Jump to ContentJump to Main Navigation
The Hypocritical HegemonHow the United States Shapes Global Rules against Tax Evasion and Avoidance$

Lukas Hakelberg

Print publication date: 2020

Print ISBN-13: 9781501748011

Published to Cornell Scholarship Online: September 2020

DOI: 10.7591/cornell/9781501748011.001.0001

Show Summary Details
Page of

PRINTED FROM Cornell University Press SCHOLARSHIP ONLINE (www.cornell.universitypressscholarship.com). (c) Copyright University of Cornell University Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in Cornell for personal use. date: 19 September 2021

Power in International Tax Politics

Power in International Tax Politics

Chapter:
(p.25) 2 Power in International Tax Politics
Source:
The Hypocritical Hegemon
Author(s):

Lukas Hakelberg

Publisher:
Cornell University Press
DOI:10.7591/cornell/9781501748011.003.0002

Abstract and Keywords

This chapter develops a theory of power in international tax politics. This theory identifies market size and regulatory capacity as the decisive resources enabling governments to issue credible threats and inducements with a view toward making other governments do what they would not otherwise do. A lack of regulatory capacity explains why the European Union has not wielded the same power in negotiations over global tax policy as the United States despite the EU's similarly sized internal market. In fact, taxation remains an exclusive member state competence. Therefore, the European Commission has no administrative authority to impose penalties on third states or foreign firms not complying with tax good governance standards applicable within the union. At the same time, the principle of nondiscrimination enshrined in EU law prevents individual EU countries from passing sanctions against other member states abetting tax evasion and avoidance. Because of the lack of regulatory centralization in the EU, the US can act as a hegemon in international tax politics. Accordingly, US preferences determined by domestic politics decisively shape the content of global tax policy. The preferences of other governments merely affect the US administration's enforcement strategy.

Keywords:   international tax politics, market size, regulatory capacity, European Union, EU law, nondiscrimination, US preferences, domestic policies, US enforcement strategy, global tax policy

The unexpected end of bank secrecy in traditional secrecy jurisdictions and the parallel survival of the status quo in bargaining over countermeasures to base erosion and profit shifting (BEPS) teach us three important lessons about the international politics of taxation. First, smaller countries make costly concessions when faced with a credible threat of sanctions from the United States. Accordingly, the US government can force smaller countries to adopt a regulatory standard like the automatic exchange of information (AEI) even if compliance worsens their lot relative to the status quo. Second, the US government can afford to ignore the same standard it imposes on smaller countries, thereby shifting adjustment costs onto foreign firms and creating a competitive advantage for US businesses. Although the resulting regime redistributes wealth from the rest of the world to the United States, other major economies, including the European Union (EU), have not been capable of countering US hypocrisy. As the Obama administration’s defense of the status quo in negotiations over BEPS also suggests, global tax policy cannot currently be shaped against the will of the US government. Yet—and this is the third lesson—the US develops a preference for international action against tax dodging only if restrictive domestic conditions apply. Ideological constraints have to prevent the administration from regressive tax reform, whereas legal constraints have to keep in check the power of interest groups, which are affected by countermeasures to tax evasion or avoidance.

Against this background, I devote the present chapter to the development of a theory of power in international tax politics. This theory identifies market size and regulatory capacity as the decisive resources enabling governments to issue (p.26) credible threats and inducements with a view toward making other governments do what they would not otherwise do. A lack of regulatory capacity explains why the EU has not wielded the same power in negotiations over global tax policy as the United States despite the EU’s similarly sized internal market. In fact, taxation remains an exclusive member state competence. Therefore, the European Commission has no administrative authority to impose penalties on third states or foreign firms not complying with tax good governance standards applicable within the union. At the same time, the principle of nondiscrimination enshrined in EU law prevents individual EU countries from passing sanctions against other member states abetting tax evasion and avoidance. Because of the lack of regulatory centralization in the EU, the US can act as a hegemon in international tax politics. Accordingly, US preferences determined by domestic politics decisively shape the content of global tax policy. The preferences of other governments merely affect the US administration’s enforcement strategy.

The Material and Institutional Sources of Power

Market Size and State Power

Scholarship seeking to explain governments’ relative power in international bargaining over financial and economic affairs has traditionally focused on the size of a country’s internal market. From this perspective, sway over global policy depends on the relative number of foreign firms ready to abide by a regulator’s decisions to gain access to customers or suppliers. The larger a market’s share in global demand or supply, the greater the financial incentive for foreign firms to secure entry. On the one hand, relative market size thus determines the extent to which a country’s market regulation has extraterritorial reach. A company whose profits are highly dependent on sales in a foreign market will, for instance, adapt the company’s products or services to local requirements rather than divest. If the rules governing its small home market differ or prevent the company from complying with the rules applicable in the large foreign market, the company will, moreover, lobby its home government for regulatory changes mirroring foreign rules. The gravitational effect of a dominant market may thus lead to the spontaneous diffusion of a powerful government’s regulatory model (Simmons 2001; Vogel 1997).

On the other hand, market size also determines whether a government can credibly threaten other governments with market closure to enforce its preferences in international negotiations. The credibility of threats depends on the difference between the costs coercive measures impose on the sender and the costs (p.27) they impose on the target. If a large country were to close its market to firms from a small country, for instance, the large country would lose a negligible share of its overall imports of goods, services, or investment. In contrast, the small country would lose a substantial share of its corresponding exports. Even if the small country closed its market in return, the large country would lose only a negligible share of its overall exports. The small country, however, would lose a substantial share of its imports. Because the large country is thus less vulnerable to market closure than the small country, the large country can wrestle concessions from the small country by conditioning market access on compliance with the large country’s demands. Inversely, the small country has no means to ensure the large country’s compliance with global rules (Drezner 2008; Krasner 1976; Legro and Moravcsik 1999).

If we accept the crucial importance of market size for state power, the outcome of international bargaining over countermeasures to tax evasion should depend on the preferences of countries with large financial markets. After all, tax evasion happens when a taxpayer hides wealth or income in a foreign account instead of declaring it in her tax return. Accordingly, countermeasures to tax evasion have to oblige banks and other financial institutions—the most likely custodians of hidden funds—to correctly identify their customers and report information about their assets and income to foreign tax authorities. Banks are, however, unlikely to comply voluntarily with data requests from foreign governments, because the after-tax return banks can offer their wealth management clients depends on financial secrecy as much as it depends on access to lucrative investment opportunities.1 Therefore, a regulator’s ability to obtain account information from foreign banks is conditional on the share of global capital demand to which the regulator can refuse access. If the share is small, a foreign bank may simply choose divestment over compliance. If the share is large, however, the foreign bank will not be able to find equivalent investment opportunities elsewhere. As a result, it has no choice but to abandon secrecy in return for continued market access.

In contrast, the outcome of bargaining over countermeasures to tax avoidance should depend on the preferences of countries with large consumer markets. Here, the regulatory goal is to prevent multinationals, which sell their products or services to customers around the world, from shifting the corresponding profits to tax havens where no substantial economic activity takes place (cf. OECD 1998, 2013b). According to international tax law, income from cross-border investment should either be taxed where the income source is located (source country) or where its beneficiaries reside (residence country).2 However, multinationals often channel their profits out of source countries untaxed, and then divert them to a corporate tax haven instead of returning them to the residence country. A government’s ability to counter these practices unilaterally should increase with (p.28)

Table 2.1 Measures of Financial Market Size in Developed and Emerging Economies

Country/Year

Market Capitalization of Listed Domestic Firms (%, World Total)

Value of Interbank Transactions (%, World Total)

Value of Securities Transactions (%, World Total)

2007

2017

2007

2016a

2007

2016a

United States

33

41

30

31

30

19

European Union

24

10

51

32

48

48

China

7

11

2

15

1

5

Japan

7

8

8

10

9

9

Brazil

2

1

2

3

4

10

India

3

3

0

0

0

0

Russia

n.a.

1

0

1

0

0

Note: Market capitalization is the share price times the number of shares outstanding for listed domestic companies. Interbank transactions are processed by interbank funds transfer systems and include transactions banks carry out on their own account and on behalf of their clients. Securities transactions are processed by central securities depositories and include all instructions to move securities between accounts.

(a) The latest year for which data was available at the time of writing. Data sources: World Bank (2018); Committee on Payment and Settlement Systems (2011); Committee on Payments and Market Infrastructures (2017).

the share that its consumer market contributes to a multinational’s global revenue. The larger the share, the higher the cost of exiting the market for tax reasons. Accordingly, a large source country could withhold taxes on dividend or royalty payments to corporate tax havens, whereas a large residence country could pass controlled foreign company (CFC) rules, adding profits booked in corporate tax havens to taxable domestic income, without risking divestment from multinationals.

If market size were the sole determinant of great power status, that status in international tax politics would characterize the United States and the EU, as a result of the union’s common market.3 As the data presented in table 2.1 show, firms listed in the United States contributed a third of the worldwide demand for equity financing in 2007 and four times as much as European and Chinese firms in 2017. Although the European financial market appears considerably smaller than the US financial market in terms of firm capitalization, the European financial market contributes a larger share to the value of transactions processed by the world’s interbank transfer systems and securities depositories. Between 2007 and 2016, the EU’s share of funds transferred among the world’s banks declined from more than half to a third. Still, the union continues to contribute about as much to the value of worldwide interbank transactions as the United States and twice as much as China. In addition, securities transactions processed by depositories in the EU consistently accounted for almost half of the value of worldwide (p.29)

Table 2.2 Foreign Portfolio Investment from Major Secrecy Jurisdictions in December 2009

Location of Asset Holder/ Issuer

United States

European Uniona

Other Major Foreign Portfolio Investment (FPI) Destinationsb

%, Total FPI (Rank)

%, Total FPI (Rank)

Country

%, Total FPI (Rank)

Austria

7

(2)

80

(1)

None

Bahamas

23

(2)

4

(4)

Brazil

57

(1)

Mexico

6

(3)

Bahrain

27

(1)

16

(3)

Turkey

22

(2)

United Arab Emirates

9

(4)

Belgium

6

(2)

88

(1)

None

—­

Bermuda

63

(1)

15

(2)

Cayman Islands

9

(3)

Cayman Islands

52

(1)

8

(3)

Brazil

29

(2)

Curaçaoc

11

(4)

36

(1)

Indonesia

15

(2)

Thailand

13

(3)

Guernsey

16

(2)

53

(1)

Cayman Islands

14

(3)

Hong Kong

11

(4)

22

(1)

Cayman Islands

20

(2)

China

18

(3)

Isle of Man

5

(3)

76

(1)

Cayman Islands

6

(2)

Jersey

23

(2)

55

(1)

None

—­

Luxembourg

16

(2)

60

(1)

None

—­

Macao

8

(4)

29

(1)

Hong Kong

20

(2)

China

18

(3)

Cayman Islands

6

(5)

Panama

59

(1)

3

(4)

Colombia

12

(2)

Brazil

9

(3)

Singapored

21

(2)

26

(1)

Japan

7

(3)

China

7

(4)

Korea

6

(5)

Switzerland

14

(2)

58

(1)

None

—­

Note: Major secrecy jurisdictions include all countries identified as such in table 1.1. Reported FPI data refer to the stock of investment in debt securities, equity and investment fund shares as of December 2009. The entity directly investing in an asset—an interposed shell company for instance—is reported as the asset holder. A beneficial owner investing through this entity is not identified. Likewise, the data does not separate investments households make through banks from banks’ proprietary trading. Despite these shortcomings, the International Monetary Fund’s FPI data remain the best available data for our purposes. BIS Locational Banking Statistics do not include investment in equity, and Treasury International Capital (TIC) data on foreign ownership of US securities does not enable the analyst to determine the US share in a foreign country’s overall portfolio investment.

(a) Includes all twenty-seven countries that were members of the EU in December 2009.

(b) Includes all countries receiving more than 5 percent of a tax haven’s total FPI.

(c) With its passage to independence in 2010, the Netherlands Antilles changed its official name to Curaçao & Sint Maarten.

(d) Data refer to December 2008 because Singapore made FPI information confidential for most destinations from 2009.

Data source: International Monetary Fund (2018).

(p.30) transactions over the course of the past decade. Most important, the United States and the EU have dominated all other countries on the usual measures of financial market size in all but one point in time during the past ten years (cf. Simmons 2001; Singer 2007). Whereas Chinese businesses have, indeed, caught up with European firms in terms of market capitalization, interbank and securities transactions processed in the Unites States and the EU have consistently accounted for 60 to 80 percent of the value of worldwide transactions.

Secrecy jurisdictions’ dependence on the US and European financial markets is reflected in the international distribution of secrecy jurisdictions’ foreign portfolio investment (FPI). In December 2009, three months before the US Congress adopted the Foreign Account Tax Compliance Act (FATCA), the largest share of overall FPI routed through fifteen out of the sixteen secrecy jurisdictions listed in table 2.2 either went to the United States or the EU. In ten out of sixteen cases, one of the two major financial markets accounted for 50 to 90 percent of all investment in debt securities, equity, and investment fund shares carried out via the respective jurisdiction. Other important destinations for individual secrecy jurisdictions include emerging economies such as Brazil, China, and Turkey or other secrecy jurisdictions such as the Cayman Islands and Hong Kong. The latter phenomenon most likely reflects the use of several conduits for a single investment stream. A private bank located in Hong Kong may, for instance, invest the deposits of a Chinese client in an investment fund registered in the Cayman Islands, which uses the money to buy company shares on the New York Stock Exchange. Owing to such constructs, FPI statistics may actually underestimate secrecy jurisdictions’ true dependence on access to major financial markets. In any case, the United States and the EU could destroy the business model of most secrecy jurisdictions by closing their markets unilaterally.

A similar picture emerges when comparing the consumer markets of major developed and emerging economies. Table 2.3 reports data for 2013, the year the Group of 20 (G20) and the Organisation for Economic Co-operation and Development (OECD) launched the BEPS initiative (G20 Leaders 2013; OECD 2013a). Whereas the number of potential customers is greatest in China and India, Americans and Europeans have more income to spend on the products and services offered by multinationals. Accordingly, the United States and the EU still account for larger shares of global imports of goods and services than China and India despite the significantly smaller US and EU populations. Their unmatched share of worldwide inbound foreign direct investment (FDI) moreover suggests that multinationals continue to locate most of their activities in the United States and the EU. This observation is of particular importance because international tax law links a government’s right to tax a multinational’s local revenue to the presence of a permanent establishment (PE) on the government’s territory. In the absence (p.31)

Table 2.3 Measures of Consumer Market Size for Major Economies in 2013

Indicators/Countries

US

EU

China

Japan

Russia

India

Population (millions)

316

507

1357

127

144

1252

National income (per adult)

49657

29245

11392

30115

22940

6020

Merchandise trade (%, global imports)

12.33

14.78

10.32

4.41

1.82

2.47

Commercial services (%, global imports)

9.85

19.74

7.52

3.70

2.81

2.84

Foreign direct investment (inbound, % world total)

19.4

33.7

3.8

0.7

2.3

0.9

Note: The selection of indicators for market size is based on Drezner (2008, 36). All EU figures refer to extra-EU trade and investment.

Data sources: UNCTAD (2014); WTO (2019a); World Inequality Database (2018).

(p.32) of a domestic plant, office, or warehouse, local sales alone do not justify the taxation of a foreign corporation.4 Therefore, inbound FDI should be the most relevant indicator of market size in the context of international tax politics.

The extent to which corporate tax havens specializing in the abetment of tax avoidance depend on access to the US and European markets is reflected in the origin of royalty and license fee payments the tax havens receive from abroad. Multinationals often use such payments to shift profits from their branches in high-tax countries to a subsidiary in a low-tax country. Accordingly, countries that do not tax revenue from the foreign lease of intellectual property—either on the basis of targeted expenditures or advance pricing agreements with individual firms—figure among the world’s largest recipients of such payments (WTO 2019b). Dutch firms, for instance, collected almost three times the amount of royalties collected by German firms in 2013, despite having invested only 15 percent of what German firms invested in domestic research and development that year (OECD 2018a). The profits multinational firms book in the Netherlands thus do not match their economic activity in the country—a fact that is indicative of tax-motivated shifts (Cobham and Janský 2017; Tørsløv, Wier, and Zucman 2018).

Against this background, the data presented in table 2.4 suggest that 70 percent of the revenue channeled to the Netherlands through license fee payments in 2013 came either from other EU member states or from the United States. Similarly,

Table 2.4 Royalty and License Fee Payments Received by Major Corporate Tax Havens in 2013

Destination/Origin

United States (%, Total)

European Union (%, Total)

Other Important Origin Jurisdictions (%, Total)

Netherlands

11

61

None

Switzerland

32

34

None

Ireland

43

19

None

Singapore

3

6

Australia

(18)

ASEANa

(17)

China

(16)

Japan

(12)

Luxembourg

n.a.

80

None

Hong Kong

15

15

China

(28)

Note: The listed destinations include all countries among the world’s top twenty-five recipients of royalty and license fee payments that effectively exempt such payments from taxation either through targeted expenditures or advance pricing agreements with individual firms (cf. European Commission 2017c, 2017b, 2017d; Inland Revenue Department 2011; Switzerland Global Enterprise 2014). Destinations are listed in descending order according to their share in global receipts of royalty and license fee payments.

(a) Association of South East Asian Nations (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam).

(p.33) Ireland, Luxembourg, and Switzerland—where the same mismatches between reported revenue and economic activity can be observed—received between 60 and 80 percent of shifted profits from the US and European markets. Hong Kong—the second largest corporate tax haven for license fee payments in Asia—collected about the same share from the United States and the EU combined as from China, whereas profits were shifted to Singapore from an unusually diverse number of markets within its wider region. Still, these figures show that most corporate tax havens would lose their attractiveness as locations for holding companies if they could no longer grant unhindered access to the US and European markets. Hence, the United States and a coalition of large EU member states, incurring revenue losses from profit shifting, should have the power to impose their tax policy preferences on corporate tax havens. The conversion of market size into an effective projection of power, however, depends on a government’s regulatory capacity.

Regulatory Capacity and State Power

Regulatory capacity is “a jurisdiction’s ability to formulate, monitor, and enforce a set of market rules . … ​At a minimum [it] consists of regulatory expertise, coherence, and the extent of statutory sanctioning authority” (Bach and Newman 2007, 831). An expert administration consists of well-trained and experienced professionals, who independently identify regulatory challenges, develop targeted policy solutions, and deploy the necessary resources to competently monitor implementation of the solutions by market participants. A coherent administration moreover ensures that the rules it develops apply uniformly across the market the administration regulates. The leeway officials enjoy in granting carve-outs and exemptions should be strictly limited, and the likelihood and intensity of audits should not depend on a company’s geographical location and political connections to local policymakers. Accordingly, a jurisdiction’s regulatory capacity will be higher when administrative authority is centralized than when it is dispersed (Posner 2009). What matters most for the projection of power in international bargaining, however, is an administration’s ability to punish noncompliance. The administration must have legal competence to penalize recalcitrant firms through monetary fines or market exclusion. Otherwise, sanction threats become cheap talk. While a large internal market may therefore be necessary for the projection of power, a jurisdiction can harness its potential only through adequate regulatory capacity (Bach and Newman 2010).

Herein lies the key difference between the United States and the EU. Since the adoption of FATCA, the US Treasury can decide to withhold 30 percent of the payments received from US sources by any foreign bank that does not comply (p.34) with the act’s reporting requirements (Grinberg 2012). Even before FATCA was enacted, the Treasury Department had the statutory authority to define the information on US clients that foreign banks had to divulge when seeking the status of a qualified intermediary (QI), and the department could, in principle, extend the reporting and due diligence obligations of all banks in the United States without prior consultation with Congress (cf. IRS 2000; Mordi 2011). When the Department of Justice (DoJ) suspects a breach of reporting obligations defined in QI or FATCA regulations, the DoJ may even threaten to seek the criminal indictment of a foreign bank from a grand jury. Since an indicted bank loses access to the clearing infrastructure for dollar-denominated transactions, such a threat from the DoJ is usually enough to force the targeted institution into a costly non-prosecution agreement. After all, no bank can participate in the international financial system without access to the currency in which the large majority of international transactions are processed. Hence, the dollar’s status as the world’s key currency significantly increases the US government’s regulatory authority over foreign banks irrespective of their exposure to the US capital market (Emmenegger 2015; Helleiner 2002).5

In contrast, the administration of direct taxation remains an exclusive member state competence in the EU. Accordingly, the European Commission neither has the authority to change the reporting obligations of banks in the common market, nor can decide to impose sanctions against banks outside the common market that refuse to disclose information on European account holders.6 Instead, member states have to agree unanimously on new reporting standards as well as on mandates for Commission negotiations on information exchange agreements with third countries. Therefore, Austria and Luxembourg were able to block the introduction of comprehensive AEI as well as the launch of corresponding negotiations with Switzerland for almost a decade (Hakelberg 2015b; Rixen and Schwarz 2012). But also since the transposition of the OECD common reporting standard (CRS) into European law, member states have not been able to develop meaningful sanctions mechanisms against third countries not complying with the new AEI standard. The only measure to date is an integrated blacklist of countries not complying with the EU’s tax good governance standards, including participation in multilateral AEI. Yet the corresponding Council conclusions merely propose defensive measures member states could apply against listed jurisdictions as they see fit and subject modifications of the list to unanimous approval by member states even when a country matches the agreed-upon criteria (Council of the European Union 2017). Owing to this lack of regulatory centralization, inclusion does not have direct material consequences for listed countries and can be vetoed by a single EU member. Instead of harnessing the power of the common (p.35) market, the EU thus leaves responsibility for sanctions and vulnerability to potential retaliation with individual member states.

Likewise, tax-avoiding multinationals have, in principle, more to fear from the US Treasury and its enforcing authorities than from the European Commission. For instance, the Internal Revenue Service (IRS) has the statutory authority to remove loopholes in US CFC rules that currently enable domestically headquartered corporations to defer tax payments on foreign profits reported in tax havens (cf. IRS 1997, 1998b). Without any additional acts of delegation from congress, the service can amend domestic transfer pricing and thin capitalization rules when abuse becomes apparent and introduce entirely new reporting obligations for multinational groups (cf. IRS 2016; US Treasury 2010). Subject to final approval by a Senate majority, the Treasury can moreover renegotiate tax treaties with foreign governments, granting or withdrawing exemptions from withholding taxes on payments from US sources. Within the EU, all of these competences remain with member states. They can each grant foreign companies access to the entire common market, while applying domestic tax law and the provisions of bilateral tax treaties. Over the last decades, tax competition has therefore been more intense in the EU than in the rest of the world (Genschel, Kemmerling, and Seils 2011). The European Commission can merely prevent the most harmful practices by ordering member states to claw back foregone tax payments from companies that have benefitted from selective fiscal privileges. Governments granting tax exemptions unequivocally to all EU firms, however, act within the bounds of their exclusive competence in direct taxation (Mazzoni and Avi-Yonah 2016).

Owing to their respective fiscal sovereignty, member states would thus have to find consensus if they wanted to overcome regulatory dispersion in tax matters. Instead of adopting a common stance with their European partners, however, Ireland, Luxembourg, and the Netherlands tailor their tax codes to the needs of US multinationals seeking to shift their profits out of the common market untaxed (Pinkernell 2012, 2014). In return, they benefit from high levels of foreign direct investment (FDI) from the United States. In 2013, 60 percent of the US FDI stock in the EU was located in these three countries, 80 percent of which was bound in holding companies. Accordingly, three quarters of the United States’ direct investment income from the EU was also channeled through Ireland, Luxembourg and the Netherlands that year (US Bureau of Economic Analysis 2018b, 2018a). Other member states would have to apply pressure to bring corporate tax havens in the EU into line. Their corresponding options are, however, severely constrained. The freedom of establishment enshrined in EU law posits that multinationals running their business from Ireland, Luxembourg, or the Netherlands (p.36) enjoy unconstrained access to the entire common market. The remaining member states have to treat them as if they were domestic companies. Accordingly, European governments can neither impose withholding taxes on payments to EU corporate tax havens, nor apply CFC rules against multinationals shifting their profits there (Genschel 2002; ECJ 2006). Because of the dispersion of regulatory authority among member states, the EU is thus unable to convert market size into power. As a result, US hegemony in international tax politics currently remains unchallenged.

Great Power Preferences in International Tax Politics

If the US Treasury has the authority to tackle tax evasion and avoidance unilaterally by regulation, why does the department make only sporadic use of its power? In this section, I submit that restrictive circumstances have to be met in domestic tax politics for the US administration to enforce countermeasures to tax dodging. In contrast to popular comment, however, I argue that budget constraints are not at the origin of increased great power activism. Instead, whether the United States supports new international tax rules depends on the feasibility of regressive tax reform and the power of affected domestic interest groups. Democratic administrations are more concerned about the tax system’s effective progressivity than their Republican opponents, whereas redistributive regulation at the international level allows the US government to appease powerful domestic interest groups by shifting adjustment costs onto foreign companies and governments.

Barriers to Regressive Tax Reform

Welfare economists assume that governments facing international tax competition seek to maximize the sum of tax revenue and domestic production (Chisik and Davies 2004; Keen and Konrad 2014). Yet how governments weigh these elements and which strategies they apply to attain their goal depends on a range of material and ideational factors. The easiest unilateral strategy to address budget constraints in a tax-competitive environment is regressive tax reform. By shifting the tax burden away from internationally mobile capital and toward immobile labor and consumption, this strategy reduces the risk of losing production to capital flight and generates additional revenue from increased payroll and value-added taxes (VAT). Accordingly, regressive tax reform has been popular among OECD governments from the 1980s throughout the first decade of the (p.37) 2000s (Beramendi and Rueda 2007; Genschel and Schwarz 2013). At the same time, however, this strategy also violates a fairness norm underpinning most modern tax systems. According to the ability-to-pay principle, high-income earners should contribute relatively more to the financing of the state than low-income earners, since those with high incomes find it easier “to bear the sacrifice of material well-being a tax burden entails” (Slemrod and Bakija 2008, 64). Given that the capital share increases while the share devoted to consumption decreases with the level of income, however, regressive tax reform shifts the tax burden from high-income to low-income taxpayers. Hence, high-income earners and their representatives are likely to support such a reform, whereas low-income earners and their representatives are likely to resist it.

Indeed, students of comparative tax politics consistently find that conservative parties prefer flat taxes on corporate profits and personal capital income. Conservative parties usually justify their preference by citing the larger role of corporations and high-income earners in saving and investment, and the positive correlation between the level of tax and capital flight suggested by the Laffer curve. In contrast, center-left governments prefer progressive taxation of corporate profits and personal capital income, which these governments justify with the ability-to-pay principle (Ganghof 2006). Basinger and Hallerberg (2004) show, for instance, that center-left governments are more hesitant than conservative ones in making competitive cuts to the corporate tax rate. Likewise, Garrett (1995) associates center-left governments with more capital taxation unless an economy is highly integrated in world markets. He explains that left parties favor high taxes on capital but are often constrained by capital mobility. Similarly, Beramendi and Rueda (2007) find that left governments have more progressive tax systems unless they are bound by corporatist commitments. In that case, these governments concede capital relief in exchange for redistribution on the spending side, financed by more indirect taxation. Andersson (2015), in turn, demonstrates that left governments have more progressive tax systems in majoritarian electoral systems, but not in proportional ones. The latter, he argues, allow them to enter into long-term agreements with conservative parties on pairing capital relief with redistributive spending financed, again, by indirect taxes. Since the United States has the power to model international regulation in financial and tax affairs according to its domestic needs and features low levels of corporatism as well as a majoritarian electoral system, Democrats should thus be consistently associated with preserving—or even increasing—the progressivity of the tax system.

In fact, Bartels (2009) demonstrates that Democrats and Republicans implement tax policies consistent with the objective interests of their core political constituencies. Whereas Democratic policymakers develop their positions based on (p.38) the views of affluent egalitarians and the middle class, Republican policymakers respond to the views of their most affluent constituents only, who want to see their material interests rather than their egalitarian convictions defended. Accordingly, all Democratic administrations between 1948 and 2005 reduced income inequality through increased public investment and spending on employment programs, as well as larger social transfers and more progressive taxation. The former set of policies fostered economic growth and reduced unemployment, disproportionately benefiting the pretax incomes of the lower class. The latter set of policies bolstered the post-tax incomes of the lower class, while limiting the growth of the upper class’ post-tax incomes. In contrast, all Republican administrations between 1948 and 2005 increased income inequality through cuts in spending on employment and social programs, inflation containment, and—most important—tax reform. Republican administrations have, in fact, held the common conviction that tax cuts had to benefit the wealthy in particular because of their decisive role in saving and investment. The Reagan and Bush administrations thus reduced tax rates imposed on top incomes and capital gains, with George W. Bush excluding corporate dividends from taxation at the individual level altogether.

Yet party ideology is not the only determinant of government attitudes toward regressive tax reform. Because of its redistributive consequences and impact on the perceived fairness of a given tax system, such reform is politically highly salient. Therefore, corresponding voter attitudes and fairness concerns may also impact government positions. Plümper, Troeger, and Winner (2009) demonstrate, for instance, that conservative governments facing an electorate with predominantly egalitarian convictions are just as unlikely as center-left governments to lower taxes on capital in response to tax competition. Accordingly, both party ideology and voter attitudes may in principle create political barriers to regressive tax reform and force governments to search for an alternative strategy to minimize capital flight. The moral economy of the United States, however, is marked by much higher popular support for market competition and much lower support for redistribution than the moral economies of other developed countries (Koos and Sachweh 2017). It is therefore highly unlikely that a Republican administration would face an electorate with predominantly egalitarian convictions. Even if this were the case, the party’s limited responsiveness to tax policy demands from voters other than its most affluent supporters would prevent a modification of its preference for regressive tax reform (Bartels 2009). As a result, Democratic government becomes a necessary condition for US support of an international initiative against tax evasion, tax avoidance, or both. For other governments this role is played by political barriers to regressive tax reform at large.

(p.39) The Power of Affected Domestic Interest Groups

A government’s ideological leaning or electoral strategy is, however, not the only determinant of the government’s preferences about global tax policy. The domestic organized interests that are most affected by debated regulation also have significant sway over their government’s position (Drezner 2008; Frieden 1991). Anti–tax evasion measures mostly affect resident individuals hiding financial wealth and capital income offshore as well as domestic banks providing offshore services to nonresidents. In contrast, anti–tax avoidance measures mostly affect locally headquartered multinationals that artificially shift their profits to tax havens. Their common objective is to maximize profits by minimizing the tax burden imposed on themselves or their clients. Whether policymakers take the preferences of these groups into account depends on their respective instrumental, structural, and discursive power. Instrumental power refers to an interest group’s ability “to exert direct influence on government decision makers through campaign contributions and lobbying efforts” (Hacker and Pierson 2002, 280). Structural power is based on an interest group’s ability to make credible threats of disinvestment (Lindblom 1977), and discursive power refers to an interest group’s ability to shape the interests and perceptions of policymakers and the general public by linking the interest group’s demands to established norms and ideas (Fuchs and Lederer 2008).

Wealthy individuals, including those evading taxes, tend to have the necessary resources and access to exert instrumental power over tax policymakers. As discussed earlier, elected decision makers in the US usually adjust their tax policy agendas to the interests of the wealthiest individuals among their constituents. This tendency may be the result of material incentives such as campaign contributions or more frequent personal interactions with local elites (Bartels 2009). In contrast, tax evaders’ structural power is limited by their inability to make credible divestment threats. Since their tax liability is linked to their citizenship or place of residence, tax evaders would have to move their center of vital interests to a tax haven, or obtain a new nationality, to prevent their home country from taxing their uncovered foreign capital income. Yet such a decision implies the cutting of exactly those social ties that may be constitutive of an individual’s wealth. Hence, US millionaires rarely migrate for tax or other reasons (Young 2017). In any case, an individual’s decision to change her place of residence should have a negligible impact on employment compared with the relocation of company headquarters or factories.7 Finally, tax evaders also have limited discursive power, as they break the law by concealing foreign capital income from the tax office. While their status as criminals reduces their authority in public discourse, the norm of equality before the law obliges policymakers to distance themselves from any crime to preserve the justice (p.40) system’s perceived legitimacy. As tax evasion is a law-and-order issue as much as a tax policy issue, open support for the perpetrators is likely to be minimal.

The domestic financial sector should have even more instrumental power over tax policy than wealthy individuals. In many countries, financial elites are regularly recruited into senior government positions, while their associations coordinate closely with policymakers over regulatory projects (Fairfield 2010). The revolving door between finance and government is particularly busy in the United States, where previous employment with an investment bank is the norm for secretaries of the Treasury, and financial institutions offer lucrative consultancy positions to retiring senior officials. Hence, the sector is directly involved in financial policymaking over which the sector also exerts substantial structural power. In the US, the financial industry increased its GDP share from 16 percent in 1975 to 24 percent in 2005, whereas the manufacturing sector’s share fell from 29 to 16 percent over the same period (Krippner 2005, 178). Finance has thus become a dominant industry sector that can make credible divestment threats, as a result of the abolition of capital controls and the technological ability to manage assets from anywhere in the world (Helleiner 1995). The sector’s discursive power is reflected in its ability to establish dominant ideas about how an economy should be organized. Apparently, this ability persists even after the 2008 financial crisis, causing scholars to puzzle over neoliberalism’s resilience and the incremental character of post-crisis regulatory reform (Blyth 2013; Thatcher and Schmidt 2013; Moschella and Tsingou 2014). Accordingly, the US position in international bargaining over financial regulation has consistently been shaped by an overarching concern for the competitiveness of US finance. The US government protects its financial institutions from the costs of international regulation by enforcing agreements that mirror domestic regulation and undercutting foreign initiatives promoting divergent rules (Helleiner 2014; Oatley and Nabors 1998; Simmons 2001; Singer 2007; Rixen 2013).

Multinationals other than financial institutions wield similar power over policymakers. Tax officials usually form an epistemic community with tax advisers and chief financial officers of large corporations. Tax officials often seek advice or even collaborate with tax law firms in drafting legislation and move back and forth between the public and private sector in some countries (Seabrooke and Wigan 2016). In the United States, corporate tax lawyers walk through the same revolving door between government service and private practice as their colleagues in finance. Hence, Treasury is well aware of the needs of multinationals headquartered in the United States (cf. IPB Tax 2013; KPMG 2014). In addition, large corporations contribute important sums to the campaigns of elected politicians and sponsor several lobbying groups focusing on tax policy (Center for Responsive Politics 2015). The impact of multinationals, however, does not depend (p.41) only on access. Multinationals also have the ability to make credible divestment threats. Corporations can, for instance, relocate headquarters and activities to low-tax jurisdictions instead of just shifting the profits, leaving governments a choice between a loss of revenue from corporate taxes and a loss of jobs (Hong and Smart 2010). Finally, multinationals can justify tax avoidance with the legality of tax planning, thereby shifting the blame to legislators who fail to remove loopholes. Alternatively, multinationals can invoke the public good by stressing their obligation to maximize profits on behalf of shareholders and by linking a lower tax burden to more investment and jobs. The number of policymakers considering the demands of tax-avoiding multinationals legitimate should therefore be higher than the number of policymakers sympathetic to tax evaders. Against this background, we can thus conclude that the limited power of affected interest groups is a necessary condition for government support of an international initiative against tax evasion, tax avoidance, or both.

The Interaction of Political Barriers and Business Power

In actual bargaining over international tax policy, decision makers obviously have to adapt to political barriers to regressive tax reform and demands from powerful interest groups at the same time. Decision-makers may, for instance, accommodate public outrage over a tax avoidance scandal by calling for more stringent international rules, while making concessions on their exact content to appease business opposition. Accordingly, different combinations of the two factors of political barriers and business power should produce different government positions toward international tax initiatives. Table 2.5 provides a stylized summary of possible constellations. Its top-left corner displays the combination of high political barriers to regressive tax reform and low adjustment costs for powerful interest groups, which is most conducive to government support for international tax initiatives. A poster example for this situation would be a center-left government that responds to its constituency’s fairness concerns by supporting an initiative that increases financial transparency in secrecy jurisdictions to the level already practiced by domestic banks. Such an initiative would increase pressure on resident tax evaders with limited power in the political process and improve the competitive position of domestic banks by leveling the regulatory playing field. The constellation becomes less permissive, however, if adjustment costs are high. This may be the case when standards debated at the international level threaten to increase the foreign tax burden of resident multinationals. As the table’s bottom-left corner shows, the government is likely to respond by trying to block rules domestic business considers particularly harmful, as the Obama administration did in the context of the BEPS project. Given the government’s ideological (p.42)

Table 2.5 Interaction of Explanatory Factors in Determining Government Preferences

Political Barriers To Regressive Tax Reform

High

Low

ADJUSTMENT COSTS FOR POWERFUL INTEREST GROUPS

LOW

Government fully supports international initiative against tax abuse.

Government is indifferent, reduces tax burden on internationally mobile tax bases.

HIGH

Government supports international initiative in public, but opposes rules affecting domestic business.

Government rejects initiative, reduces tax burden on internationally mobile tax bases.

commitment to—or popular demand for—tax fairness, however, it will not withdraw support from the initiative as a whole.

As shown in the table’s bottom-right corner, a government will oppose an initiative altogether only if low political barriers to regressive tax reform combine with high adjustment costs. This will be the case when neither a majority of voters nor a governing party’s core constituency demands action against tax dodging, but other governments do. A right-wing government with a flat-tax ideal may, for instance, need capital flight as a justification for competitive tax cuts at home. The government will thus reject international rules that could lead to a reduction of capital flight and a corresponding increase in the effective tax burden of domestic multinationals. Against this background, the conservative government will embrace international tax competition and lower the domestic tax burden on internationally mobile assets. Whereas this most restrictive constellation may also lead a government to question previous agreements, low adjustment costs in combination with low political barriers to regressive tax reform make a government more or less indifferent toward international proposals. This may, for instance, be the case when lenient transparency standards allow a conservative government to appear tough on criminal tax evasion but require additional reporting only from foreign instead of domestic banks, and keep loopholes open for more sophisticated domestic tax evaders. Such a constellation may thus lead a government to pursue international tax “politics without conviction” (Eccleston 2012, 60).

Preference Constellations and Great Power Strategies

The regulatory preferences of the United States—currently the undisputed hegemon in international tax politics—determine the outcome of initiatives against tax evasion and avoidance. The preferences of smaller governments still matter, however, in that they determine which strategy the US government applies to implement (p.43)

Table 2.6 Combinations of Government Preferences and US Strategic Choice

Great Power Preference

Pro

Contra

SMALL-COUNTRY PREFERENCE

PRO

Great power strikes voluntary agreements with foreign governments.

Great power unilaterally defects. Undermines international initiative.

CONTRA

Great power uses coercion to impose its preferred rules on foreign governments.

No initiative.

its preferred international rules. If the administration expects considerable resistance from other governments, for instance, it will deploy measures to “change the choices of other … ​regulators at reasonable cost” (Simmons 2001, 597). Accordingly, foreign opposition to the US government’s preferred international rules merely “affects the means of regulatory coordination, not the ultimate end” (Drezner 2008, 88). If a small-country coalition were, for instance, to agree on a higher level of financial transparency than practiced in the United States, the US administration could unilaterally defect and undermine the coalition’s scheme by attracting hidden capital to US shores. If, in contrast, the small-country coalition practices a lower level of financial transparency, the United States could force these countries to apply stricter standards by linking compliance to financial market access. Table 2.6 summarizes the US government’s strategic options in international tax politics.

The stylized overview of preference constellations pits the great power’s stance toward a given international tax initiative against the position of smaller governments. This analysis can be applied to bilateral as well as multilateral bargaining. The most permissive constellation is, of course, when smaller governments agree with the great power’s preferred international rules, as they provide the smaller governments with similar domestic benefits. This constellation is summarized in the top-left corner of table 2.6 and results in voluntary agreements between the great power and foreign governments. If the great power meets or expects resistance from foreign governments, however, it will use coercion to impose its preferred rules nonetheless. If neither the great power nor a smaller government is in favor of new international tax rules, there will be no corresponding initiative, because an actor capable of putting the issue on the agenda of an international organization is missing. If small countries promote such an initiative and meet the support of the great power, we end up in the bottom-left corner again. Yet if the great power is satisfied with the status quo, while smaller governments launch an initiative for new rules, the great power will undermine this initiative by (p.44) defecting unilaterally, as already described earlier. In more formal terms, we can thus conclude that the preferences of other governments determine the strategy a great power deploys to implement its preferred international tax rules.

Analytical Strategy: Testing a Theoretical Model with Historical Narratives

My aim in this book is to explain transformative change in the fight against tax evasion and avoidance. Transformative change occurs when a paradigm governing the taxation of cross-border investment and economic activity at a given point in time is superseded by a new paradigm. As the previous sections make clear, I posit that regulatory stasis will be overcome only if the United States—the hegemon in international tax politics—decides to turn from veto player to change agent. This decision, in turn, depends on the feasibility of regressive tax reform and the adjustment costs a departure from the status quo entails for powerful domestic interest groups. Once the United States has become a change agent, the position of foreign governments determines whether the US administration implements change through voluntary agreements or coercion. The relevant forum for initiatives against tax evasion and avoidance has traditionally been the OECD (Eccleston 2012; Rixen 2008). However, since my approach is based on theories of tax competition, which assume perfect capital mobility, I consider only anti–tax haven initiatives the OECD launched after this precondition had emerged at the international level. International capital mobility is usually associated with the abolition of capital controls, the establishment of the double-tax avoidance regime, and the EU’s Single European Act (Genschel 2002; Helleiner 1996; Rixen 2008). As governments had achieved these objectives only by the end of the 1980s, my study seeks to make causal statements on all initiatives against tax evasion and avoidance launched by the OECD after 1990.

In addition to the political process leading toward the multilateral adoption of AEI, these initiatives include the OECD project against harmful tax competition (HTC), the organization’s campaign for the adoption of bilateral tax information exchange agreements (TIEAs), and its most recent project against base erosion and profit shifting (BEPS) by multinational firms. The HTC project was launched by the G7 in 1996 in response to growing concerns over the volume of investment routed through tax havens. The project focused on increasing financial transparency as well as removing preferential tax regimes benefiting foreign over domestic firms. The project dissolved into the TIEA campaign in 2001 when the Bush administration withdrew US support from the project’s anti–tax avoidance elements. Between 2001 and 2009, the OECD thus focused on the promotion (p.45) of bilateral information exchange agreements providing for the mutual provision of administrative assistance upon request. Following the UBS scandal and the adoption of FATCA in 2010, the organization’s focus shifted toward the development of a global standard for AEI, and its multilateral adoption achieved in 2014. Finally, the G20 tasked the OECD in 2013 with providing a report on BEPS as well as recommendations for its abatement. This mandate resulted in a series of fifteen reports presented in 2015 and an ongoing political struggle over the interpretation and implementation of the included recommendations.

Historical Narratives and Process Verification

Focusing on a small number of initiatives that stand in temporal sequence raises several methodological issues. First, the universe of potential cases contains only four events. Therefore, quantitative analysis based on randomized case selection is unreliable, as a result of the “problem of precision” (Gerring 2007, 87). Second, the initiatives under study tend to build on the given regulatory context. They are most often responses to the perception that previous attempts at curbing tax evasion and avoidance have failed. Past experience thus informs the preferences of domestic actors as to the need for new initiatives against tax evasion and avoidance. Instead of seeing initiatives against tax evasion and avoidance as independent cases, which is a prerequisite for making causal claims based on their systematic comparison, they must thus be interpreted as episodes in a more long-term historical process. Accordingly, the following empirical chapters will not provide case studies in the classical sense. They will rather present several analytical narratives probing the plausibility of the theoretical model and thereby increasing our confidence “that it has captured the central, generalizable dynamics rather than unique elements of a particular case” (Büthe 2002, 489). The narratives are analytical in that they draw a common structure from the theoretical model and focus on those elements of the historical record considered most salient for explaining the outcome of OECD tax initiatives. Within each narrative, process verification is applied to connect this outcome to the causal conditions emphasized in this chapter.

Process verification denotes the application of process tracing in theory testing. According to Bennett and George, “the general method of process tracing is to generate and analyze data on the causal mechanisms … ​that link putative causes to observed effects” (1997, 5). Proponents argue that a causal explanation is insufficient if it relies merely on the establishment of a causal effect based on observed covariance in independent and dependent variables. Instead, it is necessary to study the process linking causes to effects to ascertain that a cause really matters for the reasons assumed by the researcher. Given that my theory provides (p.46) for several causal steps building on one another to produce the outcome,8 the method is most suitable for subjecting the theory to a rigorous test. In doing so, I rely on data drawn from official documents and statistics, previous academic research, coverage in the specialized press, and forty-two interviews with experts in international tax policy from international organizations, national governments, and the private sector. I conducted semistructured face-to-face interviews over the course of one and a half years in five different countries, and also had conversations by phone with experts located in a sixth country. My goal was to obtain a balanced ratio of testimony from interlocutors of all professional backgrounds and political leanings, as well as from small and large countries. Moreover, I gave priority to speaking to actual decision makers rather than informed bystanders. As a result, I am usually able to triangulate obtained data on a specific event from several sources. As most interlocutors agreed to provide information, including on international negotiations, only under the condition of anonymity, I will use a general description of the interviewee’s function (for example, “OECD tax official”) when citing testimony, along with the date of the interview.

Operationalization of the Theoretical Model

The theory developed in this chapter shall explain transformative change in anti–tax evasion and avoidance regulation. Transformative change implies a shift from an established to a new underlying paradigm that alters the logic of action in the regulated field (Hall 1993; Streeck and Thelen 2005). Tax evasion occurs when a household conceals financial wealth and related capital income from the tax office. The crucial prerequisite for tax evasion is the ability of secrecy jurisdictions to hide the identities of foreign investors, as local tax offices could otherwise obtain information on their residents’ offshore capital income and augment their tax base accordingly. Therefore, we will observe transformative change in the fight against tax evasion only when regulation replaces the norm of financial secrecy with financial transparency. Financial transparency implies that national tax authorities can readily obtain information on their residents’ foreign capital income through official channels. In contrast, tax avoidance refers to accounting schemes enabling multinational corporations to inflate profits in low-tax countries while deflating them in high-tax countries. These practices are enabled by the arm’s-length principle in international tax law that obliges tax authorities to treat subsidiaries of a group as separate entities. Accordingly, we will observe transformative change in the fight against tax avoidance only when regulation ends the artificial separation of group subsidiaries and treats multinational firms as unitary entities instead. Unitary taxation implies that the profits (p.47) of a multinational group are consolidated at the headquarters and then apportioned to individual jurisdictions based on a certain formula.

Whether or not transformative change has occurred at a given point in time subsequently informs the preferences of domestic actors about the need for new international tax initiatives. Center-left governments or voters with egalitarian convictions should, for instance, be even more likely to oppose regressive tax reform if they have the impression that the present regulatory context already allows capital owners to evade their fair share of tax. Therefore, we should expect these groups to voice their demand for international action against tax dodging once they obtain information on the deficiencies of the present regulatory context. Such information may, for instance, be provided by tax authorities, which realize that their foreign counterparts usually turn down requests for administrative assistance. Such information may also be provided through data leaks from foreign banks or law firms revealing that domestic actors evade or avoid taxes offshore despite existing regulation. To accommodate the causal feedback loop created by the impact of past regulation on the current preferences of voters and governments, I will begin every analytical narrative by describing how public scandals or administrative action made actors who are generally in favor of progressive taxation aware of tax dodging and caused them to demand political action. Accordingly, I will assess the importance of barriers to regressive tax reform based on the public availability of information on tax abuse and the government participation of left parties enabling the conversion of information into executive action at the international level.

Similarly, past regulation should also impact to what extent a new initiative against tax dodging affects domestic interest groups. As discussed above, multinationals are, for instance, generally interested in maximizing their earnings per share. A comparatively cheap strategy in this regard is investment in tax law expertise, enabling tax burden minimization in a given regulatory context. Once a multinational has understood how to reach its goal within the present system, however, the investment turns into a sunk cost, causing the firm to prefer legal certainty provided by the status quo to uncertainty created by new initiatives. Adjustment costs should therefore be higher when rules established at the international level depart significantly from the previous regulatory approach and thus oblige affected domestic interest groups to invest in new expertise, compliance procedures, and organizational structures. Accordingly, the analytical narratives will not only trace interest group preferences back to the impact of international tax initiatives on the interest groups’ effective tax burden or business model, but also emphasize the extent of administrative adjustment international tax initiatives are likely to precipitate. The yardstick in this regard is whether new rules (p.48) require affected actors to change their compliance procedures and organizational form.

To connect these domestic factors to the final outcome at the international level, the analytical narratives will first clarify the extent to which government preferences revealed in interviews and speeches by decision makers, as well as official documents, match the position expected for a given combination of domestic conditions in table 2.5. Once government preferences have been empirically determined, the narrative will identify the constellation in table 2.6 that best matches observed bargaining and check whether the great power chooses its strategy as expected. We observe coercion when the US administration explicitly links other countries’ access to its internal market to compliance with US demands. At a minimum, such a threat has to be articulated in an official government declaration. Yet it may also be included in legislation, regulation, or court orders. In contrast, we observe voluntary compliance when other governments adopt the great power’s preferred rules in the absence of a sanctions threat. This requires that the other governments endorse the relevant international agreements and implement them domestically. Hence, unilateral defection occurs when the great power does not transpose international rules into domestic law. In sum, transformative change will occur only if (1) revelations of tax dodging lead a Democratic US administration to demand more effective rules, (2) and these rules are reconcilable with the interests of powerful domestic veto players. Legal constraints may, however, significantly depress the discursive power of an otherwise influential interest group. The analytical narratives presented in the following chapters will show how the presence and absence of these factors determined the outcome of all OECD initiatives against tax evasion and avoidance after 1990.

Notes:

(1.) Tax evaders invest offshore to strip their capital income of its tax burden. As a result, offshore wealth grows faster than onshore wealth (Alstadsæter, Johannesen, and Zucman 2017a; Harrington 2016). Yet this possibility exists only as long as an individual who is in principle liable to tax on her worldwide income manages to hide her offshore account from her local tax office. Therefore, the level of financial secrecy has a direct effect on the after-tax return to offshore portfolio investment.

(2.) Since the 1920s, when member states of the League of Nations created the current international tax system, the prevention of double taxation, which requires reconciliation of the source and residence principles, has been the main purpose of international tax law. The OECD’s Model Tax Convention provides governments with two reconciliation methods: residence countries can exempt their residents’ foreign income from taxation altogether or credit foreign taxes against the domestic tax. The credit method is most widespread but applies only once companies repatriate their foreign profits in the form of dividends, interest, or royalties. Therefore, companies can defer tax payments by hoarding profits offshore for an indefinite amount of time or until the government grants them a repatriation tax holiday (Rixen 2008, 57–60; Pinkernell 2012).

(3.) The EU has been identified as a single actor with great power status in the regulation of finance, trade, and many other areas of economic governance (Bach and Newman 2007; Drezner 2008; Meunier and Nicolaïdis 2006; Posner 2009).

(4.) The OECD Model Agreement links source country status to the presence of a PE. A PE is a place of effective management or production. This may also include an Internet server wholly owned or controlled by a foreign company that is used to process product sales and payments. Yet tax authorities have to determine in every case whether the automatic processing of sales and payments is a core element of corporate activity. Source-country status in e-commerce therefore remains a contested issue (Pinkernell 2014, 28–30).

(5.) FATCA also obliges participating institutions to levy a withholding tax on pass-through payments from the United States to nonparticipating institutions. This requirement is meant to reduce the attractiveness of business with nonparticipating institutions and to extend the reach of FATCA beyond financial institutions with business in the United States (Grinberg 2012).

(6.) Decisions on administrative assistance in tax matters are decided by unanimity in the Council of Ministers. The directive introducing the AEI in the EU does not provide for sanctions against third states not applying this standard in their relations with member states. Moreover, any mandate for negotiations with third states on an AEI agreement also has to be granted by unanimity (cf. European Union 2014b).

(7.) According to data from the US Bureau of Labor Statistics (2017), all private households and service providers catering directly to households create about as much employment in the United States as half of the manufacturing sector.

(8.) The steps are as follows: (1) formation of government preferences at the domestic level, (2) interaction of government preferences in determining great power strategy, (3) great power strategy producing the outcome.