In their new book, Tax Cooperation in an Unjust World, Allison Christians and Laurens van Apeldoorn argue that the international tax system needs a revolution, but we don’t need to tear the system down to the studs to effect change. The “revolution” can happen incrementally.
Why do we need a revolution? The authors say there’s a link between the imbalance in taxing rights between higher-income residence countries and lower-income source countries and the ongoing human rights deficits in lower-income countries. This is problematic, they say, because wealthier countries aren’t necessarily entitled to the level of revenue they collect from the international tax system.
To develop the analysis, Christians and van Apeldoorn ask two key questions: What role does the international tax system play in achieving justice? And how exactly does the international tax system achieve justice? These are important questions because the largest international tax institutions agree that tax revenue is crucial in fighting injustice: the OECD, U.N., World Bank, and IMF are all aligned on this point. Christians and van Apeldoorn argue that policymakers can tweak and adapt the international tax framework to enable greater source-based taxation without “radical reform” or a “new world tax order.”
It’s an interesting idea in a time of change. The OECD’s two-pillar international tax reform project is partly premised on expanding source taxation, but the project is beset with complexity, and the international tax world is fatigued. In the background, some stakeholders are citing that complexity as one of several reasons why we need a new world tax order. So the book’s argument that incremental change is both possible within existing structures and can pay dividends is attention grabbing. The analysis by Christians, who is the H. Heward Stikeman Chair in Tax Law at McGill University, and van Apeldoorn, who is an assistant professor of constitutional law and legal theory at the Open University of the Netherlands, is also unique in that it relies on an interesting mix of political philosophy and tax law.
Chapter 1: Two Principles for Tax Cooperation
What role does tax play in international justice? The answer to that question partly depends on how one defines international justice in the first place.
The book offers two principles. One, called the equal benefit principle, posits that when states agree to cooperate with each other, they are entitled to equal shares of any (net) benefits that are produced. When states mutually enable cross-border economic activity, they must benefit equally, irrespective of their economic status or bargaining power. The other principle, the entitlement principle, posits that states have an entitlement to the wealth in their territory, and that entitlement provides incentives for them to cultivate their land and resources.
The entitlement principle is the one with which most are familiar. It’s the principle that policymakers and politicians frequently cite when defending the right of states to create social, economic, and political institutions that fit the needs of their citizens.
The entitlement principle also features heavily in the international taxation debate: Christians and van Apeldoorn point out that the OECD has adopted this language in the ongoing discourse over multinational tax avoidance. For example, the organization has called for tax and substance to be realigned so that jurisdictions can restore their “legitimate right to tax the profits of a taxpayer based upon income and expenses that can reasonably be considered to arise within their territory.”
Many corporations also subscribe to the idea: A 2016 review of tax strategy statements released by FTSE 100 companies revealed that about 25 percent are committed to “paying the right amount of tax where value is created,” the book notes.
This framing is important, the authors say, because international tax is a space that requires a lot of cooperation for mutually beneficial foreign investment and for determining how resulting revenue gains are shared. Further, the cooperation angle implicates the equal benefit principle.
“In expressing that the states in which ‘value’ is created have a right to tax, the OECD articulates something close to the entitlement and equal benefits principles; in drawing up rules to explain which states can lay a claim to multinational income and which (by exclusion) cannot, the OECD implicitly articulates the requirement of fair cooperation,” the book says.
This generates questions about how surpluses should be shared among cooperating states and how the international tax system can balance political autonomy while promoting international capital flows that can help the poorest countries.
This is where the authors reveal their main argument, one that is unwound over the rest of the book: Fairness requires greater source taxation. For example, source taxation like gross basis withholding taxes on outbound profit repatriations or net basis taxes on income associated with local business operations is the ideal tool because it allows source states to receive an “approximately equal share” of the returns on investment. The idea is hardly new, but what is unique is the authors’ framing, over the course of the book, within an international justice lens.
Chapter 2: Obstacles to Fair Cooperation
But there’s a big schism between the ideal world that the authors portray and the status quo, in which source-state taxation has been gradually eroded through treaties and other mechanisms. The reality is that the states most likely to rely on inbound capital investment for economic development are the ones less likely to impose their fair share of source taxation. The authors say tax competition and peer pressure to conform to international tax norms through treaties and soft law are chiefly to blame.
According to the book, the phenomenon of source countries abandoning their right to tax multinationals makes sense only if those same companies face little to no tax in their home countries when they repatriate profits. It turns out that is exactly what is happening: We are in a phase of international tax in which countries are gradually eliminating residence-based taxes on repatriated profits. This frustrates the ability of source countries to tax and creates pressure to reduce taxes on income earned by foreign residents.
That pressure would be alleviated if residence states employ worldwide tax systems with tax credits for source-based taxes, the book says. Although tax systems have elements of both, the trajectory for major capital-exporting states over the past few decades has been toward territoriality.
The notion of fair cooperation also brings up the question of reciprocity: How does one ensure reciprocity between unequal states? The authors argue that reciprocity, which is key to the OECD model tax convention, largely works between OECD member states because they exchange capital and services with each other in roughly reciprocal amounts. This is not as true in relationships involving non-OECD countries.
Meanwhile, tax treaties that equally restrict tax bases and reduce withholding tax rates for both parties do not make sense if one party is habitually the capital exporter and the other the capital importer, the book argues. In that case, the capital importer is almost always the source state, which loses its tax base. Meanwhile, capital-exporting countries benefit from reduced source taxation as an increase of their endowment, the book says.
Governments do revisit their tax positions in response to their major investment partners, but wealthy countries’ willingness to adopt source taxation has been tepid. Richer states generally do not agree to the source-heavy provisions of the U.N. model tax convention and, in some cases, have sought reduced source taxation in treaties irrespective of reciprocity. However, there has been some movement on this in Ireland and the Netherlands. In recent years, Ireland has reviewed its own treaty policy toward developing countries and renegotiated a few to boost source-country rights.
In 2020 the Netherlands announced that it would no longer try to negotiate withholding taxes down to the lowest possible level in its deliberations with developing countries. It also revealed that it would be “more willing to accept certain aspects of the U.N. Model Double Taxation Convention than it was in the past” when negotiating treaties with developing countries. As part of this, the Netherlands said it would be willing to accept higher levels of withholding taxes on dividends, interest, and royalties with developing countries.
But Ireland and the Netherlands are the exception, not the rule, and even with these policies, there’s no guarantee that lower-income countries will fully get what they need; the Netherlands, which recently reviewed its tax policy toward developing countries, found that the government has fallen short on its promises to boost developing-country rights.
In the background, the ongoing debate over tax cooperation and tax sovereignty has intensified amid global concerns that countries are engaged in harmful tax competition and that multinationals are not paying their fair share of taxes in the countries in which they do business.
In response, there is an interest in expanding worldwide taxation. The book points out that norms are shifting in this direction thanks to the U.S. global low-taxed intangible income regime, as well as the global minimum tax under pillar 2 of the OECD’s base erosion and profit-shifting 2.0 project. It’s also apparent in the OECD’s ongoing BEPS work to reallocate multinational profits away from no- and low-tax jurisdictions. This shift, as the authors later explain, is potentially important for lower-income countries.
Chapter 3: Subsistence Rights and Assistance
After laying out these tax cooperation principles and concerns, the authors explain how they apply to economic inequities. While no one can argue that there are subsistence deficits in the world, the question is whether affluent states have an obligation to help those with deficits — something the book calls a duty of assistance.
Here, the authors start their analysis with the argument that every person holds a human right to subsistence, which is a right “to assistance, if necessary, in securing clean air, food, water, clothing, shelter, basic healthcare, physical security, and the opportunity to provide for oneself the means of subsistence through work in favorable conditions.” This right, they note, is located in the U.N.’s Universal Declaration of Human Rights and other legal instruments.
This is a right that can be satisfied through the U.N.’s sustainable development goals, but it is impossible for lower-income countries to fund those goals at their spending levels, according to the book. The U.N. has estimated that developing countries will need to spend $3.3 trillion to $4.5 trillion annually for the goals but will fall short by $2.5 trillion each year.
Domestic resource mobilization, on its own, is not enough because developing countries lack the tax capacity, and the informal, nonurbanized nature of their economies does not allow for a substantial expansion of the tax base. Meanwhile, it is difficult to progressively allocate the tax burden because wealth taxes and progressive property taxes are political footballs, and progressive income and capital gains taxes can be gamed. VATs and indirect taxes, on the other hand, are too regressive.
All told, less affluent states simply cannot tax their way into meeting the sustainable development goals, which suggests that more affluent states have a duty of assistance to unlock funds that lower-income states can use for development, the book says.
“The entitlement of states to the wealth in their territory is conditional on the absence of subsistence rights deficits abroad. It would be unfair to demand that individuals accept an institutional scheme if it prevents them from attaining and maintaining a minimally decent life,” the book says. This is not novel; government-sponsored development agencies like the U.S. Agency for International Development and the U.K.’s Foreign, Commonwealth & Development Office operate through this duty of assistance lens. What is novel is how Christians and van Apeldoorn tie this to international tax.
How does the duty of assistance relate to international tax? Some might argue that the international tax system is the wrong place for wealth transfers because international tax policy is coordinated for mutually beneficial cooperation in international investment. Because of this, cash transfers might be more appropriate. Christians and van Apeldoorn push back on this argument — their premise is that if wealthier states have a duty of assistance that requires cross-border wealth transfers and they fail to fulfill that duty, they “lack an unqualified right to the wealth in their territory,” and that influences the meaning of fair tax cooperation.
Chapter 4: Tax Cooperation and Assistance
The meat of Christians and van Apeldoorn’s argument is in chapter 4. If wealthier states want to help lower-income states capture more surplus through taxation, they need to expand source-based taxation in two ways. First, lower-income states with subsistence rights should have the primary right to tax multinational income earned in their jurisdictions. Second, and as a backstop, capital-exporting states need to expand their corporate income tax passthrough regimes, which would levy tax when source countries do not. Neither of these steps is radical — the authors point out that expanded passthrough regimes have historically been common among OECD states. Further, expanded source taxing rights are something for which the U.N. has consistently advocated. Now the OECD is also working on the topic via BEPS 2.0.
“There seem to be two paths forward: either [wealthier] states will have to increase their taxes on the income that arises from cross-border investment and transfer all of the revenues associated with the cooperative surplus to states suffering subsistence rights deficits, or in the alternative, relatively affluent states will have to effectively eliminate their claims on global tax revenues in such a way as to enable states suffering from subsistence rights deficits to realize their own entitlement to tax.”
Christians and van Apeldoorn are not fans of the first solution. They argue that affluent states would be holding onto money they are not entitled to have, and if affluent states are responsible for collecting and transmitting surplus revenue, they might fail to send it or might seek accountability in how other countries are using the money. Finally, this system would also raise questions about what institutions could live up to the task of guarding the process.
But passthrough taxation is effective only to the extent that foreign taxes are creditable in the headquarter country. The book argues that tax bases will gradually shift from residence to source states if those foreign tax credits are carefully designed to eliminate duplicative taxation.
If residence countries want to enable greater source-based taxation, they should accept new or revised source withholding rates in tax treaties. They should also be open to new forms of withholding taxes on different income streams, the authors argue, although they acknowledge that this would be challenging.
Withholding taxes have historically applied to interest, dividends, rents, royalties, and capital gains, and there’s a danger that other gross-based taxes could be seen as an excise tax and subjected to trade inquiries, like the U.S. Trade Representative has done with digital services taxes. But the authors point out that the idea of income can change, as occurred with capital gains. These were not initially considered a source of income. We’re already seeing some of that shift as management fees, social insurance, and retirement payouts become subject to withholding in some treaties. Technical services fees are subject to withholding under article 12A of the U.N. model income tax treaty.
One of the book’s more creative arguments is that taxing authorities could enable this new regime through mutual agreement procedure cases. In matters involving lower-income states with subsistence rights, taxing authorities from higher-income countries would cede their taxing right over to their lower-income partner. The authors argue that the MAP process is opaque — competent authorities do not need to explain their outcomes — and competent authorities have uneven bargaining power, so it’s hard to tell how geopolitical power factors into the negotiation process.
“To the extent the obscurity of the process allows the geopolitically strong to exact concessions from those less so, the process cannot be supported as appropriate in standard rule of law terms in any event,” the book says. “But the process could be redeemed if it serves states in the fulfillment of the duty to assist.”
Chapter 5: The Burden of Subsistence Deficits
The authors acknowledge that their duty of assistance argument may be difficult for some to accept. But even if countries reject it, the duo argue that wealthier states are not entitled to more than their equal share from cross-border investment under the equal benefit principle. Beyond that, subsistence deficits may generate cost savings in a source country, and that country should be entitled to any profits generated by those savings.
Chapter 6: Cooperation Without Assistance
Ultimately, why should governments incorporate these approaches now? Christians and van Apeldoorn believe that multilateral policy negotiations at the OECD, U.N., and other bodies have expanded the global debate over fair tax cooperation and have created momentum for a fairer tax system. In this light, they say, wealthier countries have an obligation to consider how they can create more equity in the system. This is an urgent call to action because time is of the essence. It’s taken 100 years for the international tax community to rethink its norms via the OECD’s ongoing BEPS projects, and once those BEPS negotiations are done, it may take several more decades before these conversations are revisited.