Justice Brandeis once said that “sunlight is the best disinfectant.” Disclosure and transparency are often important for the legitimacy of government. In her article, Best Practices in Tax Rulings Transparency, Leandra Lederman not only creates a new typology for thinking about the costs of tax rulings in the dark, but also convincingly argues that many of the concerns against broader transparency of tax rulings is weak.
Tax rulings, as described by Lederman are rulings made by a tax authority or authorities to a specific taxpayer based on specific facts. For U.S. readers, the two most known in federal practice are Private Letter Rulings (PLRs), which speak to a specific taxpayer’s transaction, and Advanced Pricing Agreements (APAs), which fixes how the IRS will handle transfer pricing issues for a taxpayer over the course of about 3 to 5 years. In the U.S. context, PLRs are made public after a period with redactions of specifics regarding the taxpayer and their transactions, but APAs in the U.S. are never released widely.
In talking about nontransparent tax rulings, Lederman outlines three categories of costs. They are the costs to countries, the costs to taxpayers, and the risks to tax advisers.
With respect to countries, there are some significant costs. First, is the loss of tax base. The big concern of this cost is not just that countries may undermine their own tax base but that a tax ruling can create negative externalities on the tax base other countries. For example, many of the tax rulings of Luxembourg show that by using Luxembourg as an intermediary, a taxpayer could avoid taxes in other countries by routing payments through a Luxembourg shell company. Without knowledge of tax rulings, the other countries can do nothing. Second, these tax rulings can also serve to improperly subsidize companies and thereby distort competition. This cost is the crux of the state aid argument in the E.U. Third, undisclosed tax rulings can embarrass governments. Indeed, when journalists published a cache of Luxembourg’s secret tax rulings, the country looked quite bad. Fourth, nondisclosure can increase the risk that a weak tax authority will give up too much to private taxpayers. That is because the lack of transparency hinders other parts of the government from exercising oversight and pushing back on overly generous rulings. Finally, there is the risk of corruption or appearance of corruption when these matters are not made public. After all, corruption only works in the shadows. Even the appearance of corruption can undermine the legitimacy of the tax system.
With respect to taxpayers the first cost is a barrier to access. Publicly available rulings reduce that barrier by providing taxpayers who cannot afford the time or costs of applying for a ruling to draw analogies from existing disclosed rulings. That advances legitimacy, horizontal equity, and access. Relatedly, if tax rulings are nontransparent, it raises the concern that similarly situated taxpayers may receive different treatment. That too then undermines a sense of fair play.
Finally, with respect to advisors, the first cost is that with nontransparent tax rulings, the tax authority has access to materials showing how to apply the law while advisors do not. That creates a situation where the advisors are at a distinct disadvantage and at risk again for uneven application of the law. Second, it also creates problems of access for advisors. Advisors who help clients apply and receive tax rulings develop their own personal libraires of tax rulings. They then trade some of their library’s rulings for another advisor’s rulings. But those advisors who do not have their own large libraries of non-disclosed rulings are excluded from this vital trade.
Lederman then argues that public disclosure of the tax rulings with redactions addresses almost all the costs from a lack of transparency. The one exception is that for countries to protect their tax base from the negative externality cost described above, they need access to non-anonymized tax rulings. In that situation she advocates to improvements to some of the existing information exchange efforts put forward by the E.C. and the OECD. But, overall, the best practice requires widespread public disclosure of anonymized tax rulings. While transparency has costs too, Lederman shows that many of them are not borne out by experience or the data. For example, with the move to publicly available redacted PLRs, there were no declines in the number of applications for PLRs and no outsized costs. She also notes when people try to minimize the benefits of this kind of anonymized redacted publicly available rulings, they often fail to calculate that in many instances right now, everything is dark. She notes then that some knowledge here is far better than the complete lack of knowledge now about many of these tax rulings.
Perhaps the most important cost to public transparency is the fear that rulings may reveal confidential taxpayer information like trade secrets and the identity of the taxpayer even when anonymized. Lederman notes that many of these concerns though are overblown. Anonymization of the taxpayer and redacting key facts, including the industry of the taxpayer, if there are only a few players in that industry in a given jurisdiction, or the countries involved in an APA, can keep most confidential information private. Furthermore, taxpayers are not required to pursue these rulings. But these optional rulings are of significant benefit. If there is a concern that the public may be able to identify the taxpayer, even with significant pieces of information redacted, which is still a risk, the taxpayer must ultimately weigh that risk. Ultimately, Lederman concludes that the benefits of certainty the rulings provide plus the avoidance of the costs of non-transparency outweigh this risk.
Lederman’s paper situates itself nicely with recent work by others on the value and pitfalls of increased information flows between tax authorities in different jurisdictions. It also raises new questions on what the limits of confidentiality in the tax system are. Lederman distinguishes between the disclosures of anonymized rulings, which are voluntary measures, and tax returns information, which taxpayers are required to file. The latter is a thornier issue. But even within the realm of tax return information there may be some reasons why some slices should be more publicly available. That delicate line drawing exercise is something for us all to ponder.
Furthermore, Lederman’s piece also connects with issues of taxation in a democracy. Ultimately, one of the implications of her work is that transparency matters not only because of the costs of a lack of transparency, but it furthers democratic goods. Ultimately, in a democracy, the power to tax is a vital power that belongs in part to the people. Without some public transparency of tax rulings, the public and other stakeholders cannot hold these people accountable. And without public transparency as to the application of the law, it makes it hard to see if the law is operating as hoped and where there are potential gaps that need to be changed. Thus, Lederman’s work is also a welcome piece for those of us who are concerned with the overall operation of taxation as part of our democratic society.