Discussion at NYU Law School of international tax paper by Mindy Herzfeld

Today at NYU, Mindy Herzfeld presented her paper, The Case Against Tax Coordination: Lessons from BEPS. I offered comments at the session, as did Mitchell Kane, and the following is an expanded version of my notes.

As I read it, the paper’s main three claims are as follows:

1) International tax coordination, at least as represented by the OECD-BEPS project, is “problematic” at best. This critique, however, combines calling the project (a) likely to be unsuccessful on its own terms, and (b) illegitimate, or at least less legitimate than claimed. These are quite distinct, in that one might especially regret (a) in the absence of (b).

2) She sees broader difficulties in tax coordination, in part because who gets a given dollar of tax revenue is a zero-sum game.

3) She views the BEPS project’s attempted implementation as slanted in favor of developed countries &/or residence /production countries (which are not always the same! – hence the equivocal U.S. response). There’s no global consensus to allocate tax base to the place of production rather than the place of consumption, & it’s not inherently the fairer approach of the two.

I have some sympathy with Mindy’s views, although she’s more annoyed than I am by the self-righteous rhetoric that inevitably accompanies a political process like BEPS.  I’ll just make two broad points:

1) Since who gets a given dollar of revenue is zero-sum, one has to look elsewhere for gains from cooperation. But there are two places to look:

--Greater efficiency from reduced waste that makes the overall pie larger.

--Loss to someone else who’s outside the deal!

Residence & source countries can potentially meet both by addressing profit-shifting to tax havens.  There’s some waste associated with the profit-shifting, even though a lot of the underlying “activity” is just paper-shuffling.

Plus, while the havens don’t benefit from cutting out their role, suppose they’re left outside the scope of the deal. Then there’s more room for the others to benefit.

The fact that I see a logical basis for cooperation from other countries cutting out the tax havens doesn’t mean that I think the havens are doing anything wrong. They’re rationally pursuing their own self-interest. This involves responding to a type of consumer demand in the global marketplace.  A place like the Cayman Islands isn’t conniving in tax fraud by U.S. and other multinational companies – it’s simply offering a convenient and trustworthy low-tax place to “park” profits, once companies have exploited the other countries’ rules – which those countries created, not the Caymans – to make the profit-shifting legally effective in those countries.

But while, on the one hand, I don’t see the Caymans as doing something wrong – it’s being smart on behalf of their own human residents – they also don’t logically have a place at the table if the other countries decide to revise their own rules in such a way that the marketplace’s demand for what the Caymans is offering declines.

2) Both residence and source countries have reasonable goals. What puts them in conflict is entity-level corporate income taxation.

I’d like to redirect discussion, to a degree, from the question of “Which country gets to tax the income?” to that of “What are differently situated countries trying to do, and to what extent are their aims at least in principle reconcilable?”

I agree that the definition of “source” isn’t going to resolve such questions as whether the U.S. or India should tax profits from selling the fruits of U.S. IP in India. It’s true that, in principle, income is an origin concept – it’s about productive activity – while consumption is a destination concept – it’s about using the fruits of economic production. So one might initially think, if this were relevant to the global source issue, that production countries like the U.S. have a stronger claim to tax the income.

But there’s no particular reason why countries need to share tax base one way or the other, depending on whether they claim to be using an income tax or not. And in fact the U.S. income tax has a mix, not only of income and consumption tax elements, but also (and separately) of origin-based and destination-based source rules.  E.g., royalties create US source income if the property is used in the U.S., even if the IP was created abroad.

Plus, of course, policymakers in Washington are now debating a destination-based cash flow tax that would replace the corporate income tax. A key reason for their considering it is that it kinds of looks like an income tax, even though it actually isn’t.

So let’s shift to the question: What are differently situated countries trying to do?

Residence or production countries – they might like to address tax competition with regard to where production occurs, but that’s tough. Another goal is to succeed in taxing resident individuals who are corporate owner-employees but avoid paying themselves high salaries (instead, they profit through stock appreciation). This is a big part of what motivates my concern about profit-shifting by U.S. companies.

Source or consumption countries – they might like to use monopsony power to extract some of the profits that foreign multinationals could otherwise get from their consumers.  I have nothing against this either.  National self-interest relative to the interests of outsiders is par for the course, plus a lot of the multinationals are earning rents that reflect the market power they get, for example, from IP protection.  The exercise of monopsony power doesn’t necessarily reduce global efficiency when it goes up against monopoly power.

These goals aren’t in principle completely inconsistent with each other, although there’s no reason for production countries to be glad if a larger share of the profits that their own resident individuals earn end up going instead to people in the source countries.

But anyway, two things are clear. First, we’re asking the corporate income tax to do more work for different players than it really can these days. Second, we’re not as ready to move away from it, and to shift its surviving functions to other tax instruments, as one might like us to be.