers a certain tax rate, because this better reflects the political preferences this better reflects the political preferences of its citizensof its citizens

2)2) Country B lowers a certain tax rate in order Country B lowers a certain tax rate in order to attract capital base from abroadto attract capital base from abroad

What to say about these changes from the What to say about these changes from the perspective of justice?perspective of justice?

The intentionality principle (see above)The intentionality principle (see above)

What to make of the intentionality What to make of the intentionality principle?principle?

Objective:Objective:Delineate (legitimate) fiscal interdependence from Delineate (legitimate) fiscal interdependence from illegitimate tax competition.illegitimate tax competition.

Two observations:Two observations:1)1) Respecting Respecting both both principles does not lead to tax principles does not lead to tax

harmonisationharmonisation2)2) But it does lead to some pressure towards But it does lead to some pressure towards

convergence of ratesconvergence of rates

An objection:An objection:Is the intentionality principle utopian?Is the intentionality principle utopian?

ImplementationImplementation

Agreement on rules:Agreement on rules:

Definition of (multiple) residence for individuals; of economic Definition of (multiple) residence for individuals; of economic activity for multinationals; adopt Unitary Taxation with activity for multinationals; adopt Unitary Taxation with Formulary Apportionment instead of Arm’s Length PricingFormulary Apportionment instead of Arm’s Length Pricing

Reform of current practices:Reform of current practices:

Abolish bank secrecy & preferential tax regimes; make Abolish bank secrecy & preferential tax regimes; make information exchange effective and automaticinformation exchange effective and automatic

Enforcement:Enforcement:

Creation of a supranational body to provide independent Creation of a supranational body to provide independent oversight (International Tax Organisation)oversight (International Tax Organisation)

What about sovereignty?What about sovereignty?

A recent case:A recent case:

US US versus versus UBSUBS

Three kinds of sovereignty:Three kinds of sovereignty:(see (see Stephen D. Krasner, ‘Pervasive Not Perverse: Semi-Sovereigns as the Global Norm’, Stephen D. Krasner, ‘Pervasive Not Perverse: Semi-Sovereigns as the Global Norm’, Cornell International Law Journal 30 (1997)Cornell International Law Journal 30 (1997)

1)1) Domestic sovereigntyDomestic sovereignty

2)2) Westphalian sovereigntyWestphalian sovereignty

3)3) International legal sovereigntyInternational legal sovereignty

Which of these is / are relevant in the context of tax Which of these is / are relevant in the context of tax competition?competition?

Conflict between (1) and (2)Conflict between (1) and (2)

Sovereignty with strings attachedSovereignty with strings attached

In an economically interdependent world, the notion of In an economically interdependent world, the notion of Westphalian sovereignty no longer makes senseWestphalian sovereignty no longer makes sense

“… “… the easy – perhaps, indeed, the obvious – part: the easy – perhaps, indeed, the obvious – part: establishing that sovereignty (conceptually) must be limited establishing that sovereignty (conceptually) must be limited (if it is to be a right). The hard part is actually specifying (if it is to be a right). The hard part is actually specifying some concrete limits.”some concrete limits.”((Henry Shue, ‘Limiting Sovereignty’, in: J.M. Welsh (ed.), Humanitarian Intervention and International Henry Shue, ‘Limiting Sovereignty’, in: J.M. Welsh (ed.), Humanitarian Intervention and International Relations (Oxford, OUP, 2004), p. 16)Relations (Oxford, OUP, 2004), p. 16)

a notion of sovereignty that entails duties as well as rightsa notion of sovereignty that entails duties as well as rights For a suggestion as to the content of these duties, see For a suggestion as to the content of these duties, see aboveabove

What about CSR*?What about CSR*?

Different conceptions of CSR:Different conceptions of CSR:1)1) Corporate responsibility beyond the letter of the lawCorporate responsibility beyond the letter of the law2)2) Stakeholder theoryStakeholder theory3)3) A market-failure approachA market-failure approach

Consider a minimalist approach to CSR:Consider a minimalist approach to CSR:Companies have a social obligation to respect the rules of Companies have a social obligation to respect the rules of the game laid down by the regulatory frameworkthe game laid down by the regulatory framework

In particular:In particular: Companies have an obligation to pay their taxesCompanies have an obligation to pay their taxes Companies have an obligation not to undermine the Companies have an obligation not to undermine the

respect of fiscal obligationsrespect of fiscal obligations

* = Corporate Social Responsibility* = Corporate Social Responsibility

Why even the minimalist conception Why even the minimalist conception failsfails

for a manufacturer, adhering to the minimalist CSR may be feasiblefor a manufacturer, adhering to the minimalist CSR may be feasible For the tax planning industry, it seems utopianFor the tax planning industry, it seems utopian

Who are the tax planners?Who are the tax planners? The ‘Big Four’ accountancy firms; law firms; banksThe ‘Big Four’ accountancy firms; law firms; banks

How do they promote tax avoidance?How do they promote tax avoidance? By selling tax adviceBy selling tax advice By creating the legal foundation for the laws, trusts, offshore special By creating the legal foundation for the laws, trusts, offshore special

purpose vehicles and so on that make tax avoidance possiblepurpose vehicles and so on that make tax avoidance possible By promoting bank secrecyBy promoting bank secrecy

Two lessons: Two lessons: lip-service to corporate social responsibility by these companies is lip-service to corporate social responsibility by these companies is

hypocriticalhypocritical For them, respecting even a minimalist conception of CSR seems For them, respecting even a minimalist conception of CSR seems

inconceivableinconceivable

ConclusionsConclusions

In order to talk about ‘just taxation’, one In order to talk about ‘just taxation’, one needs to talk just as much about taxation as needs to talk just as much about taxation as about justiceabout justice

Tax competition undermines the fiscal Tax competition undermines the fiscal prerogatives of the state in ways that prerogatives of the state in ways that exacerbate inequalities in income and wealthexacerbate inequalities in income and wealth

Tax competition should be limited by two Tax competition should be limited by two principles – the membership and principles – the membership and intentionality principles – to ensure a intentionality principles – to ensure a background justice for international taxationbackground justice for international taxation

Yes, capitalism is in crisis, but not Yes, capitalism is in crisis, but not necessarily for the reasons we often thinknecessarily for the reasons we often think