‘An Unacceptable Surrender of Fiscal Sovereignty’: Arbitration and Sovereignty in the Double Taxation Regime

Posted: 3 Oct 2019 Last revised: 10 Jul 2020

See all articles by Martin Hearson

Martin Hearson

London School of Economics & Political Science (LSE) - Department of International Relations

Todd Tucker

Roosevelt Institute

Date Written: December 10, 2019


When do developed countries cede sovereignty over taxation?

For decades, the axis of international fiscal conflict was between tax havens (usually developing countries) and developed welfare states. In an era of austerity, the Panamas and Cayman Islands of the world were seen as helping rich individuals and corporations shield their assets from tax collectors in Paris and Washington. Scholars rightly interpreted this as a distributive conflict attributable to too much tax sovereignty, a problem of Ciudad de Panamá and George Town developing resource-sucking financial industrial policies and no international rules in place to hinder double non-taxation (i.e. income not taxed anywhere).

But in recent years, tax conflicts between developed countries have spilled out into the open. In July 2019, for example, France announced plans for a GAFA tax – a special assessment on U.S. companies Google, Apple, Facebook, and Amazon, who are seen by many observers as gaming the global tax infrastructure. The U.S. has responded by reviving a New Deal-era law that would allow them to double rates on French citizens and corporations that owe U.S. tax. These loud defections from longstanding tax law norms are in fact the latest in a series of quieter non-compliant actions that have pushed developed countries into increasingly sovereignty-compromising, mandatory, binding, and judicialized enforcement regimes.

This is a puzzling turn. Generations of fiscal realists have presumed that states would jealously guard tax sovereignty: “The revenue of the state is the state,” as Edmund Burke argued in 1790 (Burke, 1955: 105). The intimate relationship between revenue, social contract, and statehood is an important theme in the emergence of the Westphalian state, and one explanation for why international governance institutions in the area of taxation entail significantly less pooling of sovereignty than others.

Nonetheless, in the spring of 2017, 27 states acting through the OECD agreed to introduce “mandatory binding arbitration” provisions into over 150 bilateral double taxation treaties amongst themselves, requiring that disputes over interpretation be submitted to panels of independent adjudicators. At around the same time, EU member states committed to making tax arbitration between one another enforceable through domestic courts and the Court of Justice of the European Union (CJEU). Both proposals had been rejected at the turn of the 1980s, with the OECD concluding that tax arbitration would be “an unacceptable surrender of fiscal sovereignty” (OECD, 1984: 115).

This article seeks to understand why states gave up in 2017 on an institutional change they had long resisted, and in the process makes a few distinct contributions to ongoing scholarly debates. We contribute to the historical institutionalist literature by offering empirical confirmation of one of its central theoretical claims: that a political context with strong veto players (e.g. states and their tax ministries) can block fundamental change of institutions (e.g. the international anti-double tax regime set up in the 1920s). Nevertheless, as scholars in that literature have also suggested, changes in the external environment (e.g. increased capital mobility from the 1970s) can lead to drift in regimes, where old rules are on the books but no longer functional in practice. This opens up space for subversives (e.g. activist corporations and lawyers) to push states to layer new rules (e.g. arbitration) on top of the old ones. We also contribute to the literature on hierarchy in international relations by adding new depth to the idea of partial sovereignty – in our case the particular ways in which judicial sovereignty as a specific sub-type can lead to progressively deeper constraints on other modes of sovereignty. Finally, we add to the international political economy of tax scholarship by demonstrating that distributive conflict between developed countries started earlier than is generally presumed.

In Section II, we begin by discussing theories of institutional change and sovereignty, and how these might inter-relate. We develop a categorisation of dimensions of sovereignty and of sovereignty-diminishing change paths, which we apply to the case of the development of tax arbitration in Section III. Section IV concludes.

Keywords: tax treaties, double taxation, globalization

JEL Classification: H26

Suggested Citation

Hearson, Martin and Tucker, Todd, ‘An Unacceptable Surrender of Fiscal Sovereignty’: Arbitration and Sovereignty in the Double Taxation Regime (December 10, 2019). Available at SSRN: https://ssrn.com/abstract=3458663 or http://dx.doi.org/10.2139/ssrn.3458663

Martin Hearson

London School of Economics & Political Science (LSE) - Department of International Relations ( email )

Houghton Street
London, WC2A 2AE
United States

HOME PAGE: http://martinhearson.wordpress.com

Todd Tucker (Contact Author)

Roosevelt Institute ( email )

4079 Albany Post Rd.
Hyde Park, NY 12538
United States

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