International Tax Policy
Change in the Netherlands
An Advocacy Coalition Framework Analysis of Dutch Political Parties’
Changing Policy Position Towards Facilitating Base Erosion and Profit
Shifting as a Conduit-Offshore Financial Centre
Master thesis for MSc Public Administration: International and European
Governance, Leiden University
Author:
Kevin Johan de Raat
Student number:
S1504444
Thesis supervisor: Natascha van der Zwan
Date:
28 February 2021
Table of Contents
List of tables ... 3 List of figures ... 3 List of abbreviations ... 41. Introduction ... 5
The changing position of the Dutch government on tax avoidance ... 5
Explaining international tax policy change ... 6
2. Background on base erosion and profit shifting ... 8
Introduction ... 8
Scope and effects of BEPS ... 8
BEPS strategies and the role of offshore financial centres ... 9
Conclusion ... 11
3. Theoretical framework ... 13
Introduction ... 13
The Advocacy Coalition Framework ... 13
Factors influencing international tax policy in offshore financial centres ... 15
Optimal taxation policy and economic benefits ... 15
Political ideology, perceptions of capital mobility, and fiscal fairness ... 17
Public opinion and the role of the media and NGOs ... 18
Business lobbying ... 20
International pressure ... 21
An integrated theoretical framework ... 23
Conclusion ... 24
4. Methodology ... 26
Introduction ... 26
Operationalisation of variables ... 26
Policy change through shifts in power between advocacy coalitions ... 26
Policy change through a shift in policy core beliefs ... 27
Case selection ... 32
Data collection ... 32
Policy core beliefs, policy change, and balance of power between advocacy coalition ... 32
International pressure ... 34
Public opinion and information provided by the media and NGOs ... 35
Business lobbying ... 35
Data analysis ... 36
Validity and reliability ... 36
5. Case description ... 38
1996 – 2001: Rising attention for ‘Harmful Tax Competition’ ... 39
The European Commission’s Code of Conduct for business taxation ... 39
The OECD’s Harmful Tax Competition Project ... 41
Developments in the Dutch debate ... 42
2002 – 2007 ‘Protecting and improving’ the Dutch investment climate ... 42
‘Working on profit’ ... 43
International developments ... 43
2008 – 2018 Rising pressure and the first steps towards reforms ... 44
Is the Netherlands a tax haven? ... 44
Proposals for measures against BEPS ... 45
Tax avoidance scandals and international action against BEPS ... 46
The first steps towards concrete (international) reforms ... 48
A new Dutch approach towards BEPS ... 50
Conclusion ... 51
6. Empirical results ... 52
Policy change in Dutch international tax policy ... 52
Balance of power between advocacy coalitions ... 53
Changes in policy core beliefs ... 54
International pressure ... 58
Public opinion and information provided by the media and NGOs ... 59
Business lobbying ... 61
Conclusion ... 62
7. Analysis ... 63
Introduction ... 63
Policy change through a shift in balance of power of advocacy coalitions ... 63
Policy change through a shift in policy core beliefs ... 64
Empirical expectations ... 64
Analysis of empirical results ... 65
Implications for theories on policy change ... 69
Conclusion ... 69
8. Conclusion ... 71
9. Bibliography ... 73
Annex 1 ... 89 Annex 2 ... 90 Annex 3 ... 92 Annex 4 ... 97 Annex 5 ... 101
List of tables
Table 1. Events that could raise international pressure on the Netherlands 28 Table 2. Notable moments concerning information on BEPS 29 Table 3. Overview of variables and operationalisation 31 Table 4. List of relevant documents and committee debates 33
Table 5. List of relevant plenary debates 34
Table 6. Sources and data collection 35
Table 7. Left-right political spectrum in the Netherlands 53 Table 8. Coalition governments in the Netherlands in the period 1994 – 2021 53 Table 9. Indicators for policy core beliefs based on expressed arguments by political parties 56 Table 10. Policy core beliefs on BEPS expressed in party manifestos 57
Table 11. Codebook for explicit references 89
Table 12. Codebook for policy core beliefs 90
Table 13. Documents and debates selected to track policy core beliefs and explicit references 92
Table 14. Results of coding exercise 97
Table 15. Articles and policy statements of VNO-NCW on BEPS 101
List of figures
Figure 1. Simplified example of treaty shopping to shift profits to a sink-OFC 10 Figure 2. Factors influencing international tax policy in OFCs based on the Advocacy Coalition Framework 23
Figure 3. Changes in policy core beliefs 55
Figure 4. The salience of tax avoidance in the media in 1996 – 2018 59 Figure 5. References to media articles and examples of BEPS in debates and documents 60 Figure 6. Explicit references to business lobby organisations 61
List of abbreviations
ACF Advocacy Coalition Framework ATAD Anti-Tax Avoidance Directive BEPS Base erosion and profit shifting CIT Corporate income tax
Commission European Commission
Council Council of the European Union
ECOFIN Council on Economic and Financial affairs
EU European Union
FDI Foreign direct investment
G20 Group of 20
IP Intellectual property MNE Multinational enterprise
NGO Non-governmental organisation
OECD Organisation for Economic Co-operation and Development OFC Offshore Financial Centre
The changing position of the Dutch government on tax avoidance
In late 2008, the Dutch Secretary of Finance Jan Kees de Jager, mentioned to Parliament that he was looking forward to intensive cooperation with the new Obama administration to combat tax havens around the world (Kamerstukken II, 21501-07, nr. 640, 2009). Six months later, the White House listed the Netherlands, together with Ireland and Bermuda, as a tax haven (Langerock & Hietland, 2019). The Dutch government was outraged and argued that the tax haven label was completely unjustified (Trouw, 2009). It contended that the Netherlands had an attractive investment climate, not only for fiscal reasons, but also because of its infrastructure and educational system. After a day of intensive lobbying, the United States removed the Netherlands from the list of tax havens (Van Kalles, & Lalkens, 2009).
It would not be the last time that the Netherlands was associated with the words ‘tax haven’ or ‘tax paradise.’ The media, international actors, and even several Dutch political parties would continue to use these labels when talking about the Dutch international tax regime. In their original press release, the United States argued that the Netherlands was a tax haven because American multinational enterprises (MNEs) reported a third of their profits in the country, even though it was clear that these MNEs did not undertake enough economic activities in the Netherlands to earn such an amount of profits there (Langerock & Hietland, 2019). It was clear that many of these MNEs made use of the opportunities provided by Dutch international tax policy to shift their profits from states with high corporate income tax (CIT) rates, through letterbox companies in the Netherlands, to states with low or no CIT rates. The strategy of shifting profits helps MNEs avoid paying taxes in states where their income would be subject to a high CIT rate, allowing MNEs to minimise their global tax burden. Simultaneously, the strategy erodes the tax base of such ‘high tax jurisdictions,’ meaning that these jurisdictions will face lower tax revenues. These phenomena are described by the term base erosion and profit shifting (BEPS).
Several studies show that the Netherlands functions as the largest conduit-country for BEPS, also known as a conduit-offshore financial centre (OFC),1 in the world (Garcia-Bernardo et al., 2017).
Nevertheless, the government consistently denied responsibility for profit shifting that took place via the Netherlands or emphasised that they were powerless to address it unilaterally. In some cases, the government would argue that the Netherlands simply had an excellent investment climate, while in other cases, it placed the responsibility for taking action with other states, noting that unilateral actions by the Netherlands would only displace the problems (Handelingen II, nr. 67, item 29, 2016). However, this passive attitude saw a strong reversal in 2017. In this year, the government began to argue that MNEs should pay their fair share of taxes and announced a reform agenda for Dutch international tax policy to counter BEPS. This agenda included several unilateral measures that the government and several political parties previously fiercely opposed.
1 The term Offshore Financial Centre is commonly used for states that facilitate BEPS (Garcia-Bernardo et al., 2017). This term is preferred over the term ‘tax haven’, which is used in popular discussions, because it can be broken down into two subcategories that provide a better understanding what role a jurisdiction precisely plays in facilitating BEPS (see Section 2.3).
Explaining international tax policy change
The sudden change in Dutch international tax policy raises the question of what caused the government to take these actions, especially considering that the policy had been relatively stable, and the government and several Dutch political parties previously expressed strong positions on the matter. As such, the Dutch case inspires the research question of this thesis: which factors induce change in a political party’s policy position on BEPS in OFCs. In particular, the thesis will attempt to identify the factors that cause political parties in OFCs to break with their previous position on international tax policy and support more decisive action against BEPS issues.
While the fields of political science and public administration frequently discuss questions of policy change, the literature considering change in international tax policy is fragmented. Where some authors focus on functionalist economic arguments to explain choices in international tax policy (Dharmapala and Hines, 2009), others exclusively consider political factors like public opinion (Alesina et al., 2012). Likewise, some scholars emphasise the influence of business lobbying (Lindblom, 1977), while others focus on the pressure international actors like the European Union (EU) and Organisation for Economic Co-operation and Development (OECD) exercise (Eden & Kudrle, 2005). This thesis will seek to remedy this fragmentation by combining the various bodies of literature with an overall theoretical framework on policy stability and policy change to attempt to explain the observed changes in the Netherlands. One of the most comprehensive theoretical frameworks in this area is the Advocacy Coalition Framework (ACF) (Schlager, 2007). Introduced by Sabatier and Jenkins-Smith (Sabatier & Jenkins-Smith, 1993; Sabatier, 1988), the ACF is especially useful to study policies that are “characterised by substantial political conflict and high technological complexity” (Nohrstedt, 2005, p. 2). International tax policy appears to be such a policy since it is an issue of redistribution and involves technically complex laws (Seabrooke & Wigan, 2016).
The ACF assumes that policies result from the policy beliefs of a wide range of actors, which assemble themselves in advocacy coalitions based on similar beliefs (Sabatier & Jenkins-Smith, 1993). As such, there are two main pathways through which policies can change. One path argues that policy change results from an advocacy coalition coming to power (e.g. controlling the legislature and government) with different beliefs than the previous reigning advocacy coalition. Alternatively, policy change can result from a shift in policy beliefs of the reigning advocacy coalition. Nevertheless, Sabatier and Jenkins-Smith (1993) note that the policy beliefs of actors like political parties are very resistant to change and will only change under certain specific conditions.
Concerning the latter pathway, the case of the Netherlands would be a least-likely case study (Eckstein, 2011). Several political parties have traditionally fiercely defended Dutch international tax policy and resisted criticism. This makes a policy belief change on the part of these parties even more unlikely. However, if this thesis finds that the observed policy change is indeed caused by a shift in several parties’ beliefs, then the factors behind this change are expected to apply beyond the Netherlands as well. As such, this thesis would contribute to a better understanding of the factors that influence political parties’ policy beliefs on international tax matters. This is particularly relevant as the public debate on the role of MNEs in the economy and their contribution to society, fiscal or otherwise, intensifies. Multiple international actors, including the EU, the OECD, and the Group of 20 (G20), have stepped up their efforts to address BEPS and OFCs. Likewise, the media is increasingly reporting on specific cases of BEPS by MNEs, naming large companies such as Google and Apple (Dekker & Rengers, 2013). Analysing how such factors influence policy beliefs is both important for our understanding of the policy-making process in general and how political parties in OFCs can be incentivised to address BEPS issues.
To answer the research question, this thesis will analyse the case of the Netherlands from 1996 through 2018. It is expected that this period shows significant variation in the independent variables that will be examined in this thesis. Based on an analysis of parliamentary documents and other sources, the thesis will analyse the effects of a wide range of independent variables on international tax policy, including
policy beliefs of political parties and the government, international pressure, public opinion, and business lobbying. Based on a detailed chronological description of the case and the reported empirical findings, process tracing will be used to establish potential links between the different variables and the observed policy change.
The analysis shows that changes in the Dutch international tax policy concerning BEPS result from a change in policy beliefs of right-wing parties. Contrary to most left-wing parties, right-wing parties have traditionally resisted unilateral measures to counter BEPS, noting concerns about the Dutch investment climate. Yet, in 2017, a predominantly right-wing government proposed the unilateral measures that were previously so fiercely opposed. This therefore points to a change in policy beliefs of right-wing parties. Such change cannot be explained without considering the role played by international pressure, public opinion, and information provided by the media and NGOs, and business lobbying. International pressure, public opinion, and information provided by the media and NGOs seem to have forced right-wing parties to change their policy beliefs. However, in the absence of these factors, business lobbying seems to drive right-wing parties to liberalise tax rules for MNEs. Ultimately, while the above mentioned factors seem to influence the policy core beliefs of political parties, their political ideology could have a moderating influence on the factors.
This thesis will first provide a general background on BEPS, discussing the effects and technical aspects of the issue in Chapter 2. It will then continue to outline the theoretical framework and research design in Chapter 3. and Chapter 4. respectively. Based on the collected data, Chapter 5. will provide a detailed chronological description of the case, while Chapter 6. reports the empirical finding per variable. These chapters subsequently feed into the analysis in Chapter 7. A conclusion will be given in Chapter 8.
Introduction
The purpose of this chapter is to provide an overview of some of the technical aspects of BEPS. While it is beyond the scope of this thesis to provide a detailed overview of the BEPS strategies MNEs employ to lower their tax burden, general knowledge of the functioning of BEPS is necessary to understand the role that international tax policies of OFCs play in facilitating BEPS and to analyse why policymakers in OFCs might adopt or defend such policies. To that end, this chapter will first provide an overview of the academic debate on the scope of BEPS and then describe the various ways in which OFCs facilitate the BEPS strategies of MNEs.
Scope and effects of BEPS
One of the main consequences of BEPS is a reduction in CIT revenues in the high tax jurisdictions from which profits are diverted. This often leads to increased tax rates on other sources, lower government spending, or growing budget deficits (Janský, 2020; Clausing 2016). A significant effort has been made to estimate the scope of BEPS and calculate the resulting amount of lost tax revenues. For example, Wright and Zucman (2018) note that the effective foreign tax rate for American MNEs has plummeted since the mid-1990s and argue that almost half of the decrease has resulted from profit shifting. They estimate that in 2015 nearly half of the foreign profits made by American MNEs were booked in OFCs, where they were subject to a low average effective tax rate of 7%. It moreover seems that MNEs’ subsidiaries located in OFCs are much more profitable (before taxes) than subsidiaries in high-tax jurisdictions, even though most of the economic activity of MNEs occurs outside these OFCs (Tørsløv et al., 2018; Cobham & Janský, 2017). The mismatch between the distribution of economic activity and the distribution of profits suggests that BEPS is taking place on a significant scale.
Nevertheless, while there are clear indications that BEPS is taking place, formulating a uniform estimate of the resulting tax revenue losses is complicated due to a lack of robust data and a broad range of possible empirical approaches (OECD, 2013a). According to Clausing (2016), the profit-shifting behaviour of American MNEs has cost the United States’ government between USD 77 billion and USD 111 billion by 2012, which equals over 30 per cent of United States’ CIT revenues. She moreover notes that global revenue losses may have amounted to more than USD 280 billion in 2012. Likewise, the OECD (2015b) estimates that annually between USD 100 to 240 billion, or 4% to 10% of global CIT revenue, is lost due to BEPS. Other studies come to higher estimates, ranging from USD 500 to 600 billion (Cobham & Janský, 2017; Crivelli et al., 2015).
Notwithstanding the significant amount of CIT revenue lost annually because of BEPS, there is a broader academic discussion on whether profit shifting in the end benefits or disadvantages high tax jurisdictions. Some scholars argue that in cetain instances, the presence of OFCs might help high tax
2. Background on base erosion
jurisdictions compensate for the effects of distortive taxes on mobile factors2 (Hong & Smart, 2010). 3 BEPS
opportunities may make real investment less responsive to tax rate differentials. As such, while it might reduce revenues of high tax jurisdictions, it could provide these states with offsetting effects in terms of real investment (Hong & Smart, 2010; Desai et al., 2005). More generally however, most scholars and policymakers consider that the existence of OFCs has negative consequences for high tax jurisdictions (Slemrod & Wilson, 2009; Krautheim & Schmidt-Eisenlohr, 2011). Jones and Temouri (2016), for example, note that the falling corporate income tax rates in OECD member countries could be a result of the fear of base erosion caused by the existence of OFCs.
BEPS strategies and the role of offshore financial centres
In addition to analysing the scope and effects of BEPS, scholars and international organisations have focused on the different BEPS strategies that MNEs employ and the role that OFCs play in facilitating BEPS. MNEs often construct highly complex networks of parent and subsidiary entities, spread over multiple states, to organise their operations and ownership structures in a way that minimises their tax burden (Garcia-Bernardo et al., 2017). In organising these structures, MNEs strategically set up entities in what Garcia-Bernardo et al. (2017) categorise as ‘sink-OFCs’ and ‘conduit-OFCs.’ According to their definition, sink-OFCs are states that are more commonly called tax havens and that attract and retain foreign capital through low or zero CIT rates. Conduit-OFCs, on the other hand, are states that levy low or no taxes on transferring capital to other states via interest payments, royalties, dividends, or profit repatriation. Based on their empirical analysis, Garcia-Bernardo et al. (2017) identify five major conduit-OFCs, which in order of largest to smallest are the Netherlands, the United Kingdom, Switzerland, Singapore and Ireland.
Scholars and policymakers alike recognise the importance of conduit-OFCs in the BEPS strategies of MNEs (Lejour et al., 2019; Arel-Bundock, 2017; Garcia-Bernardo et al., 2017; Weyzig, 2013). One of the most extensively used BEPS strategies is to move intangible assets, such as intellectual property (IP) rights, to entities in sink-OFCs (Gupta, 2018). The entity in the sink-OFC then sets up licencing arrangements with entities of the same MNE group located in other states. As a result, these entities will have to make royalty payments to the entity located in the sink-OFC, resulting in reduced profits in high tax jurisdictions and increased profits in the sink-OFC, where they will be taxed at a lower rate or will not be taxed at all.
However, states often impose withholding taxes on corporate payments, such as interest payments, royalties, and dividends made to entities in other states, which reduces the attractiveness of these tax planning arrangements. To circumvent withholding taxes, MNEs can engage in what is commonly called ‘tax treaty shopping’ (Arel-Bundock, 2017; OECD, 2015d; Weyzig, 2013), for which Figure 1. provides an example. States regularly conclude bilateral tax treaties to eliminate double taxation and stimulate cross-border trade and investment. In these treaties, withholding taxes are often either lowered or eliminated (Hearson, 2018; OECD, 2017a; Davies, 2003). However, the terms of tax treaties and the size of a jurisdiction’s treaty network can vary significantly, and many states have not negotiated a tax treaty with each other (Hearson, 2018). When a high tax jurisdiction where an MNE makes profits and a
2 Mobile factors in this case primarily relate to capital. Investors can easily shift their investments between different states. Labour on the other hand is less mobile as the decision to move to another state to work there is a relatively large one.
3 It is commonly argued that in certain conditions, small and open economies would be better off by not levying distortive taxes on mobile factors as this would drive away mobile factors like capital and reduce productivity (Slemrod & Wilson, 2009). When these jurisdiction do levy such taxes, for political reasons for example, the presence of tax havens could help these states to compensate for the distortive effect of these taxes (Hong & Smart, 2010).
sink-OFC have not concluded a tax treaty that abolishes or lowers withholding taxes, an MNE can exploit the tax treaty networks of conduit-OFCs by establishing a holding company (or letterbox company) in such a state (Arel-Bundock, 2017; Streng, 1992). If the conduit-OFC has concluded a tax treaty with the high tax jurisdiction with low or no withholding tax on corporate payments, the MNE can shift its profits from the high tax jurisdiction to the conduit-OFC and then to the sink-OFC. In the process, the MNE minimises the impact of withholding taxes or circumvents them altogether (Weyzig, 2013).
As described above and exemplified in Figure 1., tax planning structures can take exceptionally complex forms. Sometimes they include other elements such as hybrid mismatch arrangements where MNEs exploit the difference - ‘mismatch’- between two states’ tax laws, resulting in the unintended non-taxation of international transactions (OECD 2015c; Tatarova, 2012). Another important element concerns tax rulings. MNEs and tax authorities can enter into negotiations on how certain activities of an MNE will be treated according to those states’ tax laws (OECD, 2015a). The resulting tax ruling provides certainty for an MNE on their future tax liability, which helps an MNE make investment decisions. However, MNEs might also use tax rulings to protect certain elements of aggressive tax planning schemes or create new BEPS opportunities. It can do so by dividing complex economic operations into smaller parts that obscure the scheme's tax avoidance purpose. On the other hand, some tax administrations in OFCs could also facilitate BEPS by applying tax laws in such a way that substantially benefits MNEs in ways not available to any other taxpayer (Morawski, 2020).
A key issue here is how the ‘arm’s length principle’ is applied. As noted before, an MNE consists of many separate companies located in different states. While they belong to the same MNE, these
The figure above provides an example of treaty shopping by an MNE. Here an MNE has a subsidiary in a high tax jurisdiction (jurisdiction A), where the MNE sells most of their products and thus generates most of its profits, and a subsidiary in a sink-OFC (jurisdiction B), where no corporate income taxes are levied. For the MNE, the ideal situation would to ensure that most profits end up in jurisdiction B, where profits are not taxed. To realise this, the MNE can move their intellectual property (IP), such as a brand name or an algorithm, to its entity in jurisdiction B. This entity would then license the IP to the entity in jurisdiction A. As a result, whenever the entity in jurisdiction A sells a product or service, it would have to make royalty payments to the entity in jurisdiction B for the use of IP. This decreases the profits made in jurisdiction A, while increasing the profits of the entity in jurisdiction B due to the incoming royalty payments. As such, the MNE has ‘shifted’ profits from jurisdiction A to jurisdiction B. However, since jurisdiction A has no tax treaty with jurisdiction B and imposes a withholding tax of 30% on outgoing royalty payments, the effective tax rate on the MNE’s profits does not decrease significantly. To circumvent this high withholding tax rate, the MNE chooses to set up a holding company in jurisdiction C, which is a conduit-OFC and has a large tax treaty network, including a treaty with jurisdiction A determining that royalty payments are not subject to a withholding tax. Moreover, jurisdiction C unilaterally does not subject outbound royalty payments to any withholding tax. To benefit from this situation, the MNE chooses to let the entity in jurisdiction B license the IP to the holding company in jurisdiction C, which then licenses it to the entity in jurisdiction A. By redirecting the royalty payments via jurisdiction C, the MNE avoids the high withholding tax of 30% and manages to accumulate a larger amount of profits in jurisdiction B, where they go untaxed. Similar situations exist for structures based on interest and dividend payments.
Jurisdiction C
(Conduit-OFC)
Jurisdiction A
(High-tax jurisdiction) Jurisdiction B (Sink-OFC)
No tax treaty 30% withholding tax Tax treaty 0% withholding tax Unilaterally levies no withholding tax Figure 1. Simplified example of treaty shopping to shift profits to a sink-OFC
companies are treated as separate entities. When an entity delivers a service or product to another entity of the same MNE, also known as intra-group transactions, it will have to charge the entity for the delivered product or service. In this way, the costs and profits of an MNE can be appropriately allocated to its various entities and their respective locations. Pricing such transactions is commonly referred to as ‘transfer pricing.’ However, an entity is not free to charge whatever price it desires. The OECD’s widely followed guidelines specify that transfer pricing should follow the arm’s length principle (OECD, 2017b). This means that intra-group transactions should be priced as a transaction between two independent companies, and thus at global market prices. This prevents MNEs from using transfer pricing to artificially allocate costs and profits to minimise their tax burden. MNEs can ask for a tax ruling to have certainty about how transactions should be priced. However, if the tax ruling is based on non-market conforming transfer prices, it can facilitate BEPS.
In the end, some tax planning schemes have been so effective they have been given names like the “Dutch Sandwich,”4 which has been called “one of the most successful corporate tax planning regimes
in the last half-century” (Sala, 2014, p. 575). These structures are used by the largest tech companies such as Apple, Microsoft and Google (Sala, 2014; Thorne, 2014), and allowed the latter to reduce their overseas effective tax rate to 2.4%, saving more than USD 3 billion in three years (Drucker, 2010).
It is not surprising that some of these schemes are named after the Netherlands, considering it is the largest conduit-OFC in the world (Garcia-Bernardo et al., 2017; Weyzig, 2013) and features in most major MNEs’ tax planning schemes. On paper, more than 80 of the 100 largest MNEs have their headquarters in the Netherlands (Lejour & Van ‘t Riet, 2013). Scholars note that the Netherlands is especially attractive as conduit-OFC due to its extensive tax treaty network, the absence of withholding taxes on outbound corporate payments, its tax ruling practice, and its minimal ‘substance requirements,’ which are supposed to prevent abuse (Weyzig, 2013; Evers et al., 2011). 5
Nevertheless, for states such as the Netherlands, being a conduit-OFC is not unavoidable and instead appears to be a deliberate policy choice. States can, for example, negotiate ‘anti-abuse’ clauses in their tax treaties, adopt domestic legislation that counters abuse of tax treaties, or impose withholding taxes on outbound corporate payments (Öner, 2020; Oats & Mulligan, 2019; Bradley et al., 2017; Thorne, 2014; Johannesen, 2012). A ‘principal purpose test,’ for example, would deny MNE treaty benefits for transactions that seem to have only been made with the aim to avoid taxes rather than out of economic considerations (Weber, 2017). Introducing measures such as these has been the EU and the OECD's focus in the last decade. As part of the OECD/G20 BEPS project, multiple states have negotiated a multilateral convention that would, upon ratification, amend tax treaties in such a way to prevent abuse (OECD, 2020). However, the decision of whether or not to ratify this convention or to introduce further domestic requirements to prevent BEPS is always at the discretion of the state itself.
Conclusion
To summarise, most studies find that BEPS takes place on a significant scale, with lost CIT revenues ranging from USD 100 billion to USD 600 billion per year. It has an especially negative effect on high tax jurisdictions. MNEs tend to shift profit from these states to sink-OFCs, where their profits are
4 The Dutch Sandwich, together with the Double Irish and many other structures, is a tax planning structure involving intellectual property and which allows MNEs to shift their profits to low tax jurisdictions by using subsidiaries in Ireland and the Netherlands and exploiting loopholes in tax laws (Thorne, 2014).
5 Substance requirements determine that a company must have ‘economic substance’ in a state before it can benefit from certain tax rules or tax treaties. Such requirements can for example demand that a company must have a certain number of employees in a state before it is considered to have economic substance according to the law.
subjected to low or zero taxes. Moreover, conduit-OFCs, of which the Netherlands is the largest, play a major role in facilitating BEPS. MNEs employ a range of different strategies that make use of conduit-OFCs to shift their profits to sink-OFCs. Such strategies involve, among others, treaty shopping, making use of hybrid mismatch arrangements, and using tax rulings. While these strategies have significantly reduced the effective tax rates for some MNEs, implementing anti-abuse measures could limit BEPS. In the past decade, the OECD and EU have pushed for the implementation of such rules, but for the most part, the decision whether or not to implement such regulations remains at the discretion of individual states.
Introduction
While BEPS itself has been a subject of increasing scholarly debate, OFCs' policy approaches concerning BEPS remain underexamined. Academic interest in the matter increased after 2012, when G20 leaders declared that BEPS should be prevented and later, in 2013, endorsed an OECD Action Plan aimed at tackling BEPS. Nevertheless, as set out in the previous chapter, the debate has primarily focused on the technical aspects of BEPS, including estimating its magnitude, analysing MNEs’ BEPS strategies, and studying the role of OFCs in facilitating BEPS.
In contrast, the academic literature on policy responses to BEPS, especially in OFCs, is limited. In particular, relatively little has been written on the factors that cause certain states to become or remain an OFC and which factors might lead them to take a stricter approach towards BEPS. Therefore, to formulate a robust theoretical framework appropriate for analysing international tax policy change in the Netherlands, this thesis will build upon the ‘Advocacy Coalition Framework’ (ACF). This is a broader theoretical framework that examines policy stability and policy change. The ACF has been extensively applied in different policy areas and is particularly useful for analysing stability and change in policy areas marked by complexity.
The ACF identifies several factors that might induce policy change. These factors will be further explored in the context of the academic literature that is available on international tax policy change. For example, several studies examine the role of perceived economic benefits, political ideology, public opinion, lobbying, and international pressure in influencing international tax policy. The theoretical assumptions derived from these studies will be combined with the theoretical assumptions of the ACF to formulate a single integrated theoretical framework.
To this end, this chapter will first provide an overview of the ACF. Subsequently, it will examine the identified causal factors in light of the available literature on international tax policy change. These two bodies of literature will finally be combined into a single theoretical framework which will serve as the analytical basis for the rest of this thesis.
The Advocacy Coalition Framework
Sabatier and Jenkins-Smith introduced the ACF as a theoretical lens to understand policy stability and policy change (Sabatier & Jenkins-Smith, 1993; Sabatier, 1988). It is a relevant theoretical framework for the purpose of this thesis, considering that it is particularly suitable for understanding policy stability and change in areas that are “characterized by substantial political conflict and high technological complexity” (Nohrstedt, 2005, p. 2), which international tax policy tends to be (Seabrooke & Wigan, 2016). Moreover, the ACF comprehensively integrates most of the elements used in other mainstream theories on policy change into a single framework (Schlager, 2007).
The ACF is based on three main premises (Sabatier, 1988). First of all, understanding policy change requires a timeframe of a decade or more. Secondly, policymaking should be studied in ‘policy subsystems,’ which denote a demarcated domain of interaction between actors from various institutions which are interested in the same policy field. Finally, public policies are similar to belief systems in how
3. Theoretical framework
they include “value priorities, perceptions of important causal relationships, perceptions of world states (including the magnitude of the problem), perceptions of the efficacy of policy instruments, etc.” (Sabatier, 1988, p. 132).
According to the ACF, these belief systems can be broken down into three main categories (Sabatier & Weible, 2007; Sabatier, 1988). Firstly, ‘deep core beliefs’ refer to the most fundamental normative and ontological axioms and determine a person’s personal philosophy, including what is right and what is wrong, and how someone perceives the wider world. One way to classify deep core beliefs would be based on the traditional left-right political spectrum. These beliefs are generally extraordinarily difficult to change; as Sabatier (1988, p. 145) notes, it would be “akin to a religious conversion.” Secondly, ‘policy core beliefs’ are the beliefs actors have on achieving the goals that result from their deep core beliefs in the best way. These relate to the fundamental positions taken in a specific policy area. They are often difficult to change, but can do so under certain conditions. Lastly, ‘secondary beliefs’ concern beliefs about specific design options of policies, including its administration and budgetary concerns. These beliefs are moderately easy to change (Sabatier & Weible, 2007).
The goal of policy actors is to translate these beliefs into policy. The ACF assumes that actors with the same beliefs can be aggregated into an advocacy coalition. An advocacy coalition can act in a coordinated way to achieve its policy goals. Such coalitions are most successful in translating their beliefs into policy when the coalition is dominant, i.e. when it has access to the most political resources in a subsystem. The ACF hypothesises that policy change is unlikely while the dominant coalition remains constant (Sabatier & Weible, 2007).
The theory contends that policy change is induced mainly through two ways: (I) through changes in the beliefs of the dominant coalition, and (II) through redistribution in political resources, i.e. a change of dominant coalition (Sabatier, 1988). Such changes occur as a result of external and internal shocks, policy learning, or negotiated agreement. External shocks occur outside the policy subsystem and include changes in socio-economic conditions, public opinion, decisions from other policy subsystems, and governing coalitions. Such external shocks increase the salience of relevant issues, attract policymakers' attention, and subsequently sometimes lead to a change of beliefs. Sabatier and Weible (2007, p. 199) note, however, that “the causal links between an external shock and policy change is an ongoing effort among some ACF scholars.” They nevertheless provide the example of a pro-regulatory coalition that could reconsider the adverse economic consequences of stricter regulation during an economic crisis. Despite the uncertainty about the precise causal links, the ACF presupposes that a change in one of these factors is a necessary condition for major policy changes (Sabatier & Weible, 2007).
Internal shocks on the other hand, take place within the subsystem and are the result of the introduction of new information that reveals policy failures within the subsystem (Sabatier & Weible, 2007). This attracts public attention and can sow doubt about the effectiveness of policies advocated by the dominant coalition. As such, the dominant coalition’s policy core beliefs could be undermined while those of the minority coalition might be strengthened. Additionally, both internal and external shocks can redistribute political resources among advocacy coalitions through shifts in public support, financial contributions, or more drastically through electoral changes (Sabatier & Weible, 2007).
Aside from the importance of information on policy failures, the ACF generally assumes that technical and scientific information plays a central role in modifying the beliefs of actors (Sabatier & Weible, 2007). This is also the case in policy learning, which is defined as “relatively enduring alterations of thought or behavioural intentions that result from experience and/or new information and that are concerned with the attainment or revision of policy objectives” (Sabatier & Jenkins-Smith, 1993, p. 123). Changes in beliefs through policy learning usually occur over a long period of time and tend to be most relevant for secondary beliefs. However, when combined with internal or external shocks, policy learning might also change policy core beliefs (Sabatier, 1988).
Finally, the last path towards policy change involves negotiated agreements between multiple advocacy coalitions. This requires a ‘professional forum’ where coalitions can safely negotiate agreements. Several conditions contribute to the effect of this method, including effective leadership, consensus-based decision rules, and hurting stalemates (Sabatier & Weible, 2007).
To summarise, the ACF identifies several pathways that lead to policy change and highlights several specific factors relevant to these pathways. These factors include political ideology as a basis for the deep core beliefs; external shocks, such as changes in public opinion, policy decisions and impacts from other subsystems, and changes in governing coalitions; and the introduction of new scientific or technical information (on policy failures), which can lead to policy learning or internal shocks. These factors will be further explored in the context of international tax policy change in the following sections.
Factors influencing international tax policy in offshore financial centres
The previous section provided an overview of the ACF as a general theoretical framework for analysing policy stability and change. This section will attempt to relate the factors identified by the ACF to the existing academic literature on international tax policy change in OFCs. This is however a relatively underdeveloped area of research. While there have been attempts to identify the common characteristics of OFCs - they tend to be small and affluent countries with high-quality governance institutions (Dharmapala & Hines, 2009) - little attention has been given to the factors influencing OFCs’ international tax policy. Nevertheless, several studies consider factors influencing tax policy in general. These theories will be further explored below and adapted to fit the context of policymaking in an OFC. The relevant studies on international tax policy change have been broadly categorised based on the relevant factors as identified by the ACF but do not entirely overlap. As such, this chapter will discuss (I) optimal taxation policy and economic benefits; (II) political ideology, perceptions of capital mobility, and fiscal fairness; (III) public opinion and the role of the media and NGOs; (IV) business lobbying; and (V) international pressure. These theories will further be combined with the ACF into a single theoretical framework in Section 3.4.
Optimal taxation policy and economic benefits
Before analysing the various political factors that can influence international tax policy, it is helpful to have a better view of how international tax policy is theorised to influence economic activity. It can be expected that policymakers in OFCs introduce and protect certain tax policies because they expect them to deliver certain economic benefits. However, academic research on the economic benefits for OFCs is limited, and existing research offers contradictory findings (Blanco & Rogers, 2010; Hines, 2005). Nevertheless, considering that OFCs are often small and open economies6 (Dharmapala & Hines, 2009),
the significant body of literature on the economically optimal international taxation policies for small and open economies might help better understand the choices that policymakers in OFCs make. However, it should be emphasised that this body of literature follows a functionalist logic and often disregards factors other than economic arguments.
Scholars commonly argue that small and open economies are better off when they do not tax internationally mobile factors like capital (McKeehan & Zodrow, 2017; Chao & Yu, 2014; Ghinamo et al., 2010; Hines, 2003). As Dharmapala and Hines (2009, p. 1059) explain, “the reason is that small open economies are inevitably price-takers in world markets, from which it follows that they are unable to shift any of their tax burdens onto foreign investors.” Because business capital is highly mobile and sensitive to
6 Small and open does not necessarily imply that the economy has a low GDP. It rather relates to the fact that these states participate in international trade and investment, but are price-takers rather than price-setters.
tax rate differentials between states, a small and open economy that heavily taxes capital flows (or that prevents profit shifting through anti-abuse measures) would see a lower inflow of foreign direct investment (FDI). Levying capital taxes, such as CIT, will distort the economy of such states without collecting additional tax revenues from foreign investors (McKeehan & Zodrow, 2017; Slemrod & Wilson, 2009). As a result, the ‘best’ policy choice would be to have no capital taxes or lower them to stimulate FDI.
Such policy choices might be especially relevant for small and open economies in the context of international tax competition (Ghinamo et al., 2010; Haufler & Wooton, 1999). Egger and Raff (2014) find that governments have been facing increasingly tough international tax competition since the 1980s, as governments strategically lower their CIT rates in the hope to attract MNEs and compete for FDI. Considering that small and open economies do not have a large domestic market to rely on, creating a favourable fiscal climate for foreign investors might be one of their key priorities to attract FDI and thus stimulate economic growth (Chanegriha et al., 2017; Haufler & Wooton, 1999). In such a situation, maintaining high capital taxes while also unilaterally adopting anti-abuse measures may be perceived as harming a jurisdiction’s fiscal attractiveness and deter FDI (Juranek et al., 2020; Buettner et al., 2017).
The economic theories mentioned above could explain why small and open economies aggressively lower their capital taxes or refuse to impose anti-abuse measures. As a result, they can end up as a sink- or conduit-OFC. OFCs are indeed among the largest destinations for FDI (Van ‘T Riet & Lejour, 2018; Garcia-Bernardo et al., 2017). Nevertheless, it is unclear to what extent OFCs can benefit from FDI. As Hines (2003, p 26) notes, “there is widespread belief that greater foreign investment stimulates other economic activity.” He argues that Ireland has profited from an increased inflow of FDI after further liberalising its tax regime, with rapid growth of Irish GDP as a result. Moreover, Dharmapala and Hines (2009) argue that even with very low tax rates, the increased FDI flow would broaden the tax base and limit the budgetary costs an OFC would incur.
However, the generalisability of these claims is questionable. Garcia-Bernardo et al. (2017) show that there are concrete differences between sink-OFCs and conduit-OFCs that are not considered in the studies mentioned above. Moreover, they show that substantial differences exist in the regional and sectoral specialisation within the two categories of OFCs. For example, some conduit-OFCs have predominantly attracted MNEs’ headquarters, while other OFCs primarily attract holding companies. Even if OFCs might see an inflow of FDI, Blanco and Rogers (2010) note that it often flows straight out of the jurisdiction again, making the growth implications of incoming FDI uncertain. Markle and Shackelford (2014) highlight the distinction between operating subsidiaries, which undertake economic activities, and holding companies which merely function as a passthrough for capital and involve little economic activity. These holding companies can be managed by a very small group of employees, making the employment effects of the incoming FDI negligible (IMF, 1976). Therefore, the IMF distinguishes ‘real FDI’ and ‘phantom FDI,’ with the latter denoting investments in holding companies with no substance or real links to the local economy (Damgaard et al., 2019). They note that almost 40% of global FDI may be phantom FDI, which is primarily invested in conduit-OFCs such as Luxembourg and the Netherlands, explaining their outsized role in FDI statistics. Thus, it is not clear whether OFCs economically benefit from their approach to international tax competition, as observed in the last decades.
Nevertheless, as noted above, OFCs could attempt to attract MNEs’ headquarters through their tax policies. The relation between international tax policy and the location of MNEs’ headquarters has been examined by multiple scholars but remains unclear (Baaij et al., 2015; Barrios et al., 2012; Voget, 2011; Clausing, 2010). Clausing (2010) notes that there are multiple reasons why a state would want to attract MNEs’ headquarters: they (I) are a source of national pride; (II) might increase economic activity and boost innovation with potential spill-over effects on other sectors; and (III) might generate high wage jobs. Nevertheless, Clausing (2010) also argues that these arguments have weak economic foundations and that positive economic effects might be generated more efficiently through alternative policies. The
economic effects seem to be especially questionable when the relocation only involves moving the corporate legal seat.
Academic perspectives on whether an attractive fiscal climate helps attract headquarters differ. Clausing (2010) notes that there is little systemic relationship between an MNE’s headquarters location and tax policy variable. In contrast, Baaij et al. (2015) argue that, among other factors, the attractiveness of a state’s international tax regime is an essential factor in decisions on whether to relocate MNE’s headquarter, although this predominantly concerns the company’s legal seat. Besides, Voget (2011) finds that enacting anti-abuse rules makes a state less attractive for an MNE’s headquarters.
The benefits of attracting MNEs’ headquarters and the effectiveness of having an attractive fiscal climate to do so are thus unclear. However, what might be more important is that policymakers are sensitive to relocation decisions of MNEs and have shelved controversial tax reforms in the past due to MNEs moving out of their jurisdiction (Voget, 2011). The pride and prestige associated with having MNEs headquartered in a jurisdiction might be important to politicians (Clausing, 2010). Clausing (2010, p. 744) notes that “when large and well-known multinational firms are headquartered in the home country, it may simply generate pride in the ability of the country’s firms to compete in the world economy.” A similar pride may be at play for the OFC that convinces MNEs from other states to relocate to their jurisdiction or prevents their own MNEs from leaving.
In short, according to the economic theories cited above, small and open economies like OFCs often are, have an incentive to abolish or lower their capital taxes. The widely held perception that FDI boosts economic growth has made attracting it a key concern for policymakers. In the context of international tax competition to attract FDI, not lowering capital taxes or even unilaterally imposing anti-abuse measurers might be perceived by policymakers as harming a small and open economy's fiscal attractiveness. Ending up as an OFC might then be construed as an extreme end on the spectrum of policy approaches to the intensifying competition for FDI (Palan, 1998; 2002). However, whether FDI inflows are indeed beneficial to the growth of OFCs is unclear. OFCs might want to stimulate economic growth by attracting MNEs’ headquarters or through attracting other economic activities. Nevertheless, it is uncertain whether this indeed generates tax revenues or jobs, especially when an OFC only attracts holding companies or the corporate legal seat of an MNE, and the inflow of FDI can be primarily considered as phantom FDI.
Political ideology, perceptions of capital mobility, and fiscal fairness
Independently, the economic benefits that OFCs might derive from their international tax regime seem to be unsatisfactory in explaining why some states are OFCs. A wider body of literature therefore considers the role of more political factors, rather than economic factors, in the policymaking process for international tax policy. It is generally assumed that all policymakers aim to attract FDI, but this does not mean they all follow the same tax policies. While it might not be sensical for small and open economies to impose capital taxes on foreign investors from an economic perspective, many of these states do so nonetheless, and most of these states do not become OFCs. Hines (2003) notes that policymakers might be tempted to impose these taxes based on fairness and distributional grounds. This points towards the role of ideological considerations in setting international tax policy, which the ACF labels as deep core beliefs of politicians, and which are considered to be influential in determining their policy goals and policy core beliefs.
One indication that ideology is important for international tax policy and BEPS is a study on the relation between the political preferences of American CEOs and tax avoidance. Francis et al. (2016) find that Republican CEOs are more likely to avoid corporate taxes than Democratic CEOs. They note that Democratic CEOs need more personal economic incentives to avoid corporate taxes because the decision
to avoid taxes goes against their political beliefs on tax policies. Another study finds that right-wing politicians are more likely to set lower corporate tax rates based on their preferences on the provision of public goods and retributions, and their perception of capital mobility (Osterloh and Debus, 2012). On the other hand, the redistributive goals of left-wing politicians require higher government expenditure and thus increased tax revenues, which are partially collected through CIT. As such, they are inclined to set higher corporate tax rates. Nevertheless, their corporate tax policy is also constrained by the threat of capital flight.
Osterloh and Debus (2012) note that politicians might have different perceptions of the mobility of capital. When politicians perceive capital as highly mobile, they will be more likely to choose lower CIT rates than politicians who perceive capital as immobile. The idea that politicians have different perceptions of capital mobility is supported by Heinemann and Janeba’s (2011) empirical research. They find that there is a clear ideological left-right bias in how politicians perceive capital mobility in taxation. Left-wing politicians tend to perceive a less strong relation between taxation and company location decisions than right-wing politicians. On the other hand, left-wing politicians perceive the scale on which BEPS takes place to be larger than right-wing politicians.
In addition, ideological concerns may determine what policymakers consider to be a ‘fair’ tax regime. Such consideration of fiscal fairness can have a direct impact on the policy choices of politicians. As Hines (2003) noted, governments may be inclined to impose capital taxes out of fairness considerations contrary to optimal taxation theory. The perception of fiscal fairness has received increasing academic attention, especially since the 2007-2008 financial crisis (Limberg, 2020; Limberg, 2019; Plümper and Troeger, 2009). The notion of fairness is generally based on the idea that citizens (and companies) should be treated equally (Scheve & Stasavage, 2016).
Fiscal fairness considerations directly inform the policy choices of politicians. For example, the preferences of left-wing parties for redistribution via the tax system are themselves grounded in a specific idea of fairness. Instead of following the theoretical economic optimal level of taxation by reducing capital taxes to zero, left-wing parties tend to impose a higher tax on capital and lower taxes on income from labour instead to balance the total tax burden over the multiple tax bases rather than shifting most of the burden to immobile factors (Osterloh & Debus, 2012; Angelopoulos et al., 2009). In contrast, according to Antonnetti and Anesa (2017), it is more common for right-wing politicians to justify tax avoidance. They note that this claim is consistent with the finding that systematic differences exist in the moral concerns of left-leaning people and right-leaning people, as the study of Graham et al. (2009) suggests. Considering these ideological biases, it seems reasonable to assume that left-wing politicians are less likely to formulate aggressive tax policies in response to international tax competition, which could facilitate BEPS, than right-wing politicians.
Public opinion and the role of the media and NGOs
Besides influencing the policy choices of politicians, notions of fiscal fairness held by citizens may indirectly influence international tax policy through public opinion and the electoral process. In the ACF, public opinion is considered an influential factor that can cause external shocks. This assumption matches the literature on the relation between public opinion and international tax policy change. Alesina et al. (2012), for example, show that rapid changes in the perception of what ‘fair’ tax rules are, can lead to sustained changes in tax policy. According to Plümper and Troeger (2009), voters might perceive the unequal treatment of mobile and immobile tax bases as unfair, especially when governments face budget constraints. While one might think that citizens could view such policies as unavoidable to remain competitive in a globalised world, studies have pointed out that the average person generally does not value economic efficiency arguments as much as economists do, and values equality more instead (Fehr et al., 2006). Further empirical research suggests that citizens either ignore or disagree with optimal tax
theories, and support significantly higher taxation of more mobile companies (Kolstad et al., 2018). This would imply that for small and open economies, the theoretical economic optimal level of taxation with zero capital taxes would be politically unattainable.
The considerations mentioned above raise several important questions about the role public opinion plays in OFCs. Intuitively, tax avoidance by highly profitable MNEs would not be compatible with any conception of fairness. This would logically imply that citizens in OFCs would disapprove of the tax policy choices of their government. It thus becomes the question when citizens’ considerations of fairness become so important that they influence the decision-making process on international tax policy.
According to Scheve and Stasavage (2016), the prominence of considerations on fiscal fairness can vary in time and from state to state. One important consideration is that while the taxation of MNEs might inherently be a political issue, it usually has not been a salient topic in the public debate. Scholars note that this results from the inherently technical complex nature of (international) corporate taxation (Seabrooke & Wigan, 2016; Picciotto, 2015; Büttner & Thiemann, 2017). Few citizens are interested in tax policy and only a limited group of experts and policymakers genuinely understand the inner workings. Consequently, the formulation of international tax policy often occurs in small expert settings outside the public domain. The salience of international tax policy in the public debate therefore tends to be low.
Several scholars therefore point towards the importance of civil society organisations and the media play in making international tax policy a more prominent issue in the public debate (Kneafsey & Reagan, 2020; Dallyn, 2017; Forstater & Christensen, 2017; Seabrooke & Wigan, 2013). It is argued that these organisations can translate technical issues into politically salient issues. For example, these organisations have launched persistent campaigns in which they advocated for ‘tax justice’ by making MNEs pay their ‘fair share’ of taxes.
A rise in public interest in the taxation of large MNEs can be observed after the 2007-2008 financial crisis (Dallyn, 2017; Forstater & Christensen, 2017). This is consistent with Plümper and Troeger’s (2009) findings that fiscal fairness concerns become especially relevant when governments face budget constraints. According to Dallyn (2017), the environment of post-crisis austerity has aided civil society organisations in making tax issues more politically salient. Limberg (2020; 2019) furthermore finds that the crisis itself has had significant implications for public opinion on international tax policy. He argues that citizens’ fiscal fairness principles were violated during the financial crisis when financial-risk takers were bailed out with public money. In the eyes of citizens, these bailouts symbolised unequal treatment by the state in the sense that the benefits of financial risk-taking were allocated among a select group of companies and citizens, while the costs of the bailouts are carried by society as a whole. Limberg (2020; 2019) argues that in states where the crisis hit the hardest, perception of unfairness has led to stronger demands for increased progressivity in personal income tax rates. Building on this sentiment, civil society organisations and the media have further increased the political salience of international corporate taxation through revealing major tax scandals, such as the Paradise Papers and LuxLeaks (Dallyn, 2017; Forstater & Christensen, 2017). Such reporting could also be expected to provide politicians with new (technical) information on BEPS, which might challenge their beliefs through processes of policy learning or internal shocks.
In the end, it seems that considerations on the fairness of a fiscal system can have significant effects on the international tax policy of a state, either by directly influencing the policy choices or through public opinion. Citizens are likely to demand an increase in corporate taxation when they perceive that citizens and companies are taxed unequally, even though such policies might go against economic efficiency arguments. However, citizens’ consideration of fiscal fairness seems to be especially relevant when taxation is salient in the public debate or when governments face budget constraints. Moreover, the saliency of taxation issues might increase through the intermediation of civil society organisations and the media when they for example report on large tax scandals.
Business lobbying
Besides the pressure of public opinion, politicians are also subject to pressure from the business community, which would intuitively want to lower capital taxes and preserve BEPS opportunities. The academic debate on lobbying by business suggests that their political influence is substantial. For example, Lindblom (1977) argues that businesses hold a privileged position in democratic policymaking. This position, moreover, tends to grow stronger as globalisation increases (Cerny, 1999). Politicians are structurally dependent on private investors and businesses to maintain investment and support economic growth (Bernhagen & Bräuninger, 2005; Przeworski & Wallerstein 1988; Lindblom, 1977). The tacit threat to stop investment therefore constrains the range of tax policies that politicians can follow. Consequently, business preferences have a disproportional impact on policymaking compared to the preferences of other interest groups. (Williams & Collins, 1997; Lindblom, 1977). From an ACF perspective, the (technical) information that businesses provide to politicians could cause changes in beliefs due to policy learning or internal shocks.
The asymmetrical information position of politicians vis-à-vis businesses further exacerbates the political influence of business (McCarthy, 2014 Culpepper, 2010; Bernhagen & Bräuninger, 2005). Politicians often are unable to precisely determine what the effects of some of their policy proposals are. In some of these situations, they turn to businesses and interest groups that have such information readily available. However, when policies can have negative consequences for businesses, these businesses have the incentive to exaggerate the negative effects of the proposed policies to dissuade politicians from adopting the policy. Moreover, these claims are difficult to verify for politicians, leading to increased dependency on businesses. A seemingly credible signal from business leaders that they will leave a jurisdiction in response to a certain policy could put politicians under severe pressure to reconsider their decisions (Keller, 2018; Bernhagen & Bräuninger, 2005; Lindblom, 1977). As such, it seems likely that such threats are especially powerful in small and open economies and thus also in most OFCs.
Nevertheless, it has also been pointed out that business lobbying becomes significantly less effective in policy areas that have become salient in the public debate (Culpepper, 2010). When the public does not pay attention, deference to the expertise of business is easy and risk-averse. As Culpepper (2010, p. 178) notes: “politicians do not want to risk messing up the economy unless there is a big political reward for doing so.” However, when issues become salient, and the public starts holding politicians accountable for policy outcomes, politicians and journalists are encouraged to invest in their own sources of information. The political influence of businesses is especially limited when scandals come to light that harm the business’ reputation, as it both makes issues highly salient for the public and leads politicians to rely less on businesses for information. For example, several scholars point out that the financial crisis severely curbed the financial sector's political influence due to public outrage and a loss of legitimacy (Kastner, 2018; Baker, 2010).
Based on the studies mentioned above, several theoretical assumptions can be made about the influence of business lobbying in OFCs. Businesses have an incentive to protect the international tax regime of OFCs. When issues of corporate taxation are low in salience, businesses might be able to influence politicians to either promote even more favourable tax rules or to protect the existing ones. MNEs located in OFCs might threaten politicians with a potential exit from their jurisdiction, strengthening the perception that capital is mobile. Such threats would be especially forceful considering that OFCs are often small and open economies. In contrast, when international corporate taxation becomes more salient in the public debate and when tax avoidance scandals come to the surface, it can be expected that the political influence of business lobbying decreases.
International pressure
Finally, one of the factors described in the ACF that can lead to external shocks is ‘policy decisions and impacts from other subsystems.’ An OFC’s international tax policy is inherently not only a domestic policy issue. After all, the term BEPS refers to the tax base erosion of states due to profit shifting. By facilitating profit shifting, OFCs facilitate the tax base erosion of their neighbours and other states. Eden and Kudrle (2005) note that one could even categorise OFCs as renegade states. It is imaginable that states faced with base erosion do not have a particularly positive attitude towards OFCs. Together with international organisations, these states can attempt to adopt sanctions or try to adopt international laws and guidelines to force OFCs to change their international tax policies.
There are multiple cases of unilateral actions taken by states against OFCs. For example, after numerous studies by the United States government on the scope of BEPS by American MNEs, the United States terminated several tax treaties with OFCs in the Caribbean in the 1980s (Eden & Kudrle, 2005). More recently, Mongolia terminated its tax treaty with the Netherlands, citing that multiple MNEs abused the treaty to avoid CIT in Mongolia (Deutsch & Edwards, 2013). However, such actions are rare. As described before, the purpose of tax treaties is to eliminate double taxation and provide a favourable environment for cross-border investments. Ideally, a state would renegotiate a tax treaty and strengthen anti-abuse clauses. This might prove difficult since it would require the consent of the OFC as well. The other option, terminating treaties, is a difficult decision, especially when it concerns economic and political allies between which a substantial amount of trade occurs. Moreover, the EU’s Interest and Royalty Directive abolishes withholding taxes on most corporate payments within the EU to eliminate barriers to further economic integration (Johannesen, 2012).
The role of the EU directives points to one of the more significant issues that states face when trying to coerce OFCs into policy change. Generally, scholars maintain that ‘great powers’ can impose their will on ‘smaller powers’ by virtue of their market power (Krasner, 1976). Great powers have large domestic markets and closing off their market to an OFC will likely hurt the OFC more than it will hurt the great powers. This provides great powers with a credible threat. Nevertheless, according to Hakelberg (2015, 2016), OFCs inside the EU are insulated from such threats by their neighbours because taxation issues are decided by unanimity in the Council of the European Union, and other member states cannot impose economic sanctions due to the four freedoms of the EU. On the other hand, great powers outside the EU could credibly threaten European OFCs. Hakelberg (2015, 2016) notes that in the area of personal tax evasion, the United States have forced some OFCs in the EU to change their tax policies. Nevertheless, it is unclear whether the United States are willing to use such threats in other areas. For example, when the White House listed the Netherlands as a tax haven in 2008, it quickly removed the Netherlands from the list again after intensive Dutch lobbying (Langerock & Hietland, 2019).
Exercising pressure on OFCs, especially conduit-OFCs in Europe, seems to be challenging, considering the strong economic and political ties they often have with other states. Moreover, besides being members of the EU, Eden and Kudrle (2005) note that some European OFCs are also members of the OECD. The OECD and EU are the two international bodies that have been most concerned with attempting to change the tax policies of OFCs. In 1998, the OECD started a global campaign against OFCs when it published its report on “Harmful Tax Competition” (OECD, 1998). The report described several criteria for identifying OFCs. Based on these criteria, the OECD threatened to blacklist OFCs that did not commit to reforming their tax systems.
Blacklisting is based on the principle of naming and shaming and tries to incentivise OFCs to change their tax policies to avoid the reputational costs that come with backlisting (Eggenberger, 2018; Sharman, 2009). Backlisting stigmatises OFCs and labels them as defying internationally accepted norms and rules (Adler-Nissen, 2014). Damaging a state’s reputation and credibility can lead to economic losses
