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Reflections on “BEPS”: Tax, Law and “Law and Economics”


It is virtually impossible for those concerned with international tax and public finance not to be touched by the G20-sponsored Organisation for Economic Co-operation and Development (“OECD”)  “BEPS” – “Base Erosion and Profit Shifting” – project (February 2013 OECD scoping paper and July 2013 Action Plan).  The CBC’s Sunday Morning radio program has devoted two long segments to this subject, including a recent interview with Pascal Saint-Amans, the Director of the OECD’s Centre for Tax Policy, who spoke candidly about the project and contemporary features of “globalization” that it confronts.  The Government of Canada has undertaken a review of “treaty shopping”, setting out proposals in this regard in its 2014 Federal Budget, and also in the Budget documents has invited comments on how the Government should react to BEPS.  Supranational organizations apart from the OECD such as the International Monetary Fund (“IMF”), various public interest and faith-based associations, politicians and officials in various countries speaking in respect of tax reform proposal being advanced by them, as well as the United Nations and even the Vatican have weighed in to express their views on the effects of multinational business organization and tax practices on global fiscal, economic and social order and stability. 

In some respect, the BEPS project is only the most recent foray among several preceding it into tax and economics issues that naturally arise when countries deal with each other through their taxpayers.  However, its scope and the attention it has garnered make it much more than its antecedents.  It possibly may be the most comprehensive and certainly visible re-examination of “international taxation” since contemporary international tax notions evolved from the early twentieth century work of the League of Nations undertaken to abridge tax impediments to trade in the face of countries’ fiscal sovereignty.  The OECD has in the past undertaken targeted studies addressing “harmful tax competition” and “harmful tax practices”.  All, including the present BEPS initiative, reflect an awareness of taxation’s influence on international trade and investment, and on economic development.  This sensitivity carries over from the League of Nations work directed to redressing the effects of intersecting but uncoordinated national tax claims made on the same income and taxpayers.

For several reasons, international tax analysis as framed by BEPS has scaled the barricades of “technical tax” to reveal very clearly the contours of international fiscal relations, how countries’ tax systems interact with each other and how, depending on countries’ economic interests, recalibration of those systems or at least more enlightened accommodations of each other’s interests may be required.  In so doing, BEPS has revealed how tax policy principles and “applied taxation” inform and are informed by economic analysis even outside the usual confines of public finance.

Economics and Law

Economics concerns the systematic evaluation of choices taking account of the interests of those making and affected by them (said simply by Joseph Stiglitz, in Globalization and its discontents, 2002, “Economics is the science of choice.” at p xx of the “Acknowledgments”).  Its orientation is inherently behavioral.  Law concerns the systematic organization of those choices.  It too is behavioral.  It is interesting, at this stage of the BEPS project, to step away from its “technical” aspects  and to consider how BEPS is revealing, even fostering, connections between law and economics in relation to what fundamentally is behavioral analysis to which each, in its own way, contributes.

Economic events are framed by legal systems.  Legal systems adopt impersonal forms and conventions – “fictions” such as “corporations” and “contracts” — to express economic events and provide order and predictability for their execution:  to define relationships and economic objects, i.e., “property” and “services”, to allocate benefits and responsibilities  associated with economic events among their participants (detectible through evidence of parties’ actual dealings in relation to the forms by which they are evidenced), and to offer remedies if these arrangements devolve into disorder. 

Tax law sits atop the private law, and is vicariously defined and influenced by it.  Political borders “get in the way” of sovereign choices; countries’ legal and tax systems do not naturally or systematically align on their own, and countries’ public priorities served by taxation are not homogeneous.  Economics contemplates choices with which the law, let alone a mélange of countries’ laws, may not easily contend.  The law, on the other hand, needs to express and constrain those economic choices so that, as much as possible, they can be effectively implemented.  Consistent outlooks on, if not approaches to, “international taxation” help to engender coherence between the economic arrangements as they naturally would occur and their effects when those arrangements are, as they must be, framed by the law.

BEPS and Economics:  A Play on Supply and Demand

BEPS fundamentally is concerned with distortions of the “natural course” of economic events in a business setting through and indeed because of various modes of intermediation, recharacterization, and “dematerialisation” (Mervyn King, Tax Systems in the 21st Century, 1996) facilitated by the law, so as to cause those events to have effects that economic analysis would consider inconsistent with what is actually taking place.  BEPS happens when “legal construction” overtakes economic events.  Effectively the law does more than simply organize economic events coherently within an established legal and tax order; it becomes an input – in the nature of an economic factor of production and a source of private return, possibly at the expense of countries and their legal systems that host income generating opportunities.  This creates what lawyers and economists familiar with Coasian cost – benefit analysis underlying the discipline of “law and economics” (R. H. Coase, The Firm The Market and the Law, 1988 compendium of previously published papers, notably The Problem of Social Cost, 1960) might describe as dead-weight losses.  In contemporary BEPS lexicon, such losses would be attributed to “double non-taxation” created by the very legal and tax systems meant to support orderly trade flows by allocating taxing rights consistently according to where economic events occur and those benefiting from them are located so as to avoid “double taxation” through the excessive exercise of tax rights by some countries in relation to others – countries otherwise able to sustain a credible tax claim in economic terms. 

“Law and Economics” and Tax

The “law and economics” discipline is meant to inform remedies (regulation, which for this discussion is assumed to include tax regulation) for systemic frictions and resulting distortions that arise when beneficiaries of economic outcomes do not bear related costs.  BEPS is essentially about that.  Countries host economic activity; hosting, as any host knows, requires resources that need to be funded (or at least meaningfully “appreciated”) with tangible or other “consideration” of some kind provided or “offered” by the “hosted”. These include public resources that are inputs to private commercial activity.

Preoccupying the BEPS debate, particularly in the area of taxation known as “transfer pricing”, is how and with what emphasis, essentially, a more traditional economics supply or demand model should dominate. That is, should profits be associated with the countries where observable contributions are made by economic actors – the supply side of business – and accordingly should perceived distortions be evaluated from this perspective?  In that case, what is the “value” of agreeing to assume “risk” within a multinational corporate family; what “return” should legally separate “members” of the “economic firm” earn among themselves and relative to “each other” for ostensibly bearing “risk” inherent in the “firm’s” existence and operation?  Or, should the focus be on the countries in which “markets” – the demand side of the business manifested by consumers and sales – are located. Part of this tension arises from a common view that that inputs do not generate profits on their own no matter how many actors are engaged in production, without sales in markets where that effort (input contributions) is translated through cultivated consumer awareness (marketing) into sales.  This reflects an old transfer pricing question, whether “cost centers” can be considered “profit centers” because of the savings and resulting advantages they may generate for a “firm”.

The most basic international tax questions in BEPS are concerned with these economic issues expressed in the language of international tax:  What is the qualitative and geographic “source” of income? and, What sort of presence – “permanent establishment” – must a business actually or constructively have in a country where its products and services are produced and/or sold so as to make it taxable there – in other words, to compel it to contribute support for the environment  that allows profit-making activities to take place?  These are persistent and enduring notions in international taxation; but they do not define themselves nor, necessarily, are they or their connotations unchanging in light of changed circumstances.  Countries, with their particular economic and fiscal interests in mind, may not share views about how these determinations should be made, at least at the margins.  The BEPS project gives flight to latent global insecurity about what these notions mean in a contemporary business environment, and indeed whether they mean anything that still would readily justify, allow for and explain administrable tax claims or concessions.  Accordingly, when it comes right down to it, BEPS is testing the legitimacy of foundational “source” and “permanent establishment” devices the tax law uses, and largely has taken for granted, to parse economic activity, as well as the elasticity of those concepts, through legal interpretation and evidentiary analysis, to reliably align economic events with the countries in which returns from those events are actually generated.

BEPS Achievements

What has the BEPS project produced so far?  If, fundamentally, a main objective is to stimulate well-informed and provocative policy thinking, to identify systemic biases and particular interests so as to make those responsible for them accountable to acknowledge and explain them, and to create “discomfort” with mantra-like defenses of the existing order, the BEPS project already has produced a great deal, possibly as much as could reasonably be expected without changes in law the OECD lacks authority to implement.  An existing order can be bettered by confronting itself even if that critical examination affirms some aspects of that order. This, however, takes this discussion in the direction of an earlier observation about the behavioral aspects of law and economics.

In practical terms, a considerable amount of high quality, timely, focused international tax analysis attuned to prevailing economic and business forces has been produced in a very short time.  It continues to be debated internationally in public consultations of unprecedented scope.  The most optimistic aspiration of the BEPS Action Plan is clear enough:  the entrenchment of evolved international tax “norms” or expectations, not merely as guidance but, as may be necessary to effect change, as actionable law.  In a world without an “international tax order” or “international tax authority”, however, that intrinsically altruistic goal is ambitious.  Moreover, legal change requires countries to act – to change law where clarity or altered direction is required.  The OECD’s work cannot be a substitute for necessary legal change, but it can nevertheless contribute mightily to “consciousness raising” that makes it difficult to avoid change eventually and in the meantime may be forceful and influential with respect to the application of existing law.

In three important but possibly subtle ways, BEPS has already produced significant results.

First BEPS has in fact raised international consciousness – not only about how law and business practices contribute to, though also can be seen to distort, economic events, but also about how the manner in which economic and business forces are organized affects economic choices including by developing countries.  Indeed, among all participants in the BEPS debate – including governments, advisors, taxpayers, institutions and social commentators – BEPS has also created an undisguised measure of self-consciousness about BEPS effects – not just typical business and tax effects, but more fundamental economic, social and political outcomes ‑ and participants’ responsibilities for, and obligations to help to understand and explain, them.  Consciousness and self-consciousness about influences on public policy and the responsibilities of actors exerting such influences are key catalysts to the evolution of informed policy, even if patience is required because immediate prescriptive changes may be hard to achieve.

Second, BEPS has fostered a more objective and visible practical understanding of “tax competition” among countries, illuminated by very specific examples of, and at the limit of the implications of, the imperfect intersection of countries’ tax and legal systems in relation to the economic events they frame.  “Tax competition” is not an Olympic event; nor necessarily is it inherently “bad” – but there is little doubt that it “is”.  It may not even be about the degree of taxation, in the sense that countries’ would not be expected to adopt each other’s tax rates or other tax system features.  Tax competition describes the outcome of countries enacting law, including tax law, that plays to their economic interests and strengths so as to advance their interests including via their taxpayers (without, presumably, offending trade law regulation), while mitigating their economic vulnerabilities or shortcomings. 

This may be perceived to occur at the fiscal expense of other countries and their citizens who nevertheless may actually enjoy practical day-to-day benefits from economic activity fostered by those “competitive” initiatives.  This in turn can be expected to feed tax policy responses by those other countries that are similarly motivated.

All this is to say that the cost – benefit is analysis underlying BEPS is textured and complicated; the reasons for countries’ taxing rights being as they are is as important in the analysis as how they seem to apply.  Part of that cost-benefit analysis, however, is detecting when BEPS outcomes become goals in themselves ‑ when the methods offered by the law to achieve them are antithetical to the reasonable expectations underlying economic choices made by countries with an awareness no doubt of each other’s circumstances.  At such a point “tax competition” ceases merely to be descriptive, and may take on a different guise as a primary tool of private rather than public interests, possibly at the expense of both.

Enter “law and economics”; not however the economics of typical public finance, but of “choice”.  Those who benefit from economic opportunities that might not occur in the same way in a different fiscal environment presumably should share the cost of those opportunities. In pragmatic business terms, the suppliers should pay for “public” as well as private inputs.  But consumers, too, should be responsible for costs of their consumption which might well be measured in terms of benefits that they enjoy from hosting production and from consuming.  The search for an “international tax” balance mirrors the balancing of these economic factors.  Taxation thinks of this balance in terms of income “source” and business presence ‑ “permanent establishment” ‑ notions that effectively connect taxation and public finance in and to what inevitably, but not pejoratively, is a “tax competition” debate. 

Third, BEPS has raised the level of awareness about how problematic it may be to expect others to conform to one’s own expectations about how economic priorities should be established and legal regulation framed.  BEPS is humbling that way.  Again this implicates “tax competition” as a dimension of countries’ sovereignty.  This is not a new realization although it may have received less attention in this present context than it deserves.  Joseph Stiglitz has written about what can happen when organizations such as the IMF or the World Bank perceive the economic circumstances and needs of countries they assist in those organizations’ own image and that of their principal constituents, taking less account, perhaps, than would be more fruitful or respectful of the interests and capabilities of those being affected (Joseph Stiglitz, Globalization and its discontents, 2002).  This might be an issue particularly for developing countries confronting BEPS.  Perhaps they may be concerned about losing or losing out on economic opportunities as fall-out from BEPS-induced realignments of the international tax order.  Possibly this would be as much a concern as, or at least one to be balanced intelligently with, how they and their citizens are rewarded fairly for the human and other resources they contribute to business activity on their own terms and within the capabilities of their tax and other systems according to self-determined economic and social policies.  The “balance” they seek may be different and in each case unique in relation to that to which developed countries and their taxpayers aspire, but for that may be no less worthy.  Given the connection of “international tax” rules to the development of any country’s economic objectives the significance of this advancement in thinking and awareness produced by BEPS should not be underestimated.

Scott Wilkie is an Executive Fellow at The School of Public Policy.