Tax treaties are a ubiquitous feature in the landscape of international taxation, with several thousand bilateral instruments operating to regulate the taxing power of their signatories. However, in recent years, scholars have begun to challenge the century-old principles underlying the tax treaty. Some of these challenges concern the capacity of an institution formed in the aftermath of the First World War to handle our digital and much more globalized economy. Other challenges concern the role of the tax treaty in protecting the interests of wealthier countries.
The bulk of Professor Rebecca Kysar’s essay is dedicated to a critical examination of the tax treaty, as currently constituted. Tax treaties have been justified as tools for preventing double taxation, combatting tax evasion, inhibiting double non-taxation, encouraging foreign direct investment, respecting comity, providing certainty and predictability, institutionalizing non-discrimination, and binding governments to follow good tax policy even when confronted with the demands of political expediency. Professor Kysar addresses each of these issues in turn.
She describes double taxation as a red herring and, drawing on the work of Professor Daniel Shaviro and others, argues that the important consideration is not the number of jurisdictions that impose tax, but rather the overall tax burden. According to this theory, it is only when the choice of investment venue does not affect the overall tax burden that global resources will be used efficiently. My own position is that neutralizing the effect of taxation on international investment, if it could be achieved, would in fact misallocate resources to the detriment of aggregate global welfare. Taxes and subsidies are the mechanisms whereby potential host countries signal to the market the expected costs and benefits of hosting foreign investment. The effect of the investment on the lives of residents of the host country is a crucial element in the global social welfare function. By not permitting tax differentials to play a role in international investment decisions, capital export neutrality would prevent the market from taking into account the impact of international investment on the welfare of the host country’s residents and would inhibit the directing of resources to their most efficient uses.
With regard to the other purported goals of tax treaties, Professor Kysar argues that measures such as FATCA are more effective in combatting tax evasion than are the information exchange provisions in tax treaties, that double non-taxation is largely a byproduct of the tax treaties themselves, that there is little empirical evidence that tax treaties increase foreign direct investment, that other trade relationships and agreements guarantee comity as least as well as do tax treaties, that the goals of certainty, predictability, and nondiscrimination are plagued by ambiguous terms and references, and that the pre-commitment feature of tax treaties may rest upon unwarranted assumptions.
In the next part of the article, Professor Kysar describes some the disadvantages of the current tax treaty network. Perhaps the most significant issue is distributional. It has been persuasively argued by a number of scholars that the unstated purpose of tax treaties at the time of their inception was to preserve the taxing rights of the major mercantile powers at the expense of their colonies and former colonies and that tax treaties continue to favor capital exporting countries at the expense of those that host foreign investment. Another problematic effect of tax treaties is the stagnation of domestic policy and international norms. Innovative tax reforms – such as the adoption of a destination-based cash flow tax or the rethinking of the foreign tax credit – are often stymied because they violate international treaty obligation. The territorial-worldwide dichotomy that forms the basis of tax treaties is a difficult paradigm to overcome. Furthermore, far from preventing tax avoidance, tax treaties – as already noted – are often the source of opportunities for tax abuse.
Why then do countries continue to adhere to the antiquated norms of tax treaties? Professor Kysar suggests several reasons. First, treaty negotiation is more opaque than is the legislative process, so that special interest groups have a greater opportunity to shape the tax treaty to their benefit. Second, as argued by Professor Tsilly Dagan, the existence of a tax treaty network creates a lock-in effect that discourages significant deviation from the norm.
Given the acknowledged problems with current tax treaties, Professor Kysar goes on to suggest what might be done. She reviews the standard treaty provisions one by one and grades them as “harmful,” “neutral,” “perhaps unnecessary,” and “helpful.” She then proposes abandoning some and refining, clarifying, or amending others. However, the focus of her proposals is the replacement of the current one-size-fits-all international tax treaty with individualized bilateral treaties that are narrowly tailored to the interests of the signatories thereto.
Professor Kysar’s article is an important contribution to the growing body of literature that is exploring the means of adopting the international tax regime to the needs of the early twenty-first century.