Tax Policy Colloquium, week 4: Adam Kern's Illusions of Justice in International Taxation

 Yesterday at the Tax Policy Colloquium, Adam Kern presented his paper, Illusions of Justice in International Taxation. It is a chapter from his Princeton Politics Department dissertation in process (in the realm of political theory) entitled Principles of International Taxation. Kern is also an NYU Law grad who took the colloquium a couple of years back. The project aims to bring philosophical principles and expertise to bear on international taxation – to date a very under-inhabited field by philosophers, although a few, such as Peter Dietsch, who appeared at our colloquium a few years back, have been working in it.

The project, like Liam Murphy’s and Thomas Nagel’s The Myth of Ownership, has both what one might call a destructive or ground-clearing component – aiming to clear away ill-reasoned implicit philosophizing in the field – and a constructive one, aiming to erect something else in its place.

The chapter we discussed is mainly concerned with ground-clearing. As such, like Murphy-Nagel, it has relatively little to say to the likes of me, since I already agreed with its critiques of what I would agree are ill-founded and ad hoc normative principles. Nonetheless, it may make a significant contribution to the field, given that those principles may be far more widely accepted than I tend to realize. I tend to focus on their proponents’ complementary arguments that raise consequentialist and indeed welfarist issues.

The project differs from, without contradicting, my international tax writings in that it is centrally concerned with exploring what would be a globally just international tax regime. My work generally takes for granted national “selfishness” (i.e., exclusive or nearly exclusive concern with the welfare of one’s own people), not because that is necessarily morally defensible, but because it’s the world we live in & which mainly interests me. I do think about multilateral cooperation to achieve better end-states, insofar as it appears to be feasible or sustainable within the selfish framework, and I also consider the possibility (since it appears to be realistic) that countries may value cooperating rather than defecting in a prisoner’s dilemma-type setting, even if they could get away with more defecting than they undertake, so long as they believe that others tend to be similarly minded. But that still is very different than asking what a given country would do if it accepted that global justice should guide its actions.

Okay, turning to the paper itself: It discusses the Capture Principle, which it defines as holding that (i) countries have a package of rights to tax income generated from activities inside their borders, and (ii) the value of the package should be proportionate to the amount of income generated from such activities. Put more in everyday language, I would say that the Capture Principle holds that source-based income taxation is just. Hence, countries not only can (and perhaps even should?) justly engage in it themselves, but should accept the justice of other countries doing so as well. The paper rejects this principle, and a subsequent chapter apparently does the same for the Affiliation Principle (and hence for residence-based income taxation).

At least from this chapter, it is not entirely clear to me what a given country that currently is engaged in source-based and residence-based corporate (and other) income taxation should do once it realizes that the Capture and Affiliation Principles are wrong. And the project does not rule out the possibility that these approaches could be largely sensible in practice, albeit as interpreted and modified to further, rather than set back, global justice. But they don’t stand on their own as inherently just or as having more than contingent and instrumental value. By analogy, consider the Murphy-Nagel rejection of entitlement to one’s own market-derived labor income as inherently just. This does not contradict viewing market arrangements as having desirable incentive effects that might lead to a system in which people’s after-tax returns are generally strongly affected by the level of their pretax earnings.

Very quickly, the chapter’s main arguments can be summarized as follows: Proponents of the Capture Principle, as applied to the source-based taxation of foreign multinational companies (MNCs), base it on a notion of reciprocity between the MNCs’ foreign owners and their domestic customers. (As an aside, I would tend to think of the relevant reciprocity as more between different countries’ governments, acting on behalf of their own residents.)  But all their arguments fail, even if one accepts arguendo their underlying moral premises.

First, the Principle of Fair Play, which abhors free-riding, posits that, since the MNCs are benefiting from locally created public goods and infrastructure, they have a moral obligation to contribute to funding it. The paper argues, however, that merely positing a duty so to contribute does not show that such contributions should depend on applying source-based corporate income taxation. What ought to be contributed is indeed the very question at issue.

Second, the Compensatory Principle finds a moral obligation to reimburse the source jurisdiction for the (marginal?) costs imposed by the MNC’s inbound activity. As an aside, I have always found this frequently-heard argument peculiar, because countries generally want inbound investment and consumer goods, based on their considering these things net benefits to themselves, not net costly. Arguing that it’s only fair to reimburse costs is a bit ill-directed to the circumstance of perceived net benefit. This is why countries typically welcome inbound investment, as well as inbound consumer goods unless they are being protectionist, even if they would also like (subject to concerns about tax competition) to get some revenue.  However, since the paper is generally accepting arguendo the contested principles’ underlying premises, it emphasizes the fact that marginal cost imposed is so ill-related to domestically sourced income. It contrasts, for example, an MNC that sends heavily laden trucks along a country’s roads, in the course of generating only minimal profits, with one that makes a ton of money through derivatives trading.

Third, the Contributory Argument, in two different flavors, purportedly supports source-based corporate income taxation of foreign-owned MNCs. In its proprietary version, it notes that, if countries rightfully have the property right to exclude outside access from their physical space and consumer markets, a source-based corporate income tax follows from that. The paper responds that there may be no particular reason why the access fee would take that form. (But might it be a permissive form?) In its distributive version, the contributory argument asserts that nations are entitled to their shares of the global surplus that they help create, ostensibly justifying the use of a source-based corporate income tax to realize that rightful claim. The paper responds that the creation of global surplus is simply too intermingled among all nations to allow for treating source-based income as a proxy therefor.

A war fought on enemy territory – Again, in all these cases, the paper accepts arguendo lines of argument that the author may not accept – and, in one case, expressly states in a footnote that he does not accept – in order to show that, even if  the broad principles are valid, the conclusions don’t follow.

Two other arguments that it appears to accept arguendo – and that I myself don’t accept, very likely with the author’s agreement – are that (1) the geographical source of income can meaningfully be determine, at least in principle, and (2) for the distributive version of the Contributive Argument, that (a) allowing producers to reap the full market prices from what they offer is not just potentially efficient but also independently just, and (b) that this just claim transfers from a given individual to his or her country. In common with Murphy and Nagel, I think of markets as being rightly favored in appropriate circumstances because of their efficiency properties in those circumstances, not on independent grounds of moral entitlement to the market values one is able to realize.

Accordingly, the chapter’s main structure is to attack propositions in the form A -> B, based on accepting A arguendo even though welfarists such as me (and also many non-welfarists, including Kern) would not accept A to begin with, other than conceivably on contingent empirical grounds.

The use of source-based corporate income taxation in international tax policy – Many of the paper’s rebuttals reflect corporate income taxation’s unrelatedness to rationales for taxing outside MNCs. The case for income taxation stands on views about tax burden distribution as between (resident) individuals. Its origins and rationale have nothing to do with the international setting. But once one has an income tax on resident individuals, one may have good reason for extending it first to resident corporations, and then to foreign corporations on what is deemed to be their domestic source income. Even if these two extensions make perfect sense, however, it would be a surprising coincidence if the income taxes thereby imposed on foreign MNCs happened to match the various rationales that have been extended for source-based taxation of outsiders.

But what are the proponents of the Capture Principle really (or mainly or also) saying? – While there are also reasonable consequentialist arguments in favor of source-based corporate income taxation, I agree that the views justifying the Capture Principle on separate moral grounds can be found in the literature. But I wonder if the paper takes them more seriously than one needs to – or perhaps, even than the proponents really take these arguments themselves. They often are trying to rationalize current practice, or else something close to it or plausibly evolved from it, rather than seeking to deduce in the abstract how cross-border taxation might work. So perhaps what they are mainly saying is that a system that assigns a large role to source-based corporate income taxation (a) is not wholly ridiculous, and (b) facilitates desirable multilateral coordination. E.g., all income is “taxed once,” even leaving aside residence-based taxation, if everyone has a source-based tax, their rules for it are reasonably consistent, and tax havens don’t end up with much under these rules because so little happens in the havens on either the production or the consumption side.

For myself, that claim is good enough, not to prove itself or resolve anything, but to help set up a framework for analysis, including by interrogating it, and potentially rejecting it in whole or in part on empirically rooted consequentialist grounds. Plus, again I’m personally interested less in the ideal, which I see as beyond practical reach anyway, as in thinking about how countries’ (and their political actors’) incentives and perceived interests shape behavior, hopefully in directions that might be better rather than worse from both a national and a global standpoint.

Thus, as with Murphy-Nagel (and this, of course, is good company), I view it as an allied and constructive effort that doesn’t speak as much directly to me as to others who may need to have their consciousnesses raised, so to speak.