Cornell Studies in Money

The North-South Dimension to Global Tax Politics

Martin Hearson

• Publisher: Cornell University Press
• Year: 2021
• ISBN:
  9781501755996
• Topic: Business
• Subtopic: Corporate Governance
• Index: Business

In Imposing Standards, Martin Hearson shifts the focus of political rhetoric regarding international tax rules from tax havens and the Global North to the damaging impact of this regime on the Global South. Even when not exploited by tax dodgers, international tax standards place severe limits on the ability of developing countries to tax businesses, denying the Global South access to much-needed revenue. The international rules that allow tax avoidance by multinational corporations have dominated political debate about international tax in the United States and Europe, especially since the global financial crisis of 2007–2008.

Hearson asks how developing countries willingly gave up their right to tax foreign companies, charting their assimilation into an OECD-led regime from the days of early independence to the present day. Based on interviews with treaty negotiators, policymakers and lobbyists, as well as observation at intergovernmental meetings, archival research, and fieldwork in Africa and Asia, Imposing Standards shows that capacity constraints and imperfect negotiation strategies in developing countries were exploited by capital-exporting states, shielding multinationals from taxation and depriving nations in the Global South of revenue they both need and deserve.

Thanks to generous funding from the Gates Foundation, the ebook editions of this book are available as Open Access volumes from Cornell Open (cornellpress.cornell.edu/cornell-open) and other repositories.

1

THE PROBLEM WITH TAX TREATIES

African countries have been brainwashed into thinking that they need [tax] treaties. But they don’t.

—Tax treaty negotiator, African country

Stories of tax-dodging corporate giants make headlines on a weekly basis. Nonetheless, governments manage to collect over US$2 trillion in corporate income tax each year, much of it from big multinational businesses.¹ This book is about the rules governments have negotiated to divide the tax base among themselves: how they are designed to work, rather than how they are circumvented by unscrupulous companies and individuals.² As a long tradition of legal scholarship argues, those rules, written by a club of higher-income countries, deny lower-income countries a fair share.³ Tax is hardly unique in this regard, and the past two decades have seen backlashes against institutions of global economic governance that exhibit such a bias, including the IMF, the World Trade Organization (WTO), and the network of bilateral investment treaties (BITs).⁴ There are now some signs of organized discontent in the international tax regime, but its long-standing resilience, while other lopsided regimes have faltered, makes it an interesting case in the broader story of global economic governance.

The key mechanism depriving lower-income countries of tax revenues is something they have signed up for—and in which they continue to participate—entirely voluntarily: a network of bilateral treaties, and the international standards that those treaties encode into hard law. Tax treaties cover 82 percent of the world’s foreign direct investment (FDI) stocks, including 81 percent of the FDI in lower-income countries.⁵ They set limits on when, and in some cases at what rate, signatories can tax cross-border economic activity, primarily imposing restrictions on the host countries of FDI. Many legal scholars are skeptical of the benefits. According to Tsilly Dagan, the main effect of these tax treaties is “regressive redistribution—to the benefit of the developed countries at the expense of the developing ones.”⁶ Kim Brooks and Richard Krever agree that “the success of the high-income states in negotiating ever more treaties has come at the expense of the tax revenue bases of low-income countries.”⁷ If this is the case, why have lower-income countries been willing to sign more than a thousand of these treaties?

The vast majority of literature—policy and academic—sees tax treaties as instruments through which lower-income countries compete for inward investment. A cross-country study of the reasons countries sign tax treaties, conducted by Fabian Barthel and Eric Neumayer in 2012, found that countries were more likely to sign up when their competitors for foreign investment had already done so.⁸ This conclusion appears to be borne out in policy discourse too. For example, investment promotion literature from countries including Kenya and Zimbabwe highlights tax treaties as important factors that should attract investors.⁹ In budget speeches introducing tax treaties to Uganda’s parliament, successive finance ministers have explained that their purpose was “to protect taxpayers against double taxation, and to ensure that the tax system does not discourage direct foreign investment” and “to reduce tax impediments to cross border trade and investment.”¹⁰ A study conducted by the Ministry of Finance of Peru states that “these conventions create a favourable environment for investment. In signing a double taxation convention, a country is sending a positive signal to foreign investment and offering investors security with respect to the elements negotiated.”¹¹

There are a number of problems with this: there is little evidence that tax treaties have a positive impact on investment in lower-income countries; I found conflicting views among those involved in the treaty-making process in lower-income countries as to the purpose of tax treaties, with many of those who negotiate treaties skeptical that they attract investment; capital-exporting countries are frequently the ones initiating and driving negotiations, not lower-income countries; and the tax competition literature does not tell us why lower-income countries typically give away far more in negotiations than they need to in order to secure an agreement.

To the extent that tax competition is a fact, then, it is a social fact. What matters is how it is understood by different actors. In this book, I characterize two competing narratives among those involved in making tax treaties. A tax competition motivation, based on the unsubstantiated claim that treaties will attract investment, is shared among those who are less familiar with the technical details. This includes politicians, nonspecialist civil servants, and business executives who lobby them. Treaties are seen as a trade-off between investment promotion and revenue raising, although the fiscal costs, which are hard to estimate, are not always given much weight in the assessment.

The narrative among tax treaty specialists, both in government and in business, is different. Often socialized into a transnational policy community, their detailed technical knowledge comes as part of a package, developed and refined among experts from OECD countries. A powerful logic of appropriateness pervades this community: the OECD’s model tax treaty is the acceptable way to tax multinational companies. Its bias against lower-income countries was never agreed to by those countries at a political level; instead, it is justified in technical terms as more economically efficient. Proponents of this view accept that companies’ investment decisions may well be influenced by the presence or absence of a particular treaty, and a country with a wide treaty network may be expected to have more cross-border investment. The main mechanism through which this should occur, they suggest, is the convergence on OECD standards set out in the treaty, not the creation of tax-rate-based distortions. Tax professionals in advisory firms and multinational companies share with civil servants the objective of disseminating OECD standards. If they want to be part of this expert community, there is little room for those from lower-income countries to challenge such a long-standing consensus, even where it exhibits a strong bias against them.

For half a century, higher-income countries have taken advantage of these two narratives, together with capacity constraints and imperfect rationality in lower-income countries, to negotiate hundreds of treaties that constrain the taxing rights of lower-income countries unnecessarily. All along, but rarely acknowledged, the higher-income countries have been in competition with each other to give their multinational investors a competitive edge by securing the most advantageous tax treaties. Yet the tax costs of this competition endure for a long time in the lower-income countries with which they sign. Almost three hundred African tax treaties, well over half those in force, are more than two decades old, meaning that they were signed in the last century.

The closest analogy to this situation is BITs. Like tax treaties, they are country-specific tax incentives with questionable effectiveness at promoting investment, which have nonetheless proliferated throughout the Global South. Literature on BITs recognizes that to understand lower-income countries’ decisions to conclude, we must acknowledge that policymakers’ rationality is “bounded.”¹² BITs, it is argued, were at first perceived by lower-income countries as a cost-free means to signal political and economic ties with others, and to attract investment. Little attention was paid to the potential downsides. It was only years after they were signed that investors began to use their dispute settlement clauses, and even then lower-income countries did not immediately learn from each other’s experiences, although they did become much more reluctant to sign them.¹³

Tax treaties are a more difficult case to explain than BITs, because their costs to signatory governments are immediate, predictable, and significant. There has been no slowdown in tax treaty negotiation, as there has been for BITs, but some lower-income countries have begun to question the costs and benefits of their tax treaty networks. Indonesia, Senegal, South Africa, Rwanda, Argentina, Mongolia, Zambia, and Malawi are among those that have canceled or renegotiated tax treaties, while others, such as Uganda, have undertaken reviews.¹⁴ Civil society groups have begun to mount campaigns against particular tax treaties, culminating in TJNA’s lawsuit in Kenya.¹⁵ Even the IMF now cautions lower-income countries that they “would be well-advised to sign treaties only with considerable caution.”¹⁶

Aside from questioning the existence of treaties per se, there is a steady drumbeat of concern that the tax treaty system has too great a bias toward the interests of capital-exporting “residence” countries and against capital-importing “source” countries. According to a press release by a group of finance ministers from francophone lower-income countries, “The global tax system is stacked in favour of paying taxes in the headquarters countries of transnational companies, rather than in the countries where raw materials are produced. International tax and investment treaties need to be revised to give preference to paying tax in ‘source’ countries.”¹⁷ The African Tax Administration Forum (ATAF), a membership organization for revenue authorities, notes that “Africa is still beset by serious issues such as … tax treaties with no appropriate tax allocation rights between source and residence taxation and thus susceptible to abuse.”¹⁸ An official statement from the Indian government concurs: “The OECD principles have evolved from the perspective of only higher-income countries since they were prepared by the OECD countries, and many issues relating to lower-income countries have not been taken into consideration. This has resulted in serious curtailment of the taxing powers of the lower-income countries in relation to international transactions.”¹⁹

Bilateral tax treaties differ from BITs in that they are drafted in a highly multilateralized context. Each one is derived directly or indirectly from a model formulated and promoted by the OECD, which inherited this role from the League of Nations. That model, naturally, embodies the interests of OECD countries, a club of capital-rich higher-income nations. Alternatives exist, in particular the UN model bilateral treaty, which makes some modest changes to the OECD model in the interests of lower-income countries. Yet it is the OECD model that predominates, even in tax treaties signed by pairs of lower-income countries.²⁰ Put simply, lower-income countries have given up large chunks of their tax bases by signing these treaties, with few certain gains to show as a result. This book is an attempt to understand why.

It is a substantively important question affecting the livelihoods of hundreds of millions of people. Today, on average, OECD member states collect taxes amounting to 34 percent of gross domestic product (GDP), while in Africa the equivalent figure is half that amount.²¹ This reflects a lower level of taxable capacity within their economies, and the availability of “rent” income from natural resource extraction and overseas aid.²² On the other hand, corporate tax revenue is twice as important to African governments as it is to OECD governments as a share of total revenue raised, and tends to come disproportionately from multinational investors.²³ Lower-income countries’ decisions over the taxation of inward investment are thus crucially important to the provision of public services and ultimately to their development prospects.

What Are Tax Treaties?

The global network of over three thousand bilateral tax treaties is the “hard law” foundation of the international tax regime: its DNA. Enforceable in domestic courts and—increasingly—through a bespoke system of international arbitration, tax treaties take precedence over domestic law in most countries.²⁴ This foundational role has two quite different elements. On the one hand, tax treaties are explicitly political, each one the outcome of a bilateral negotiation between two countries that carves up the right to tax the cross-border economic activity between them. The language of “taxing rights” commonly used in discussions about tax treaties reflects the sacrifice of sovereignty that they entail,²⁵ and goes some way to explaining why states have only been willing to enter into binding agreements at the bilateral level, where they have more control over the content.²⁶

On the other hand, most of that content is a cookie-cutter replication of one of the multilateral models, largely deriving from the OECD model.²⁷ Just as DNA is organized into chromosomes, all tax treaties follow the same structure of articles, and the most significant variation within many of those articles comes down to jus...

Table of contents

• Acknowledgments
• Abbreviations
• Prologue
• 1. The Problem with Tax Treaties
• 2. A History of Lower-Income Countries in (and out of) Global Tax Governance
• 3. The Competition Discourse and North-South Relations
• 4. The International Tax Community and the Politics of Expertise
• 5. The United Kingdom
• 6. Zambia
• 7. Vietnam and Cambodia
• 8. Historical Legacies in a Rapidly Changing World
• Appendix
• Notes
• Bibliography
• Index