2. Overview
1. Importance of international considerations in
tax design
2. The UK Tax system
3. International Tax competition
4. Options for capital income tax reform
2
3. 1. Importance of international
considerations in tax design: distinctions
Source
– Territoriality and Capital income neutrality
– DTR: exemption
– In a small economy a tax will raise borrowing costs and fall on investments
– Savings decisions are unaffected
Residence
– Tax on income or wealth of domestic residents
– Capital export neutrality
– DTR: credit
– In a small economy, the tax will reduce after tax returns on lending and fall
on savers
– Investment allocation is unaffected
3
4. 1. Importance of international
considerations in tax design: distinctions
Taxes on normal returns to capital
Taxes on rents
– Firm-specific or mobile (brand, know-how etc.)
– Location-specific or immobile (natural resources,
agglomeration effects etc.)
Scope for taxes on immobile rents
– Not discussed thoroughly in paper
Fundamental theorem: a small open economy
should not levy sourced-based taxes because
the burden is shifted onto immobile factors
4
5. 1. Importance of international
considerations in tax design: scope for
source-based taxes
Scope for source based (corporation) taxes is limited and
should be vanishing if governments behave optimally
GHS: this does not appear to be the case: why?
– Location-specific rents can be exploited
– Capital may not be perfectly mobile
– If capital exporters impose residence based taxes and allow
crediting of host country taxes there is an incentive for source
based countries to raise their tax rates
– Corporate taxes on foreigners are a backstop for the personal tax
system in host countries to avoid round-tripping
– “Tax illusion”: voters are unaware source based-taxes are shifted
onto immobile factors
GHS agnostic on weight of different reasons
Passing comment: in most countries withholding taxes on interest have
been abolished (with one notable exception)
5
6. 1. Importance of international
considerations in tax design: empirical
evidence
Considerable volume of solid empirical evidence
that the allocation of investments is highly tax
sensitive (though the size of the effects is not
measured precisely)
Much evidence of tax-avoiding profit shifting
Global responsiveness to changes in tax rates of
other jurisdictions
Tax rates (nominal and effective) have declined in
the past 30 years but corporate tax revenues have
remained stable or actually increased
6
7. 3. International Tax competition: case
against
A jurisdiction that unilaterally lowers taxes will attract mobile
factors of production thereby reducing national income and tax
revenues in other jurisdictions.
=> Spill-over effect (fiscal externality)
In a non-cooperative game framework with many jurisdictions
this will result in a “race to the bottom”
=> Under-provision of public goods
=> Strong case for tax co-ordination
Note: this analysis applies to all taxes on mobile factors of production (little
difference between labour and capital mobility)
7
8. 3. International Tax competition: case
for competition
Gains from tax coordination presume a benevolent
government acting in the best interests of citizens
“Starving the beast” through tax competition is a way to
reduce inefficiencies in government
– Rent seeking behaviour of bureaucrats and politicians
– Inefficiencies from redistributive policies
– Inability to pre-commit to an efficient intertemporal path of
taxation
Other argument against coordination: common tax
policy is not responsive to requirements of individual
jurisdictions (national autonomy)
8
9. 3. International Tax competition
GHS seem to suggest that tax competition/ coordination is an
empirical matter
Results are reported of a GE model for OECD countries
– Cost of capital differs across countries, leading to wedges in
marginal productivities
– Coordination leads to a more efficient allocation of capital (raising
total income by 0.4%)
– However, welfare rises in aggregate by only 0.1% because of
induced increase in factor supplies but
– There are significant differences in distributional impact amng
various countries
– Other distortions persist limiting scope of benefits from
harmonisation (second-best argument)
On balanced GHS are non-committal regarding the benefits from tax
harmonisation in the absence of compensation mechanisms
9
10. 3. International Tax competition:
Policy Response
OECD: Harmful Tax Practices
EU Code of Conduct on Preferential Tax Regime
EU Savings Directive
Authors view: these measures have not necessarily had
the intended consequences
– Tax havens may be beneficial
– The reduction of preferential tax regimes may lead to more explicit
tax rate competition
– Savings directive leaves large loopholes
Common Consolidated Tax Base
Role of European Court of Justice
10
11. 3. International Tax competition:
Common consolidated tax base
Objective: multinational companies could opt to have
their business income taxed under a common set of
rules valid for all EU countries, base would be
apportioned according to formula, each country
would apply own tax rate
No need to discuss with various tax authorities and
sharp reduction in transfer pricing
Problems:
– Relation with non EU (formula apportionment with
separate accounting)
– Intangibles in formula (valuation)
11
12. 3. International Tax competition: ECJ
Internal Market (1992): “freedom of
movement of goods services capital and
persons”
ECJ is striking down rules that appear to
disciminate on grounds of nationality or limit
four freedoms
Authors: describe the various areas affected but
no judgement
12
13. 4. Options for capital income tax
reform
Alternative concepts of tax neutrality (can we think
of territoriality and residence in other terms)
– GHS recognize a trend towards exemption
– Justification
Most international investments occur through acquisition
If all companies are to be treated on a par in a bidding
the valuation of assets should be unaffected by tax
(ownership neutrality)
Holding company regimes (participation exemption)
Spanish shopping spree
Countries are trying to place their multinationals at a
competitive advantage in a bidding environment
13
14. 4. Options for capital income tax
reform
Should UK move to territoriality?
– What do we think of the current system?
– If one believes that deferral entails that the current credit
system operates like an exemption system then the
behavioural response to moving towards an exemption
system should be small
– GHS argue that such a move would probably result in a
small net loss of revenue
– GHS however suggest design of new system would be
critical (without going into details)
The UK does not have an active/passive distinction
UK does not have complex interest and expense allocation
rules
14
15. 4. Options for capital income tax
reform
Common Consolidated Tax Base (CCCTB) vs. Home state taxation
(HST)
– EU: 27 national corporate tax regimes
– High compliance and costs for multinationals and significant costs of
administration
CCCTB
– Option would be to define a common base
Home state taxation (Gammie & Lodin)
– MNCs calculate EU wide tax on a consolidated basis according to the rules
of the country of residence of parent company
– Tax base would be allocated according to formula apportionment and
revenues would be allocated on the basis of tax rates in individual
countries
– Pros: flexibility no need for a common base and optional for companies
– Cons: competition for headquarters may narrow tax base (though mutual
recognition of tax bases would limit problem) and potentially lower
revenues if companies opt for system with lower revenues.
– GHS do not appear to favour HST
15
16. 4. Options for capital income tax
reform
ACE
CBIT
Dual Income Tax
16
17. 17
Conclusions
Source based taxation is under pressure but
there is continued for taxation in foreseeable
future
The benefits for tax co-ordination are small
Current reform proposals appear to solve
certain issues but have some flaws
19. Insufficient description of UK tax system and
comparison with US, Canada and main EU
countries
– How much revenue does the UK raise from foreign
source income?
– CFC regime, working of DTR in UK versus other
countries, active/passive income, transfer pricing
– What are perceived to be the main areas needing
adjustment?
– Major changes in recent years
General Aspects
19
20. Elements not considered in this
version
Editorial: International aspects of the taxation of
labour, wealth and consumption (including
transaction taxes)
Several current issues treated only in a cursory
fashion (example: active/passive distinction,
corporate personal tax integration in an open
economy, transfer pricing)
=> Prime focus on certain aspects of corporate tax
(individual income tax discussed only in passing)
20
21. Macro-background
– Trends in the economy (de-materialisation, services, finance etc.
– Do these trends pose permanent or passing issues for tax policy?
Political framework
– Internal market
– Constraints on sovereignty
– Which audience for the policy recommendations ? Domestic or
European?
Evaluation
– Will the EU go ahead? What solution is desirable at the EU level? If
coordinated solutions are not found what is a reasonable standalone
policy?
General Aspects
21
22. 22
Specific issues
The attractions and limits of exemption
Rents and source based taxes
Financing complications
Collective investment vehicles
23. 23
Attractions and limits of
exemption
Attractions: Simplicity and EU compatibility
as applied on the continent
– Participation exemption (parent-subsidiary
directive – non black-listed countries)
– Black listed countries (CFC)
Back-stop provisions
– Active-passive
Losses, triangulations
24. 24
Rents and sourced based taxes
Do rents represent a solid basis for believing in a
source based tax system?
Are foreigners being truly taxed? Who
incorporates agglomeration and other location
specific rents?
Timing issues are important
If assets tradeable, capitalisation effects are
important and rents are taxed upfront
Capital gains tax crucial
25. 25
Financing complications
Debt-equity distinction is a major issue at the
international level
Financing arrangements are important in the
way exemption and residence operate
Example: authors suggest that exemption is
equivalent to ownership neutrality
Yes only if financing is loaded unto acquired
company
26. 26
Collective investment vehicles
Collective investment vehicles have proliferated in
recent year
– create greater liquidity from previously untradeable assets
– Diversification
Corporate form desirable but not corporate tax
– Pass-through treatment desirable for investors: If you
previously owned a building directly you still wish to be
taxed in the same fashion
– Limited liability and transferability
Reliance on Residence of final investors
Source-based taxes have not worked
Editor's Notes
Source
Territoriality: tax levied on all income arising within a border
Capital income neutrality: domestic and inbound investments treated equally
In a small economy (i.e. with no power on capital markets), a tax will raise borrowing costs and fall on investments
Neutral in respect of inter-temporal terms of trade (leave savings decisions unaffected since returns obtained on international capital markets are untaxed)
Residence
Tax on income or wealth of domestic residents
Capital export neutrality: Tax treatment of domestic and foreign source income are treated identically
In a small economy, the tax will reduce after tax returns on lending and fall on savers
Neutrality in terms of intra-temporal allocation of resources (investment will be unaffected)
Very little mention in Meade
Major theoretical advances made in past 30 years
Important backdrop: tax policy in the European Union, especially after the Internal Market
Very new literature:
Outgrowth of fiscal federalism literature (mid-1970s) but with many novel twists relying heavily on game-theoretic framework
DIFFERENCE BETWEEN LABOUR AND CAPITAL MOBILITY : definition of social welfare function. With labour mobility is it citizens or residents?
Cremer and Pestiau concise and very clear survey of the literature
International Tax competition: OECD: Harmful Tax Practices
Aim: discourage preferential tax regimes targeted to non-residents
Targets: low tax rates, absence of exchange of information and “ring-fencing” (benefits to non-residents not available to domestic residents)
GHS
Non-committal but suggest that Tax Havens may actually stimulate activity in other jurisdictions
EU Code of Conduct on Preferential Tax Regime
GHS: does a ban increase revenues and reduce competition?
Not necessarily?
If countries choose to reduce their general tax and eliminate preferences this may lead to greater confrontation on lrates
International Tax competition: Savings Directive
Objective: eliminate cross-border tax evasion and help EU governments, safeguard residence–based taxation on individual investors
Instrument: exchange of information or withholding tax
Little tax revenue:
income shifted out of EU
Symbolic gesture
Little revenue
International Tax competition: Common consolidated tax base
Objective: multinational companies could opt to have their business income taxed under a common set of rules valid for all EU countries
No need to discuss with various tax authorities and sharp reduction in transfer pricing
European Court Justice: Tax laws
must not discriminate between nationals of different countries
May not violate “freedom of movement of goods services capital and persons”
ECJ is striking down rules that appear to disciminate on grounds of nationality or limit four freedoms
International Tax competition: ECJ
Discriminatory imputation credits
France, Germany, Italy and UK have replaced system
Loss offsets
Transfer Pricing rules viewed as discriminatory if applied to other EU jursidicirtions and not domestic transactions
CFC rules (Cadbury Schweppes) ECJ precludes UK from applying CFC within EU except for “wholly artficial arrangements”
Differential treatment of domestic and foreign dividends
Options for capital income tax reform
Alternative concepts of tax neutrality (can we think of territoriality and residence in other terms)
GHS recognize a trend towards exemption
Justification
Most international investments occur through acquisition
If all companies are to be treated on a par in a bidding the valuation of assets should be unaffected by tax (ownership neutrality)
Holding company regimes (participation exemption)
Spanish shopping spree
Countries are trying to place their multinationals at a competitive advantage in a bidding environment
International Tax competition: OECD: Harmful Tax Practices
Aim: discourage preferential tax regimes targeted to non-residents
Targets: low tax rates, absence of exchange of information and “ring-fencing” (benefits to non-residents not available to domestic residents)
GHS
Non-committal but suggest that Tax Havens may actually stimulate activity in other jurisdictions
EU Code of Conduct on Preferential Tax Regime
GHS: does a ban increase revenues and reduce competition?
Not necessarily?
If countries choose to reduce their general tax and eliminate preferences this may lead to greater confrontation on lrates
International Tax competition: Savings Directive
Objective: eliminate cross-border tax evasion and help EU governments, safeguard residence–based taxation on individual investors
Instrument: exchange of information or withholding tax
Little tax revenue:
income shifted out of EU
Symbolic gesture
Little revenue
Options for capital income tax reform
Is there a case for ACE?
ACE: allowance for corporate equity
Deduction for normal return to equity
Goal: Neutrality in investment decisions (equivalent to immediate expensing) and between debt and equity finance
Transition problems
Higher tax rates for revenue neutral reforms may result in relocation and profit shifting
Options for capital income tax reform
Is there a case for CBIT?
CBIT: comprehensive business income tax
Elimination of interest deductibility
Goal: Neutrality between debt and equity finance and lower tax rates
More attractive to high growth and profitable companies (note start-ups tend to have less debt)
Drawback:
Difficult to estimate potential revenue changes if CBIT accompanied by lowering of personal taxes
increase cost of capital for debt-financed investment
Options for capital income tax reform
Is there a case for a Dual Income Tax?
DIT: flat rate on capital income and a progressive tax on labour income
Popular in Nordic countries and proposed elsewhere (Germany)
Basic element “capital” (defined extremely broadly and with an extremely wide base) and other income
Norwegian version of the DIT (“shareholder income tax adjustment”) allows a deduction at the shareholder level of a riskless interest rate.
GHS appear to consider that UK policymakers should consider DIT as an alternative
GHS are mute about the specific features of DIT that make it different from existing tax system for FDI for UK-based multinationals
Rather difficult to do full justice to topics:
Complex Conceptually: interacting jurisdictions (game theoretical framework)
Complex organisations: multinational companies span many jurisdictions are often involved intricate financial transactions difficult to observe from the outside. Especially in cases of cross-border M&A in many instances LARGE and specific features to companies involved dominate the character if ttransactions. EMPIRICAL EVIDENCE is not easy to obtain
Complex tax law: there can be little doubt that the international aspects of the tax law are among the most difficult and specialised. (to this one must add the multi-jurisdictional aspect and supranational)
DOING FULL JUSTICE TO THEORY AND POLICY IS DIFFICULT TASK