Handbook on the Politics of Taxation 1788979419, 9781788979412

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HANDBOOK ON THE POLITICS OF TAXATION

Handbook on the Politics of Taxation Edited by

Lukas Hakelberg Otto Suhr Institute of Political Science, Freie Universität Berlin, Germany

Laura Seelkopf School of Economics and Political Science, University of St. Gallen, Switzerland

Cheltenham, UK • Northampton, MA, USA

© Lukas Hakelberg and Laura Seelkopf 2021

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2021943512 This book is available electronically in the Political Science and Public Policy subject collection http://dx.doi.org/10.4337/9781788979429

02

ISBN 978 1 78897 941 2 (cased) ISBN 978 1 78897 942 9 (eBook)

Contents

List of tablesviii List of contributorsix Acknowledgementsxi List of abbreviationsxii 1 PART I

Introduction to the Handbook on the Politics of Taxation1 Lukas Hakelberg and Laura Seelkopf THE HISTORICAL EVOLUTION OF MODERN TAX SYSTEMS

2

Premodern taxation Edgar Kiser

17

3

War and taxation: the father of all things or rather an obsession? Patrick Emmenegger and André Walter

32

4

Political institutions and taxation, 1800–1945 Per F. Andersson

47

5

The colonial tax state Laura Seelkopf

64

PART II COMPARATIVE TAX POLITICS A: THE BASICS 6

The domestic determinants of tax mixes Achim Kemmerling and Zbigniew Truchlewski

82

7

Size and structure of the tax state in comparative perspective Lukas Haffert

98

8

Political regimes and taxation: do democratic rule and regime stability count? Christian von Haldenwang

113

9

The politics of tax expenditures Christian von Haldenwang, Achim Kemmerling, Agustin Redonda and Zbigniew Truchlewski

128

10

Fiscal decentralization Amuitz Garmendia Madariaga

146

v

vi  Handbook on the politics of taxation PART II COMPARATIVE TAX POLITICS B: CURRENT DEBATES 11

A race to the bottom? The politics of tax competition Hanna Lierse

166

12

Taxation and inequality Julian Limberg

178

13

Taxation and gender Laura Seelkopf

192

14

The politics of green taxation Lena Maria Schaffer

208

PART III INTERNATIONAL TAX POLITICS A: THE BASICS 15

Politics and the diffusion of tax policy Duane Swank

229

16

The politics and history of global tax governance Martin Hearson and Thomas Rixen

244

17

The OECD’s governance of international corporate taxation: initiatives, instruments, and legitimacy Richard Eccleston and Lachlan Johnson

18

The politics of taxation in the European Union Indra Römgens and Aanor Roland

260 276

PART III INTERNATIONAL TAX POLITICS B: CURRENT DEBATES 19

Power and resistance in the global fight against tax evasion Loriana Crasnic and Lukas Hakelberg

293

20

The politics of taxing financial transactions in the EU Saliha Metinsoy

309

21

Revenue challenges in developing countries: can international assistance help? 323 Ida Bastiaens

22

The politics of taxing the digital economy Rasmus Corlin Christensen and Wouter Lips

338

PART IV PREFERENCE FORMATION 23

Why do people pay taxes? Explaining tax compliance by individuals Alice Guerra and Brooke Harrington

355

Contents  vii 24

What do people want? Explaining voter tax preferences Sarah Berens and Margarita Gelepithis

374

25

Business interest groups and tax policy Néstor Castañeda

388

Index405

Tables

4.1

Tax introductions, participation, and constraints

54

4.2

Ideology and tax introduction

58

10.1

Available information in the 2014 OECD Fiscal Decentralization Database on a selection of countries

154

12.1

Inequality and tax policy making worldwide, 1981–2005

186

14.1

Environmental tax category used by Eurostat and example taxes on different bases in each category

210

16.1

Priorities for cooperation in different phases of global tax governance

246

23.1

A selective list of experimental contributions on individual tax compliance

357

23.2

Determinants of individuals’ tax compliance

359

24.1

Tax level preferences

377

25.1

Business coordination and tax policy

394

viii

Contributors

Per F. Andersson, Post-Doctoral Researcher, Department of Political Science, Stockholm University, Sweden, and Department of Political Science, Copenhagen University, Denmark. Ida Bastiaens, Associate Professor, Department of Political Science, Fordham University, New York, United States. Sarah Berens, Assistant Professor of Political Economy, Department of Political Science, University of Innsbruck, Austria. Néstor Castañeda, Associate Professor, Institute of the Americas, University College London, United Kingdom. Rasmus Corlin Christensen, Post-Doctoral Researcher, Department of Organisation, Copenhagen Business School, Denmark. Loriana Crasnic, Post-Doctoral Researcher, Department of Political Science, University of Zurich, Switzerland. Richard Eccleston, Professor, Political Science, University of Tasmania, Australia. Patrick Emmenegger, Professor of Public Policy and Comparative Political Economy, Department of Political Science, University of St Gallen, Switzerland. Amuitz Garmendia Madariaga, Assistant Professor of Political Science, Department of Social Sciences, Universidad Carlos III de Madrid, Spain. Margarita Gelepithis, Lecturer in Public Policy, Department of Politics and International Relations, University of Cambridge, United Kingdom. Alice Guerra, Professor of Economic Policy, Department of Economics, University of Bologna, Rimini Campus, Italy. Lukas Haffert, Post-Doctoral Researcher, Department of Political Science, University of Zurich, Switzerland. Lukas Hakelberg, Post-Doctoral Researcher, Otto-Suhr-Institute of Political Science, Freie Universität Berlin, Germany. Brooke Harrington, Professor of Sociology, Department of Sociology, Dartmouth College, United States. Martin Hearson, Research Fellow, Institute of Development Studies, United Kingdom. Lachlan Johnson, PhD Candidate, Politics and International Relations, University of Tasmania, Australia.

ix

x Contributors Achim Kemmerling, Director, Willy Brandt School of Public Policy, University of Erfurt, Germany. Edgar Kiser, Professor of Sociology, Department of Social Research and Public Policy, New York University Abu Dhabi, United Arab Emirates. Hanna Lierse, Post-Doctoral Researcher, Research Center for Inequality and Social Policy, University of Bremen, Germany. Julian Limberg, Lecturer in Public Policy, Department of Political Economy, King’s College London, United Kingdom. Wouter Lips, Post-Doctoral Researcher, Department of Political Science, Ghent University, Belgium. Saliha Metinsoy, Assistant Professor, Department of International Relations and International Organization, University of Groningen, the Netherlands. Agustin Redonda, Senior Fellow, Council on Economic Policies, Switzerland. Thomas Rixen, Professor of International and Comparative Political Economy, Freie Universität Berlin, Germany. Aanor Roland, PhD Candidate, Department of Political Science, Bielefeld University, Germany. Indra Römgens, PhD Candidate, Department of Political Science, Radboud University, the Netherlands. Lena Maria Schaffer, Assistant Professor of Political Science, Department of Political Science, University of Lucerne, Switzerland. Laura Seelkopf, Assistant Professor of International Political Economy, School of Economics and Political Science, University of St Gallen, Switzerland. Duane Swank, Professor Emeritus, Department of Political Science, Marquette University, United States. Zbigniew Truchlewski, Research Officer, European Institute, London School of Economics, United Kingdom. Christian von Haldenwang, Senior Researcher, German Development Institute/Deutsches Institut für Entwicklungspolitik, Bonn, Germany. André Walter, Post-Doctoral Researcher, Department of Political Science, University of St Gallen, Switzerland.

Acknowledgements

This handbook would not have been possible without the invaluable input of many bright and enthusiastic people. First and foremost, we are deeply indebted to the 32 contributors, who dedicated their time and expertise to this handbook. Without them, compiling and reviewing 25 chapters on all aspects of tax politics would have been impossible. In this regard, Julian Limberg deserves an honourable mention for repeatedly providing thorough and constructive reviews at very short notice. Given that this project began with a section on “Taxation in the twenty-first century” at the ECPR’s 2018 meeting in Hamburg, we also thank Despina Alexiadou, Per Andersson, Vincent Arel-Bundock, Loriana Crasnic, Richard Eccleston, Philipp Genschel, Christian von Haldenwang, Achim Kemmerling, Thomas Rixen, Nan Zhang, and Paula Zuluaga for the impressive jobs they did as panel chairs and discussants. The first milestone for the handbook was an inspiring discussion at the University of Bamberg, which would not have been possible without the invaluable organizational support provided by Claudia Genslein and Lea Maurer, and funding from the impact budget of the Horizon 2020 project “Combatting Fiscal Fraud and Empowering Regulators” generously made available by Duncan Wigan and smoothly administered by Svetlana Wolkov. Last but not least, we are grateful to Anna Damerow, Stefan Hee, Felicia Riethmüller, and Maxim Zubok, whose assistance greatly facilitated our editorial work. Lukas Hakelberg acknowledges funding from the European Union’s Horizon 2020 research and innovation program 2014–18 under grant number 727145 – “Combatting Fiscal Fraud and Empowering Regulators.” Laura Seelkopf acknowledges funding from the Deutsche Forschungsgemeinschaft (German Research Foundation) – Projektnummer 374666841 – SFB 1342.

xi

Abbreviations

AEoI ALP ATAD BEPS CBCR CIT CME CO2 CRS DAC DST DTA ECJ EEC EU FATCA FDI FFI FGFF FTT G20 GDP GHG GST HTC IMF INH IO IRS ISSP LAPOP MAJ

automatic exchange of information arm’s length principle Anti-Tax Avoidance Directive Base Erosion and Profit Shifting country-by-country reporting corporate income tax coordinated market economy carbon dioxide common reporting standard Directive of Administrative Cooperation digital services tax double taxation agreement European Court of Justice European Economic Community European Union Foreign Account Tax Compliance Act foreign direct investment foreign financial institution First Generation of Fiscal Federalism financial transactions tax Group of 20 gross domestic product greenhouse gas general sales tax Harmful Tax Competition International Monetary Fund inheritance tax international organization Internal Revenue Service International Social Survey Programme Latin American Public Opinion Project majoritarian xii

Abbreviations xiii MID MNC MNE MTC MVT NGO OECD OEEC OFC PIT PR PTR QIP R&D SCG SDG SEZ SGFF SME SSC TCJA TID TSC UBS UK UN US VAT VFI

mortgage interest deduction multinational corporation multinational enterprise model tax convention median voter theory non-governmental organization Organisation for Economic Co-operation and Development Organisation for European Economic Co-operation offshore financial center personal income tax proportional representation preferential tax regime Qualified Intermediary Program research and development subcentral government Sustainable Development Goal special economic zone Second Generation of Fiscal Federalism small and medium-sized enterprise social security contributions Tax Cuts and Jobs Act Tax Introduction Database taxes and social contributions Union Bank of Switzerland United Kingdom United Nations United States value-added tax vertical fiscal imbalance

1. Introduction to the Handbook on the Politics of Taxation Lukas Hakelberg and Laura Seelkopf

1. INTRODUCTION There is no rule without revenue. Since rule is ultimately based on coercion, any ruler needs to pay agents, who enforce the rules, and their matériel. Otherwise, disobedience and overthrow are likely to follow (Levi, 1988). Throughout history, rulers have relied on three main ways to obtain the required revenue. They have conquered or raided the owners and producers of resources, earned rents from the export of natural resources or have indebted themselves internally or abroad to finance their operations. All these have clear downsides: relying on conquest forces rulers to constantly expand, which is likely to result in imperial overstretch and defeat (e.g. Barkey, 1994; Neumann & Wigen, 2018); natural resources run out or drop in value depending on world market prices (e.g. Beblawi, 1987; Ross, 2015); and credit is only given so long as the promise of repayment is feasible – ultimately requiring another revenue stream to be credible (e.g. Centeno, 2002; Stasavage, 2011). Hence, most countries have evolved into Steuerstaaten (tax states) over time (Schumpeter, 1918). A notable exception remains North Korea, which abolished its taxes in 1974 (Genschel & Seelkopf, 2016). All other former communist countries have since then (re)introduced taxes to steer their capitalist economies.1 Nowadays, basically all states worldwide have at least some modern taxes in their revenue arsenal (Seelkopf et al., 2019) – albeit with varying histories, revenue sizes and mixes as this book will show. A tax is an “obligation to contribute money or goods to the state in exchange for nothing in particular” (Martin et al., 2009, p. 3). Direct taxes are imposed on income, wealth, or property, whereas indirect taxes are imposed on transactions and consumption. Moving into taxation requires rulers to engage in state building. They need administrations staffed with bureaucrats, who assess income and wealth, monitor transactions, and collect tax payments. To make taxation effective, rulers also need to prevent their subjects from hiding income, wealth, or transactions from bureaucrats. They can do this the authoritarian way and invest in enforcement and deterrence, or they can go the constitutional route and foster quasi-voluntary compliance among taxpayers (Karaman & Pamuk, 2013; Seelkopf, 2018; Levi, 1988). To this end, rulers need to build institutions that legitimate their rule by granting taxpayers the right of representation and some control over government spending. As a result, the state becomes more likely to provide public goods requested by its constituents (e.g. Dincecco et al., 2011; Levi, 1988). Given its intimate relationship with state building and representation, the move to taxation makes revenue collection highly political. Whereas resource rents and foreign loans have often prevented rulers from engaging with their subjects (e.g. Centeno, 2002; Queralt, 2019), or undermined already existing representative institutions (Ross, 2015), taxation has regularly entailed requests for political participation and control from domestic taxpayers. To be sure, 1

2  Handbook on the politics of taxation

Source: Web of Knowledge, 6 December 2019.

Figure 1.1

A bibliometric meta-analysis for “tax” and taxation” sorted by discipline

taxation without representation is far spread, but has also motivated protest and regime change across the world and in different time periods (see Andersson, this volume; Haldenwang, this volume). Building the fiscal capacity necessary to tax the people may thus have fundamental consequences for a country’s political regime. Short of revolution, however, it may also intensify political conflict over redistribution within a given political system. Wealthy elites, for instance, only have to fear a state, whose bureaucrats are actually able to assess and tax their income and assets. Hence, they are more likely to engage in politics where fiscal capacity is high (Kasara & Suryanarayan, 2019). At the international level, differences in fiscal capacity may determine whether a country can finance the military apparatus necessary for imperial expansion, or disappears from the map (Brewer, 1990; Tilly, 1975; also see Emmenegger & Walter, this volume). In sum, “without tax revenue there would be neither … redistribution and public goods … nor the ability of the state to defend its very existence” (Morgan & Prasad, 2009, p. 1351). Despite the close connection between taxation and fundamental subjects of political science, including state development, institutions, conflict, and power, the discipline has produced surprisingly little research on the matter, at least when compared to neighboring disciplines such as economics, or closely related policy fields such as social policy. As Figure 1.1 shows, economics is the main discipline when it comes to research on taxation, publishing more articles than all the following research fields together. Political science is only in seventh place, falling even behind environmental and energy studies, which often sees taxation as an important instrument to fight the climate crisis (see Schaffer, this volume). Interestingly, this changes if one looks at the main spending area, namely the welfare state. Here, political science produces

Introduction  3

Source: Web of Knowledge, 6 December 2019.

Figure 1.2

Number of published articles over time by discipline

the most research, three times as much as on taxation and double the articles from economics.2 The observation that political science seems to care much about the spending side of the state, but not how governments raise the money in the first place, is not only a recent phenomenon. If we compare articles over time, economics has dominated the debate for decades and continues to do so as Figure 1.2 illustrates. The number of publications on taxation in economics journals has tripled over the past 30 years, whereas the equivalent number for political science only increased slightly after 2010 (and has even slightly declined since 1990 if we look at it as a share of overall publications). This handbook seeks to remedy political scientists’ apparent neglect of the topic by introducing students and researchers to the exciting literature the discipline has produced on the politics of taxation and by identifying fruitful avenues for further research. To this end, the handbook is made up of four parts, which each relate to a major research area in political science. Part I is devoted to the link between taxation and state building. It explains how war, democratization, and colonization transformed limited forms of governance based on premodern taxation of heads and trade into modern tax states. Part II focuses on the comparative politics of taxation. It illustrates how interests, institutions, and ideas determine who pays how much, thereby remedying or exacerbating social and economic inequalities. Part III deals with the role of taxation in international relations. It highlights how changing combinations of competition, cooperation, and coercion impact national tax policy, and how domestic and transnational politics shape regional and global tax policy. Part IV reviews research on taxation and preference formation. It explains how political actors, including voters, parties, and business associations, position themselves towards taxation.

4  Handbook on the politics of taxation Drawing on insights from the 25 contributions to this handbook’s four parts, the following section provides an overview of the nuts and bolts of taxation, including its purposes, the types of taxes, their functioning, and justifications. Afterwards we discuss the main causes of tax policy at different political levels and its consequences for economic development, different types of inequality, and the distribution of power. The concluding section identifies blind spots and biases in the political science literature on taxation and suggests avenues for future research. We call for more research into overlooked taxes, societal groups, and world regions. As this handbook shows, political science brings important insights into the study of taxation hereby enriching debates in other disciplines such as economics and providing crucial observations for policy debates.

2.

THE NUTS AND BOLTS OF TAXATION

2.1 Definition In its narrowest sense, a tax is a compulsory charge paid by citizens to the state without direct consideration. That is, the state does not usually earmark tax revenue for specific purposes but uses the revenue to finance its budget. The lack of an immediate return service distinguishes a tax from other charges paid to the state, including fees and contributions. It also prevents the taxpayer from refusing to pay, because she does not agree with the use of her tax money. In contrast, fees are bound to a specific purpose that directly benefits the payor. Examples include tolls paid for road use, parking charges, and administrative fees. Contributions are also bound to specific purposes but benefit groups instead of individuals. Examples include unemployment insurance, health insurance, and public pensions. Although they are conceptually distinct from taxes, researchers often lump social security contributions together with tax revenue when assessing the overall size of the tax state (see Kemmerling & Truchlewski, this volume). 2.2

The Purposes of Taxation

According to the canonical categorization by Musgrave (1959), tax policy pursues three main goals: allocation, redistribution, and stabilization. Taxes allocate resources from the private to the public sector, thereby enabling the provision of public goods like the rule of law, security, education, infrastructure, and healthcare. They may also allocate resources within the private sector by making certain activities more costly than others. Classic examples include environmental taxes, which put a price on pollution to deter people from wasteful or harmful behavior, and excises on alcohol and tobacco, which are supposed to limit unhealthy consumption (see Schaffer, this volume). But policymakers may also build rebates and expenditures into the corporate income tax to encourage investment in certain industry sectors while deterring it in others. Deductions for research and development, involving the creation of intellectual property and well-paid jobs, are a recent example (see Haffert, this volume; Haldenwang et al., this volume). In addition, taxes redistribute resources between different social groups. They may, for instance, limit economic inequality by charging wealth and income at progressive rates, which increase with the size of a taxpayer’s fortune or salary, and financing social spending (see Limberg, this volume). But policymakers may not always use taxes to redistribute from

Introduction  5 the rich to the poor. For the better part of history, landlords taxed peasants in kind or through forced labor to ensure the operation of their estates (see Kiser, this volume). Likewise, colonial powers have often imposed head taxes and forced labor on colonized peoples to finance a military-administrative apparatus, overseeing the exploitation of natural resources (see Seelkopf, Chapter 5, this volume). Because of their potentially dramatic impact on the economic prosperity of different social groups, tax politics are often highly conflictual, which may explain political scientists’ preoccupation with the redistributive function of taxation (see Haffert, this volume; Kemmerling & Truchlewski, this volume). Finally, tax policy can help to stabilize the economy. In times of crisis, policymakers have tried to provide stimulus via the supply side through corporate tax cuts, and via the demand side through reductions in taxes on consumption. They may also enable taxpayers to defer tax payments into the future or make targeted rebates and exemptions more generous. Inversely, tax increases could prevent speculative bubbles and the crises they entail by making short-term financial transactions less attractive. Financial transactions taxes have been in place in at least 16 countries at one time or another, the oldest example being the United Kingdom’s stamp duty, which is still in place today. Given the global integration of financial markets, these taxes were also proposed in the Group of 20 and the European Union (EU) after the financial crisis of 2007–2008. Owing to resistance from the financial sector, however, none of these proposals has so far been implemented (see Metinsoy, this volume). 2.3

Tax Types

Next to differentiating between purposes of taxation, scholars have also identified several types of taxes. The most widespread categorization is between direct and indirect taxes. The former category includes taxes on income, corporate profits, wealth, inheritance, and property. Natural and legal persons declare the corresponding tax bases in their tax returns and pay taxes due directly to the state.3 The latter category comprises taxes on consumption, including the value-added tax (VAT)4 and other general sales taxes, as well as targeted excises on tobacco, alcohol, energy, and emissions. These taxes are ultimately paid by the consumer but transferred to the state by the vendor. Direct taxes are commonly considered to be progressive in modern societies.5 Many income tax systems combine a tax-free amount with a disproportionate increase of the tax rate as income rises. Hence, low-income earners usually pay a smaller share of their income in taxes than high-income earners. At the same time, other direct taxes fall exclusively on the owners of financial assets and immovable property, who are – by definition – wealthier than people without property. In contrast, indirect taxes are commonly considered to be regressive, because low-income earners usually consume a larger share of their income than high-income earners. The categorization of taxes according to their presumed distributive impact is, however, a subject of ongoing theoretical debate and empirical investigation. Many countries in Eastern Europe, for instance, introduced flat taxes during the 1990s, which do not increase with the income of taxpayers. Here, everyone pays the same rate, making the tax proportional rather than progressive (Appel, 2011). Similarly, many Western countries have introduced dual-income tax systems, providing for a reduced rate on capital income. Given that the share of interest, capital gains, and dividends increases with overall income, such rebates make the income tax regressive at the top (Ganghof, 2006). Many scholars argue, moreover, that the true incidence of taxes on capital falls on labor, as shareholders react to higher taxes by requesting

6  Handbook on the politics of taxation higher returns from corporations, which cut jobs and wages in response (see Kemmerling & Truchlewski, this volume). The progressivity of capital taxation thus becomes a political question: can trade unions and/or the state prevent shareholders from shifting the tax burden towards labor or not? Finally, policymakers can also make indirect taxes progressive by introducing higher rates for luxury products or the transfer of property.6 In some developing countries, indirect taxes are de facto progressive as many people live and consume outside the formal economy. Nevertheless, they are less progressive than direct taxes and will become more regressive as informality decreases. Another important categorization is between easy- and hard-to-collect taxes. The literature usually identifies customs and head taxes as easy to collect. The former only requires officials at a few points of entry, whereas the latter is easy to assess. Corporate income taxes are also relatively easy to collect, as tax administrators only need to assess the few big firms to collect the majority of revenues. In contrast, VAT and personal income taxes are commonly considered hard to collect. Their implementation presupposes a largely formal economy and requires a large number of administrators with considerable expertise in monitoring transactions and assessing income. Accordingly, scholars often associate the introduction of hard-to-collect taxes with a substantial increase in fiscal capacity and the emergence of the modern tax state (see Kiser, this volume; Seelkopf, Chapter 5, this volume). Against this background, international organizations have created programs to assist developing countries in shifting the focus of their tax systems from easy- to hard-to-collect taxes. This is a reaction to international tax competition, which puts pressure on corporate taxes (see Swank, this volume; Lierse, this volume), and convenient from a free-trade perspective, since the transition involves the abolition of customs duties (see Bastiaens, this volume). 2.4

Principles of Taxation

Depending on their type and precise implementation, taxes have different consequences for the allocation and distribution of resources in society. Accordingly, policymakers need to justify their choices and they usually do so by drawing on one of four principles: equal treatment, ability to pay, compensation, and efficiency. Which principle policymakers choose often follows from the material consequences of proposed reform for their core constituencies (see Berens & Gelepithis, this volume; Castañeda, this volume). Whether citizens find the normative justification of proposed tax reform convincing or not then impacts their support of the measure and their willingness to comply (see Berens & Gelepithis, this volume; Guerra & Harrington, this volume). What is a fair tax system? Proponents of the equal treatment principle argue that the state has an obligation to treat its citizens as equals. Just like there should be equality before the law and in political participation – as embodied in the norm one person one vote – the tax system should treat all citizens the same. That is, all taxpayers should pay the same rate irrespective of their income level. Taxes on consumption respect this principle as they apply equally to all transactions without regard to the economic prosperity of the respective consumer. Moreover, policymakers usually invoke the equal treatment principle when justifying flat taxes on income. At the same time, the equal treatment principle could also justify a head tax, which imposes the same lump-sum payment on all citizens but does not seem particularly fair to us today. This criticism notwithstanding, the equal treatment principle has been a powerful

Introduction  7 weapon in political debate on tax reform, fielded mostly by opponents of redistribution from the rich to the poor (Scheve & Stasavage, 2016, p. 6). In contrast, advocates of redistribution argue that paying a certain share of income in tax is a larger sacrifice for people who are barely able to cover their basic needs than for people who save or invest most of their income. Accordingly, a flat tax does not imply the same sacrifice for all. Consider two taxpayers, who both pay 25 percent of their income in tax. The first taxpayer earns €1 million, the second €40,000 a year. Whereas paying €250,000 may prevent the first taxpayer from buying a holiday home, paying €10,000 may prevent the second taxpayer from going on holidays at all. Therefore, proponents of redistribution argue that people should be taxed based on their ability to pay.7 This principle is embodied in today’s progressive income tax systems, which impose higher rates on higher incomes. Still, the principle has been criticized from two angles. First, opponents argue that ability to pay ignores how income was earned. Maybe the first taxpayer deserves the holiday home because of the effort she put in to earn €1 million a year. Second, critics question the applicability of ability to pay. Where exactly should policymakers set progressive tax rates when individual sacrifice is hard to measure and varies from person to person (Scheve & Stasavage, 2016, pp. 26–32)? Whereas the equal treatment principle resonates mostly with right-leaning – and the ability to pay principle mostly with left-leaning – voters and policymakers, arguments based on the two remaining principles have in the past reached across this political divide. First, a growing literature on compensatory fairness shows that the state’s failure to treat citizens as equals may give rise to demands for compensation, which have the potential to persuade right-leaning voters and policymakers of the need for redistribution. Scheve and Stasavage (2016) show that wars of mass mobilization – during which governments draft predominantly young and poor people into the army, whereas old and wealthy people benefit from an expanding war economy – produced substantial increases in top-income and inheritance tax rates. Moreover, Limberg (2019, 2020) demonstrates that banking crises have repeatedly enabled compensatory arguments, given that wealthy capital owners benefitted from expanding financial markets, whereas governments socialized the cost of the resulting crises. Like wars, these crises translated into tax increases on the highest incomes, albeit at a more modest level. It remains to be seen whether inequalities exacerbated by the coronavirus pandemic will underpin similar demands for compensation in the future. A second set of arguments with substantial appeal across the main political divide is based on claims of efficiency. A tax is considered efficient when it produces a relatively large amount of revenue with a relatively small impact on economic activity, and at relatively low administrative cost. The VAT, for instance, is often considered efficient because it taxes the value added at every stage of the value chain at relatively modest rates. This leads to large revenues without discouraging any particular economic activity. Right-leaning governments often like the tax because it enables tax cuts on wealth and income, whereas left-leaning governments often like the tax because the revenue it produces enables redistribution on the spending side (see Haffert, this volume; Kemmerling & Truchlewski, this volume). Conversely, progressive taxes on income and wealth are often considered inefficient, as they are believed to discourage domestic saving and investment, encourage cross-border capital flight, and require large administrations. As left-leaning governments bought into corresponding arguments, they often reduced taxes on capital income, wealth, and corporate profits (see Lierse, this volume; Swank, this volume). Yet, the efficiency of progressive taxes crucially depends on the level of international cooperation against tax evasion and avoidance (see Crasnic & Hakelberg,

8  Handbook on the politics of taxation this volume; Hearson & Rixen, this volume). If the owners of capital lack an exit option, they become more likely to invest domestically despite an increasing tax burden. Hence, the optimal tax rate on capital rises with the level of international cooperation – that is, administrative effort (Saez & Zucman, 2019).

3.

THE CAUSES AND CONSEQUENCES OF TAX POLICY

3.1

The Drivers of Taxation

The thrust of the literature on comparative public policy focuses on explanatory factors falling within one of these three broad categories. Research on tax policy is no different. Interests play the main role in the literature on fiscal bargains, for instance, which explains how rulers and ruled agree on the type and level of taxes. Whereas rulers want to maximize revenue to finance their politics, the ruled want to limit tax payments and obtain control over government spending. The ideal typical result is an exchange of increased taxation for political representation (see Kiser, this volume; Andersson, this volume). Focusing on more recent times, the literature on partisan politics argues that political parties choose tax policies that match the interests of their core voter constituencies. Traditionally, center-left parties catered to workers, whereas center-right parties catered to capital owners. Recent research shows, however, that political representatives of all political leanings have become more responsive to the richest members of their respective constituencies (see Berens & Gelepithis, this volume; Limberg, this volume). Similarly, the literature on business power suggests that lobbying from employer organizations moves tax policy outcomes away from voter preferences (see Castañeda, this volume). Before political actors can reveal their interests through policy, vote, or investment decisions, however, they need to form beliefs about what their interests are. Is it, for instance, in the interest of business to minimize tax payments to zero, or would this imperil infrastructure, the rule of law, and human capital formation on which their activities rely? Similarly, is it in the interest of the poor to tap the rich and redistribute their wealth into their own pockets, or would this rather endanger their jobs and long-term prosperity? The answer to these questions depends on the ideas political actors have about the likely redistributive or allocational consequences of tax policy choices. Such ideas can be shaped by personal attitudes and experience (see Berens & Gelepithis, this volume), but they may also be altered by powerful narratives proposed by the media, lobbyists, and experts (see Metinsoy, this volume; Kemmerling & Truchlewski, this volume). There is, for instance, ongoing debate over the question whether the threat of cross-border capital flight, which caused policymakers across the world to cut taxes on capital income and corporate profits, is an actual material constraint or a powerful neoliberal idea (see Lierse, this volume; Swank, this volume). Finally, institutions, including political regimes, tax systems, welfare state structures, or international agreements, define the range of possible tax policy choices. By fostering voluntary compliance, representative institutions may, for instance, enable the introduction of hard-to-collect taxes on income and consumption (see Andersson, this volume; Haldenwang, this volume). Likewise, increasing an established tax is often easier for policymakers than introducing a new tax, given that taxpayers are used to paying the former, whereas they are uncertain about the future impact of the latter; whence the saying “old taxes are good taxes.”

Introduction  9 Next to established forms of revenue collection, established forms of spending also impact tax policy choice. Center-left parties may, for instance, be more inclined to introduce regressive consumption taxes, if they expect the additional revenue will bolster welfare spending. Such expectations may be supported by the likelihood of coalition governments determined by the electoral system (see Haffert, this volume). Conversely, some voters may resist tax increases, if they believe that the welfare state will distribute the benefits to the “undeserving poor” (see Berens & Gelepithis, this volume). Although relevant institutions are often located at the same political level as decision making on taxation, this is by no means always the case. The leeway municipalities or regions enjoy in setting tax policy is usually determined by constitutional arrangements at the federal level, which in turn reflect established principles of subsidiarity, efficiency, and accountability (see Garmendia Madariaga, this volume). At the same time, national tax policy choices are also affected by the level of international coordination. The establishment of an international tax system preventing the double taxation of cross-border investment contributed to the globalization of capital markets, thereby increasing competitive pressure on capital taxation at the national level (see Eccleston & Johnson, this volume; Hearson & Rixen, this volume). Similarly, the EU’s decision to liberalize capital movements within the common market, while leaving the taxation of capital income and corporate profits wholly under the control of member states, intensified tax competition inside the union (see Römgens & Roland, this volume). Conversely, international institutions can also curb the risk of capital flight, thereby giving effective sovereignty over capital taxation back to national parliaments (Ahrens et al., 2020; Hakelberg & Rixen, 2020). The establishment of a multilateral regime for the automatic exchange of information on bank accounts has, for instance, recently curbed the ability of private households to hide foreign income from the tax office (see Crasnic & Hakelberg, this volume). Similarly, the adoption of country-by-country reporting at the EU and global levels now makes it easier for national tax authorities to identify mismatches between a company’s economic activity and its reported profits (see Römgens & Roland, this volume). More fundamentally, international coordination is most likely the only way in which a digital economy that no longer relies on physical presence to deliver its goods and services may be taxed in the future (see Christensen & Lips, this volume). As the spread of VAT in developing countries – fostered by aid and consultancy from the International Monetary Fund – already foreshadowed (see Bastiaens, this volume), national tax systems could thus be increasingly shaped by policy scripts developed by international organizations and technical experts. 3.2

The Effects of Tax Policy

Whichever tax policy results from the interaction of the above factors has important consequences for central objects of investigation in political science. As briefly discussed in the introduction, the wish to expand taxation has often obliged rulers to engage in state building. Bureaucracies had to be created to assess and collect taxes, whereas political rights had to be granted to foster voluntary compliance on the part of taxpayers. But the fiscal bargain underpinning the tax state did more than just increase the legitimacy of new taxes. The regularization of revenue collection also reduced the risk of ad hoc expropriations, thereby contributing to the securing of property rights. Moreover, parliaments’ increased control over government spending provided elites with a lever to influence policy. As a result, the state began to use

10  Handbook on the politics of taxation tax revenue to invest in public goods such as an independent judiciary, public infrastructure, and education, which in turn underpinned the expansion of economic activity (see Kiser, this volume; Andersson, this volume). This is why the capacity to tax is often used as a synonym and best measure of general state capacity (Rogers & Weller, 2014). Given the positive effect the exchange of taxation for representation has often had on economic growth, contemporary international organizations are keen on fostering domestic revenue collection in developing countries (see Bastiaens, this volume). The underlying idea is that governments, which rely on domestic taxation instead of resource rents or foreign loans, become more responsive to the demands of taxpayers. Next to economic and political development, taxation also has a substantial impact on economic and social inequalities. Because of a wave of regressive tax reforms since the 1980s, which have shifted the tax burden from capital to labor and consumption, income and wealth inequality has increased in virtually all industrialized countries. By increasing taxes on top incomes and wealth, governments could counter this trend. But despite popular opposition to rising inequality, a reversal of the general tax policy trend has not yet materialized (see Limberg, this volume). Class inequalities are, however, not the only type of economic inequality that is affected by taxation. Colonial tax systems exploited natives and forced them to pay for their own subjugation (see Seelkopf, Chapter 5, this volume). The South African apartheid regime established a progressive income tax system that enabled redistribution from rich whites to poor whites, but excluded people of color, thereby exacerbating racial inequalities (Lieberman, 2003). Likewise, the shape of the income tax system may also perpetuate gender inequalities by providing incentives for single-earner married couples, while penalizing the lower-earning (mostly female) partner in double-earner couples and unmarried couples (see Seelkopf, Chapter 13, this volume). Finally, taxation may also produce inequalities between firms. By not taxing energy-intensive sectors, governments fail to curb climate change and potentially disadvantage more energy-efficient firms (see Schaffer, this volume). Governments also need to find ways to tax a digital economy that no longer relies on physical presence to interact with customers. Otherwise, they violate the equal treatment principle regarding online and offline businesses, which provide the same service (see Christensen & Lips, this volume). Whereas increased state capacity may enable governments to reduce class inequality by redistributing domestically, it may also underpin power differentials at the international level, which may contribute to the creation and perpetuation of global inequality. The fiscal bargain struck between the British Crown and Parliament after the Glorious Revolution, for instance, did not only extend budgetary control to the commons. It also enabled Britain to finance and win the Nine Years War against France (North & Weingast, 1989). Subsequently, its superior fiscal-military apparatus enabled Britain to first rule the seas and later project power across a globe-spanning empire (Brewer, 1990; Sharman, 2019). The British government’s ability to tax expanding commerce and industrial activity thus underpinned colonial expansion, the legacy of which still curbs the economic performance of many developing countries today (Acemoglu et al., 2001; Nunn, 2008). Similarly, power asymmetries between parties to a bilateral tax treaty bias the resulting distribution of taxing rights to the detriment of developing countries (Hearson, 2018). Because of an initial lack of resources, governments may be forced to renounce substantial amounts of future revenue from the taxation of cross-border economic activity. This may prevent investment in public goods at home, while boosting profits abroad, the likely result being the reproduction of global inequality.

Introduction  11

4.

THE STUDY OF TAXATION IN POLITICAL SCIENCE: BIASES, BLIND SPOTS, AND FUTURE RESEARCH

While political science is still underrepresented in the research on taxation, this handbook shows how much the discipline has to offer in furthering our understanding of what drives tax policy and how in turn taxation affects state capacity and societal inequalities. Many questions facing societies today cannot be answered without a deeper understanding of the politics of taxation – simulating the optimal tax mix is not enough if we do not understand how to get there. We need more interdisciplinary research to understand the political economy of taxation. The insights the handbook offers range from studies of individual preferences to the politics of international organizations. They cover developed and developing countries, autocracies and democracies, taxes of the past and taxes of the future. Yet, there remain blind spots, on which future research should shine a light. We identify three important ones: missing taxes, missing groups, and missing regions. Let’s discuss each in turn. First, the majority of studies focus on three taxes: personal and corporate income taxes and VAT. From a revenue perspective, the personal income tax was considered the queen of taxes in the early and mid-twentieth century, whereas VAT has taken over as the most promising revenue-raising tool today – especially in developing countries. Yet, this ignores other important tax instruments such as trade taxes, which raised a lot of money throughout history and still do so in many developing countries, and social security contributions, which though not strictly taxes, bring more money into governments’ coffers in countries such as the Netherlands, France, or Estonia than any of their taxes. From a redistributive perspective, scholars in recent decades have focused heavily on the effects of global tax competition on the ability of governments to tax mobile capital. The most prominent indicator in this regard has been the corporate income tax rate. Other taxes with strong redistributive effects such as net wealth, inheritance or property taxes, or taxes that curb tax competition such as financial transactions taxes remain understudied. Likewise, the taxation of the digital economy, which has huge distributive effects between individuals, sectors, and countries, requires more attention from a political science point of view (see Christensen & Lips, this volume for first insights). And finally, taxes with a strong regulatory impact are also often ignored in political science research. Especially the political feasibility of green taxes, which have a very prominent place in energy research and global discussions on how to limit the climate crisis, remain underexplored (but see Schaffer, this volume). Second, when it comes to the behavior and preferences of individuals, researchers mostly focus on differences along economic or ideological lines.8 They analyze whether rich or poor people are more likely to cheat on their taxes or whether left-leaning voters support a bigger and more redistributive tax state (see Limberg, this volume; Guerra & Harrington, this volume; Berens & Gelepithis, this volume). Yet other important groups remain largely ignored. We still know very little about the differences between male and female taxpayers or how taxation affects different ethnic groups. Even in experiments, where the analysis of subgroup effects is becoming the norm at least as robustness checks (Neumayer & Plümper, 2017, ch. 11), average treatment effects dominate. This might reflect tight research budgets that do not allow for large enough samples to test for subgroup effects. Yet, part of this oversight might also be explained by the nature of the researchers themselves. The majority of articles are written by white male scholars, whose personal experience may divert their attention away from topics predominantly affecting other groups (see also Seelkopf, Chapter 13, this volume). This bars

12  Handbook on the politics of taxation

Note: MCP = multiple-countries publication; SCP = single-country publication. Source: Web of Knowledge, 6 December 2019.

Figure 1.3

Countries of authors’ affiliation, based on the 500 publications with the most citations within political science on “tax” and “taxation”

the way towards better-tailored tax policy choices and towards a clearer understanding of who benefits and who loses. Lastly, the vast majority of tax research is based on empirical insights from developed democracies. As Figure 1.3 illustrates, it is not difficult to understand why. With the exception of Brazil, the authors of the 500 top tax publications in political science all stem from the Western world.9 The United States and Europe dominate tax research and they mostly focus on what they know and where they live – potentially also due to data availability issues that individual researchers face. As understandable as this might be from a human perspective, it leaves huge knowledge gaps for the study of taxation. How do we know that theories developed and tested in the West explain tax policy choices elsewhere? Western-dominated donor organizations such as the International Monetary Fund or the World Bank often advise the developing world to implement taxes that work well in the West. Yet, as the story of the personal income tax has shown, this might not always be good advice. As we have seen, external enemies have often rallied people around the tax flag and increased tax volumes and progressivity in the West. The underlying fiscal contract might look very different in former colonies, where modern taxes were not introduced to fight a common enemy, but by the enemy to subjugate the native population (see Seelkopf, Chapter 5, this volume). And whereas a stable party system along class lines drives political cleavages in the West (and therefore explains the strong focus on class-based redistributive coalitions), politics looks very different in other world regions, where the majority of people live (see Berens & Gelepithis, this volume). Not only are many

Introduction  13 countries not democratic, but political systems are much less stable and cleavages along ethnic or religious lines often dominate class-based politics. Currently we observe two trends that are promising in allowing researchers to overcome these problems. First, there are new and large data-gathering initiatives that provide data on tax systems outside the developed world for all to use (see e.g. Prichard et al., 2017; Albers et al., 2020; Seelkopf et al., 2019). Second, the causal inference turn makes survey, lab, and field experiments in developing countries suddenly more attractive as they are on average cheaper to implement there. In sum, we hope that future research incorporates many more voices from a variety of scholars around the globe and starts filling in the blind spots our discipline still has when it comes to the politics of taxation. Political science as a discipline has much to offer in understanding differences across regimes and individuals. Its wide range of applied research methods and its openness to other disciplines makes it the ideal candidate to study how politics helps or hinders the implementation of new taxes and how they in turn affect the local, national, or international system in which they emerge. Taxes are the “source of life” for the state (Marx, 2008, p. 128), a “sinew of power” (Brewer, 1990, p. 88). Studying them allows us to discern “the thunder of world history” (Schumpeter, 1918, p. 332), as they provide us with a “blueprint for uncovering the most fundamental arrangements in society” (Henricks & Seamster, 2017, p. 169). Against this background, we invite all readers to join the contributors to this volume on an intellectual journey towards the heart of politics.

NOTES 1.

Taxation under communism remains a very interesting, but understudied subject. Some communist countries such as Yugoslavia still had sectors of the economy that were market-based and hence applied taxes to them. Others such as Russia formally taxed its companies, but de facto these taxes were mere accounting instruments in state-owned enterprises that were entirely decided by the ruling elite and not based on real economic value or consistent rates. Given the dominance of (various forms of) capitalism, the chapters in the handbook all focus on the politics of taxation in market-based economies. 2. Based on a Web of Knowledge search on 23 November 2020, political science (economics) has published 4501 (2859) articles on the “welfare state” or “social policy” and 1572 (13,552) on “taxation.” 3. At least traditionally; the system of tax withholding, where the payer of an income, i.e. a company, rather than the recipient of the income, i.e. the employee, transfers the tax to the government has greatly increased tax compliance and efficiency. 4. Value-added taxes are today‘s most common form of consumption tax. Different to their predecessors, they do not tax every transaction at a (low) rate, but only tax the added value of a transaction. This encourages production of goods across companies and countries and also makes tax evasion harder as everyone in the chain of a transaction has to evade the tax. 5. Historically, direct taxes were often very regressive as they targeted the heads and huts of the poor and often exempted the rich. Indirect internal and external trade taxes were in these cases often the more progressive form of taxation (see e.g. Kiser, this volume; Seelkopf, Chapter 5, this volume). 6. Yet, similar to lower rates on essential items, this is a very crude measure as the rate still applies to the good or service consumed and not to the ability to pay of the consumer. In general, indirect taxes are not a good instrument for redistribution. Here, direct taxes on wealth and income for redistribution at the top and progressive social spending (paid for instance by indirect taxes) at the bottom are better policy tools. 7. A similar principle in economics is vertical equity, meaning that across the income spectrum, people who earn more should pay at least as much if not more than people that have less. Horizontal equity in turn refers to the type of income. Independent of its source, the same amount of income should

14  Handbook on the politics of taxation be taxed at the same level. Tax systems that treat for instance foreign and domestic firms or income from labor and capital differently go against this principle. 8. Interestingly enough, this is even true for political science research that does not care about taxation per se. Many use the position of individuals or political parties on taxation to classify them in a left–right political spectrum. Here again taxation becomes an important indicator, but the topic itself remains neglected. 9. This is probably the result of two selection effects. First, despite the much larger population, there are simply fewer universities and scholars in the Global South. Due to the scarcity of educated personnel they also often have to fulfill important roles in running their country, which leaves much less time for research. Where such research exists, it often is written in languages other than English and follows a different logic than a typical research article in top English-speaking journals. Both of these mechanisms make it much harder for scholars from the Global South to publish in peer-reviewed Northern journals and publishing houses.

REFERENCES Acemoglu, D., Johnson, S., & Robinson, J. A. (2001). The colonial origins of comparative development: An empirical investigation. American Economic Review, 91(5), 1369–1401. Ahrens, L., Bothner, F., Hakelberg, L., & Rixen, T. (2020). New room to maneuver? National tax policy under increasing financial transparency. Socio-Economic Review. https://​doi​.org/​10​.1093/​ser/​ mwaa007 Albers, T., Jerven, M., & Suesse, M. (2020). The Fiscal State in Africa: Evidence for a Century of Growth. African Economic History Network Working Paper Series (55). www​.aehnetwork​.org/​ working​-papers/​the​-fiscal​-state​-in​-africa​-evidence​-from​-a​-century​-of​-growth/​ Appel, H. (2011). Tax Politics in Eastern Europe: Globalization, Regional Integration, and the Democratic Compromise. University of Michigan Press. Barkey, K. (1994). Bandits and Bureaucrats: The Ottoman Route to State Centralization. Cornell University Press. Beblawi, H. (1987). The rentier state in the Arab world. Arab Studies Quarterly, 9(4), 383–398. Brewer, J. (1990). The Sinews of Power: War, Money, and the English State, 1688–1783. Harvard University Press. Centeno, M. A. (2002). Blood and Debt: War and the Nation-State in Latin America. Penn State Press. Dincecco, M., Federico, G., & Vindigni, A. (2011). Warfare, taxation, and political change: Evidence from the Italian Risorgimento. Journal of Economic History, 71(4), 887–914. Ganghof, S. (2006). The Politics of Income Taxation: A Comparative Analysis. ECPR Press. Genschel, P., & Seelkopf, L. (2016). Did they learn to tax? Taxation trends outside the OECD. Review of International Political Economy, 23(2), 316–344. Hakelberg, L., & Rixen, T. (2020). Is neoliberalism still spreading? The impact of international cooperation on capital taxation. Review of International Political Economy. https://​doi​.org/​10​.1080/​09692290​ .2020​.1752769 Hearson, M. (2018). When do developing countries negotiate away their corporate tax base? Journal of International Development, 30(2), 233–255. Henricks, K., & Seamster, L. (2017). Mechanisms of the racial tax state. Critical Sociology, 43(2), 169–179. https://​doi​.org/​10​.1177/​0896920516670463 Karaman, K. K., & Pamuk, Ş. (2013). Different paths to the modern state in Europe: The interaction between warfare, economic structure, and political regime. American Political Science Review, 107(3), 603–626. Kasara, K., & Suryanarayan, P. (2019). Bureaucratic capacity and class voting: Evidence from across the world and the United States. Journal of Politics, 82(3), 1097–1112. Levi, M. (1988). Of Rule and Revenue. University of California Press. Lieberman, E. S. (2003). Race and Regionalism in the Politics of Taxation in Brazil and South Africa. Cambridge University Press.

Introduction  15 Limberg, J. (2019). “Tax the rich”? The financial crisis, fiscal fairness, and progressive income taxation. European Political Science Review, 11(3), 319–336. Limberg, J. (2020). Banking crises and the modern tax state. Socio-Economic Review. https://​doi​.org/​10​ .1093/​ser/​mwz055 Martin, I. W., Mehrotra, A. K., & Prasad, M. (2009). The thunder of history: The origins and development of the new fiscal sociology. In I. W. Martin, A. K. Mehrotra, & M. Prasad (eds), The New Fiscal Sociology: Taxation in Comparative and Historical Perspective, 1–27. Cambridge University Press. Marx, K. (2008). The 18th Brumaire of Louis Bonaparte. Wildside Press LLC. Morgan, K. J., & Prasad, M. (2009). The origins of tax systems: A French-American comparison. American Journal of Sociology, 114(5), 1350–1394. Musgrave, R. A. (1959). Theory of Public Finance: A Study in Public Economy. McGraw-Hill. Neumann, I. B., & Wigen, E. (2018). The Steppe Tradition in International Relations: Russians, Turks and European State Building 4000 BCE–2017 CE. Cambridge University Press. Neumayer, E., & Plümper, T. (2017). Robustness Tests for Quantitative Research: Methodological Tools in the Social Sciences. Cambridge University Press. North, D. C., & Weingast, B. R. (1989). Constitutions and commitment: The evolution of institutions governing public choice in seventeenth-century England. Journal of Economic History, 49(4), 803–832. Nunn, N. (2008). The long-term effects of Africa’s slave trades. Quarterly Journal of Economics, 123(1), 139–176. Prichard, W., Cobham, A., & Goodall, A. (2017). The ICTD Government Revenue Dataset. ICTD Working Paper, no. 19. www​.ictd​.ac/​datasets/​the​-ictd​-government​-revenue​-dataset Queralt, D. (2019). War, international finance, and fiscal capacity in the long run. International Organization, 73(4), 713–753. Rogers, M. Z., & Weller, N. (2014). Income taxation and the validity of state capacity indicators. Journal of Public Policy, 34(2), 183–206. Ross, M. L. (2015). What have we learned about the resource curse? Annual Review of Political Science, 18(1), 239–259. Saez, E., & Zucman, G. (2019). The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay. Norton & Company. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton University Press. Schumpeter, J. A. (1918). Die Krise des Steuerstaats. Leuschner & Lubensky. Seelkopf, L. (2018). Sind Demokratien die besseren Steuerstaaten? Ein globaler Vergleich, 1980–2010 [Are democracies the better tax states? A global comparison 1980 to 2010]. Politische Vierteljahresschrift, 59(1), 63–80. Seelkopf, L., Bubek, M., Eihmanis, E., Ganderson, J., Limberg, J., Mnaili, Y., Zuluaga, P., & Genschel, P. (2019). The rise of modern taxation: A new comprehensive dataset of tax introductions worldwide. Review of International Organizations, 16, 1–25. Sharman, J. C. (2019). Power and profit at sea: The rise of the West in the making of the international system. International Security, 43(4), 163–196. Stasavage, D. (2011). States of Credit: Size, Power, and the Development of European Polities. Princeton University Press. Tilly, C. (1975). The Formation of National States in Western Europe. Princeton University Press.

PART I THE HISTORICAL EVOLUTION OF MODERN TAX SYSTEMS

2. Premodern taxation Edgar Kiser

1. INTRODUCTION This chapter provides an analytical history of premodern taxation from the earliest states and empires through the early modern era (roughly 400 BCE–1800 CE). In addition to this temporal definition, the premodern era can be defined by its main economic and political features. Almost all premodern economies were primarily or exclusively agrarian, which limited what could be taxed, the total amount of tax that could be extracted, and the administrative systems that could be used to collect taxes. Trade and production in towns developed very unevenly across time and space prior to the Industrial Revolution, and their development explains much of the variation in premodern taxation. The political systems in the premodern era were almost exclusively autocratic, controlled by kings, queens, tsars, emperors, and sultans. Early features of democracy such as voting institutions developed in some times and places, and they too led to important variations across premodern tax systems. Variations in economic and political systems also resulted in differences in class power across premodern states, and these too significantly impacted premodern tax systems, as they do in modern states.1 The characteristics of premodern taxes were shaped by these economic and political contexts. Premodern systems of taxation were unable to extract much revenue (rarely more than 5 percent of gross domestic product (GDP)), relied on a narrow range of taxes that only roughly tapped economic production, and were usually collected using very inefficient patrimonial administrative systems. Modern systems of taxation are characterized by high total revenue (up to 50 percent of GDP in some states), a wide variety of taxes (dominated by taxes on income, sales, and capital), and efficient centralized bureaucratic tax administrations. The chapter will be organized around three dimensions of tax systems, focusing on the structural and institutional determinants of total tax revenue (taxation/GDP), tax structure (what and who are taxed), and tax administration (how taxes are assessed and collected).2 The main focus of the chapter will be on tax administration, for the simple reason that it varied much more in the premodern era than total tax revenue or tax structure. In terms of total taxation and tax structure, the main features distinguishing premodern states from modern states are their high degree of homogeneity and stasis. As noted above, almost all of them were unable to extract much revenue and relied on a narrow range of taxes, and this changed little throughout the premodern era. Although we will not only note but focus on exceptions to this generalization, the fact that total taxation and tax structure did not vary much in the premodern era allows us to summarize them fairly quickly. In contrast to this, there were significant variations both across cases and over time in premodern tax administrations – ranging from public to private, centralized to decentralized, and formal to informal. Premodern tax administration is not easily summarized, so we will devote more of this chapter to accounting for its many variations. It is interesting to note that modern states are the opposite – they vary dramatically in the amount of tax revenue they are able to extract and in the types of taxes they impose, but the basic structure (although not the effectiveness) of their tax administrations vary much less. 17

18  Handbook on the politics of taxation Our main focus will be on general patterns in premodern tax systems, but we will also discuss exceptional cases, especially those that were “leading edges” (Mann, 1986, p. 5) of significant transformations in total tax revenue, tax structure, and tax administration. These leading edges will often be areas in which trade and towns and democratic institutions developed (often due to revolutions), and transformed the nature of tax systems. We conclude with a short discussion of the transition to modern taxation, by exploring the conditions under which states could dramatically increase their tax revenues, transform their tax structures to better tap economic production (such as the origins of the income tax), and develop effective centralized and bureaucratic tax administrations (see Emmenegger & Walter, this volume; Andersson, this volume; Seelkopf, Chapter 5, this volume). Our interest in leading edges leads to an empirical focus on Europe, and to a lesser extent China, because most innovations in systems of taxation originated there. The history of premodern systems of taxation is important for two main reasons. First, if we want to develop and test general theories of taxation, we need to avoid the presentist and western biases in contemporary social science and look at a much broader range of historical cases. Second, due to the partially path-dependent nature of the evolution of tax institutions, we can’t fully understand them without knowing their history (Acemoglu & Robinson, 2012; Fukuyama, 2011; Kiser & Karceski, 2017; Pierson, 2000; Steinmo, 2010). Our chapter builds on an emerging consensus in political economy on three issues. First, most important political outcomes are the joint product of structural conditions and institutions. Until fairly recently, there was an unfortunate division of labor in the study of politics, with sociologists concentrating on social structure and social groups/movements and political scientists focusing more on political institutions. Building on Levi (1988), North (1990), and Greif (2006), recent work in political economy has transcended this divide (Acemoglu & Robinson, 2012; Fukuyama, 2011; Steinmo, 2010). We follow their lead – each of our sections begins with structural causes, then moves to political institutions and interactions between the two. Second, there is an emerging cross-disciplinary consensus on a contractual view of tax systems (Bang, 2015; Kiser & Barzel, 1991; Levi, 1988; Martin et al., 2009; North & Weingast, 1989). In all (not just democratic) states, fiscal systems are based on implicit or explicit contracts between rulers and ruled governing taxation and spending, and the relationship between the two. How this fiscal contract is made, modified, and enforced in the premodern eras will be a recurring theme of our analysis. Third, beginning with Mann’s (1984) stress on infrastructural power and continuing with the focus on state capacity in many recent works (Acemoglu & Robinson, 2012; Besley & Persson, 2011; Hoffman, 2015; Lieberman, 2003), scholars have been increasingly concerned with the implementation of state policy. We build on this work by focusing on the development of effective administration, and exploring its effects on other aspects of taxation.

2.

TAX REVENUE IN PREMODERN STATES

Premodern rulers were never able to extract large shares of economic production. Prior to the Industrial Revolution, very few states were able to get much revenue from their populations. Premodern states and empires were “low taxation societies” (Bang, 2015, p. 552; see also Monson, 2015; O’Brien, 2012; Scheidel, 2015) that rarely extracted more than 5 percent of GDP (Bean, 1973, p. 212; Mann, 1993, p. 369).

Premodern taxation  19 There are several reasons these states couldn’t get much tax revenue. First, there wasn’t much to tax. Economic growth is the main long-term motor of increasing tax revenue/GDP. Because there was little or no growth in per capita income prior to the Industrial Revolution (Clark, 2007; North et al., 2009, p. 3), we should not expect much growth in tax revenue. Of course, there were significant variations in levels of economic development in premodern states, and where capitalism developed earlier, tax revenue was higher (Tilly, 1990). Second, class power limited state revenue. Premodern autocrats needed the support of aristocratic landowners (and often the leaders of religious organizations) to maintain their power, and they purchased that support almost everywhere by giving them an exemption from (at least direct) taxation. In addition to this, aristocrats limited rulers’ taxation of peasants. Since landowners and rulers were competing to extract resources from peasants, aristocrats often sided with peasants in their attempts to prevent rulers from increasing their taxes (Brenner, 1976; Monson & Scheidel, 2015). Third, the demand for state spending was limited. War was the main source of the demand for tax revenue in all premodern states (Ertman, 1997; Kiser & Linton, 2002; Tilly, 1990; Emmenegger & Walter, this volume), and the tax revenue of states did begin to increase in early modern Europe due to a dramatic increase in the frequency and scale of warfare (O’Brien, 2012).3 The part of this argument that is rarely noted is that war was practically the only source of demand for taxation prior to the nineteenth century (only a few premodern states provided infrastructure like irrigation systems or welfare such as grain redistribution). Fourth, the capacity of the state to collect taxes was very limited. Rulers of states could neither afford nor control a sufficient number of officials to adequately assess and collect taxes (see Section 4). As a result, prior to the development of the income tax, tax revenue was only loosely connected to economic production or wealth. Rulers either sold the rights to collect taxes to private tax farmers or accepted fixed lump sum payments from localities. Over time these stable, low tax levels came to be viewed as “customary” or based on tradition (Weber, 1978), making them even more resistant to change. There is an ongoing debate about whether increases in democracy in the premodern era (the development of voting institutions) decreased or increased the ability of states to extract revenue. The basic argument made in the power/conflict tradition is that voting institutions only arise when autocratic rulers are too weak to maintain their monopoly on decision-making power, and thus decrease the ability of rulers to extract revenue. They begin by assuming corporate actors (states and classes) with different interests (given by their structural positions) involved in zero-sum games (Bendix, 1978, p. 189; Hintze, 1975, pp. 309, 313; Poggi, 1978, pp. 36–37, 47; Tilly, 1990, p. 64; Weber, 1978, pp. 1013, 1087). For example, Weber (1978, pp. 1057, 1352) argues that medieval rulers bargained with subjects in voting institutions only when they lacked the power to coerce tax payments from them beyond their customary feudal obligations. Weber’s focus on the power of rulers relative to subjects has influenced many contemporary scholars. Blockmans (1978, pp. 202–203) and Poggi (1978, pp. 36–42) argue that representative voting is likely to emerge when towns become powerful relative to rulers.4 Tilly (1990) claims that representative voting emerges as a result of military pressures created by competing states in Europe, supporting the argument that the main differences in the form and persistence of voting institutions are caused by variations in the strength of towns. A second type of argument, coming from rational choice theory, suggests that rulers and subjects are rational actors maximizing a combination of wealth and security, and argues that voting institutions emerged as an unintended outcome of wealth seeking by rulers and subjects

20  Handbook on the politics of taxation (Kiser & Barzel, 1991). Voting institutions were mechanisms that allowed rulers and subjects to cooperate with each other on mutually profitable projects by enabling rulers to make credible commitments to subjects. The stress on the need for credible commitments in the relationship between rulers and subjects has created a view of the state that models conditions in which rulers will willingly cede power to some of their subjects (Barzel & Kiser, 1997; Bates & Lien, 1985; Kiser & Barzel, 1991; North & Weingast, 1989; Root, 1989). Barzel and Kiser (1997) note that an autocratic ruler who maximizes wealth and security of rule can gain wealth by using voting institutions to cooperate with subjects on joint ventures like war and defense.5 Voting institutions are created to help resolve three sets of problems that arise in joint ventures between rulers and subjects: decision making by multiple individuals, rulers’ confiscation of subjects’ gains, and subjects’ confiscation from each other.6 One function of voting institutions is to facilitate the collective action needed for the choice and management of large projects like war. By expressing the view of the majorities, voting institutions provide information to rulers on the projects that generate benefits to voters in excess of their contributions (taxes). The second potential problem in these joint ventures is rulers confiscating from subjects. By providing an organizational basis for collective action, voting institutions decrease the threat of confiscation by the ruler, and thus contribute to the ruler’s ability to make credible commitments. Since the ruler is more powerful than any individual subject but not more powerful than all of them, his commitments can be made credible if he can facilitate subjects’ collective action. Third, subjects with voting rights must guard against confiscation by each other. This problem will be avoided by linking the amount paid in taxes to the amount of benefit received as a result of the policy.7 Democracy also facilitates the development of state legitimacy and quasi-voluntary compliance, decreasing the costs of tax collection and the amount of tax evasion (Levi, 1988). Finally, democracy raises the expectations of citizens as to what states should provide, increasing the demand for public goods. The classical Athenian city-state was an early leading edge in taxation and a notable exception to the inability of premodern states to raise revenue, in part because of its early democratization. The Athenian city-state was a central node in Mediterranean trade, and merchants’ interests were paramount in the political and tax system. The result was unprecedented economic growth and revenue collection compared to other ancient states. Athens was among the most urbanized regions in the world, had an unusually large middle class, and per capita GDP and tax revenue were higher not only than other ancient states but most premodern states (Ober, 2015, p. 493). Their fiscal institutions were one of the main determinants of their economic success (Ober, 2015, p. 494). Medieval England and France also increased revenue when their voting institutions developed (Barzel & Kiser, 1997). The historical record shows that medieval voting institutions initially developed in both England and France under relatively strong rulers (Strayer, 1955, p. 18; Major, 1960, p. 16). Moreover, English rulers were far more powerful than their French counterparts prior to the development of voting institutions (McIlwain, 1932, p. 709), but voting developed first and was strongest in England. In addition, the rise of towns was not independent of the rulers but rather took place with their consent and under their charters (from which they profited handsomely). The English Revolution (1640–1688) made England the leading edge in revenue generation in the early modern era, by further increasing democratization. North and Weingast (1989) show how the Glorious Revolution of 1688 increased tax revenue further by increasing the ability of monarchs to bargain with and to make credible commitments to taxpayers.

Premodern taxation  21

3.

TAX STRUCTURE IN PREMODERN STATES

Premodern states taxed a large and diverse array of things, but the basic tax structure was usually pretty simple: they taxed people (using forced labor or poll taxes), land or its produce (in kind or in money), and the movement of goods (customs on external borders and many types of sales and excise taxes internally) (Bang, 2015; Kiser & Levi, 2015, p. 559; Monson, 2015; Tarschys, 1988). These states also got a lot of revenue from non-tax sources such as state lands, fees, and monopolies – they were “domain states” as well as “tax states” (Schumpeter, 1991 [1918]), but we focus only on tax revenue. One of the most important features of premodern tax structure was its loose relation to the economy, so tax revenue was not highly correlated with economic fluctuations. Administrative limitations prevented states from measuring actual economic production, so direct taxation had to rely on a series of rough proxies for wealth, such as the number of chimneys or windows in a house. Moreover, the dispersed nature of land made collection costs very high. Variations in the structure of the economy also determined variations in tax structure. The main variations in premodern tax structures were a function of the level of development of urban centers, trade, and capitalism (Bang, 2015; Tilly, 1990). States lacking these things relied on direct taxation of people and/or land, whereas states in more economically developed areas had a more varied tax structure and a greater reliance on indirect taxes such as customs sales and excise taxes. Goods moving through bottlenecks such as ports or town gates were much easier to tax, so countries with more trade could usually raise more revenue (Tarschys, 1988; Tilly, 1990). Differences in tax structure were also products of very specific differences in economic structure. For example, from the thirteenth through the seventeenth centuries, one of the main sources of revenue in Spain was taxes on the Mesta, a powerful sheep ranchers’ guild that controlled large transhumant flocks. In exchange for these taxes, Spanish monarchs granted them right of way to move their flocks all over the country (Klein, 1920). Another case was the “tavern taxes” on vodka in Russia. They were started by Ivan the Terrible in the 1540s, and by the 1850s taxes on vodka made up almost half of state revenue (Brown, 2011). A second defining feature of premodern tax structure is that it was highly regressive. This was mainly a product of tax exemptions given to aristocratic landowners and religious organizations. Aristocratic exemptions were initially justified by the military service they provided in feudal systems, but they persisted long after the decline of feudalism due to the power of aristocrats relative to monarchs (Anderson, 1974). The exemption of religious organizations is probably best seen as payment for the legitimacy they gave to monarchs, such as the notion of the “Divine Right of Kings” in Europe. Direct taxes were paid mainly by conquered subjects, religious minorities, and peasants. Indirect taxes, generally more regressive than direct taxes, were actually the least regressive part of premodern tax systems. Tax regressivity was highest in the most agrarian states (usually only peasants were paying) and was somewhat less regressive in states with some capitalist development (since merchants and guilds paid as well). When democratic institutions developed in premodern states, the regressivity of tax structure usually declined. The most extreme example of the decline of regressivity was the Greek city-states in the classical era (510–323 BC). Due to a rare combination of early democracy, a high level of trade, and stability, taxation was less regressive in Greece than elsewhere in the premodern world (Mackil, 2015) – there was even regular direct taxation of wealthy citizens (Ober, 2015, p. 494). The use of liturgical taxation, voluntary payments by the rich to fund public goods (such as providing a ship for the navy), began in classical Greek city-states

22  Handbook on the politics of taxation (Lyttkens, 1992). Although voting rights were extremely restricted by modern standards (slaves and women were excluded), Athens was far more democratic than other states at the time. This was also true in Greek city-states and the Roman Republic (which copied many Greek political institutions). Republican Rome even taxed the rich in order to redistribute to the poor (Ober, 2015, p. 494), but aristocratic power over state policy was much greater than in Athens (Tan, 2015, p. 208). Ober (2015, p. 493) describes Athens as a “strikingly egalitarian” citizen republic based on “participatory democracy.” Taxes were passed by a majority vote of the citizen assembly, and citizens were even paid to attend (Ober, 2015, pp. 496–499). Revenues were earmarked for particular spending projects, making it easier for citizens to monitor the link between taxation and spending (Ober, 2015, pp. 496–497).

4.

TAX ADMINISTRATION IN PREMODERN STATES

Centralized bureaucratic tax administrations were extremely rare in premodern states, due to the structural conditions they faced. The size, geography, and climate of a country affect the efficiency of tax administration by determining the cost and difficulty of monitoring agents. The effects of these aspects of the natural environment on the efficiency of tax collection are contingent on the level of development of technologies of communications, transportation, and information processing (Weber, 1978, p. 224). When these technologies of control are not developed (as in the premodern era), monitoring capacity will be poor and centralized bureaucracies relying on weak sanctions (fixed salaries, promotion, and dismissal) will be inefficient. Premodern rulers compensated for poor monitoring in three ways: by using stronger sanctions (Becker & Stigler, 1974), relying on agents they personally trust, or using extreme forms of decentralization. All of these solutions are aspects of what Weber (1978, pp. 228–234; pp. 1028–1064) called patrimonialism, a broad concept referring to several different types of administrative forms, including tax farming (privatized collection) and slave agents (both provide stronger sanctions), recruiting kin and agents with patronage ties (personal trust), and using feudalism, prebendalism (paying officials in land for military service, as in the Ottoman timar system), or local notables like English Justices of the Peace (extreme decentralization).8 Administrative systems relying on personal ties are generally corrupt, but this may not be true of the other forms of patrimonialism, such as decentralization and privatization. There are many types of patrimonialism, and in different contexts, some may be effective and others ineffective. 4.1

Determinants of Centralization

Centralization refers to the type of relationship that exists between rulers and provincial and local agents, and can be understood in terms of the distribution of residual claimancy. The residual claimant in any joint venture is the one who has the right (claim) to the variable part of the proceeds of the activity (the residual) – the actor who gets the profits or takes the loss. In terms of tax administration, centralized bureaucratic systems can be defined as those in which the ruler is the full residual claimant, because all agents are paid fixed salaries. Decentralized systems are those in which provincial and local agents are residual claimants. This definition allows us to specify the degree of centralization of any administrative system: the greater the

Premodern taxation  23 number of agents who are residual claimants, and the lower they are in the administrative hierarchy, the more decentralized the system. Other more specific features of centralization follow from the distribution of residual claimancy. When rulers are residual claimants, they have strong incentives to ensure that agents collect all of the tax they are supposed to collect, since the revenue of the state (their income) varies according to the performance of these agents. This means they will want to control the selection of agents. When rulers are not residual claimants, they will often allow agents to be selected locally, or will select agents on criteria irrelevant to their performance as administrators (status, military ability, or ability to pay for the position). Rulers who are residual claimants also have strong incentives to monitor the performance of these agents closely. This requires the collection of detailed information on the performance of agents, and thus usually entails a fairly large central administration in charge of monitoring and accounting, and paying agents. Therefore, holding constant technologies of accounting and record keeping, the smaller the central administrative staff relative to the size of the country, population, and number of officials, the more decentralized the system. In the most decentralized types of administration, such as feudalism and prebendalism, rulers allow agents to pay themselves from plots of land and dependent peasants. The main virtue of this system is that there is no need for resources to flow from the provinces to the capital or provincial capital (as revenue) and back (as salaries). Thus, the lower the flows of resources between the central administration and the provinces, the more decentralized the system. To sum up, tax administration is more centralized to the extent that: (1) rulers are residual claimants; (2) rulers retain control of selection of agents; (3) rulers closely monitor agents with a central administration large enough for the task; and (4) resources flow from localities to the capital and back. 4.2

Determinants of Privatized Tax Administration

In premodern states, different types of taxes were collected using different types of patrimonial agency relations – tax structure dictated tax administration. Tax farming (a way to strengthen sanctions by making agents full residual claimants) was generally used for indirect taxes (customs, sales, excise) and decentralization was used for most direct taxes (usually on land), for three reasons (this paragraph draws on Kiser, 1994). First, the revenue from indirect taxes is more mobile and less predictable (since there is more variation over time), both of which make the detection of corruption and evasion more difficult. Second, measurement problems that lead to bribery in exchange for underassessment are more severe for indirect than for direct taxation because of the difficulty of checking/repeating measurement (unlike land, the goods move on). As a result of both of these factors, bureaucratic agents on fixed salaries collecting indirect taxes are expected to be very corrupt when the monitoring capacity of principals is poor. These problems can only be mitigated by privatizing tax collection, thus making agents residual claimants with strong incentives to collect as much tax as possible. This problem with tax farming, strong incentives making agents overzealous in tax collection, is the reason it is rarely used for direct tax collection. Many assets tapped by direct taxation have a high capital component (e.g., land), so a system like tax farming that often leads to overtaxation will have more negative (longer-term) effects. Therefore, rulers generally used decentralized forms of agency like feudalism, prebendalism, and local notables to collect land taxes, instead of using tax farming.

24  Handbook on the politics of taxation 4.3

Determinants of Bureaucratization

Bureaucratic administration is characterized by hiring tax officials on the basis of merit (Weber, 1978). This can only be done if powerful social classes (in the premodern era, usually aristocrats) do not have a monopoly on administrative positions. The weakening of the power of aristocrats is a necessary condition for bureaucratization, because aristocrats were embedded in lucrative positions in patrimonial administrations, and didn’t want to give them up. Although bureaucratic administration of tax collection was rare in the premodern era, because aristocrats usually had the power to prevent it, it was not entirely absent. Qin China (221–206 BCE) was the leading edge of administrative bureaucratization (Fukuyama, 2011, pp. 110–124; Kiser & Cai, 2003), but it didn’t diffuse to Europe until the eighteenth century.9 Why did a partially bureaucratized administrative system develop in Qin China about two millennia before it did in European states? The Warring States era (481–221 BCE) that preceded the Qin unification of China created the necessary conditions for bureaucratization by creating a bureaucratic model (based on Legalist philosophy), facilitating the development of roads, and providing trained and disciplined personnel. The Chinese case illustrates that bureaucratization is not just a function of efficiency considerations, but of power, as well. Bureaucratization often occurs only after revolutions or devastating wars sweep away aristocratic power (Kiser & Kane, 2001; Kiser & Schneider, 1994; Skocpol, 1979). The main factor differentiating Qin China from other states and empires was the extreme weakness of the aristocracy produced by an unusually long period of severe warfare. Extensive aristocratic warfare killed much of the dominant class, allowing rulers to hire agents on the basis of merit rather than aristocratic status. Although Qin China was more bureaucratic than any other state or empire prior to the seventeenth century, it was far from completely bureaucratic. Bureaucratization was limited to top officials in central administration located in the capital. The reason for this is that top officials are much easier to monitor – they are less numerous and less distant than lower-level officials. The lower levels of Chinese administration were patrimonial, relying on local notables and ad hoc clerks and “runners” to collect taxes (Huang, 1974). The government of ancient Athens was much less bureaucratic than Qin and Han China, but it had even higher administrative impartiality, one of the most important benefits of bureaucracy (Weber, 1978). The impartiality of Athenian tax administration was derived from its participatory democratic ideology and institutions. It was run by citizen amateurs, chosen by lottery or elected, working in collegial boards on short (usually one year) terms (Ober, 2015, pp. 496–497). Even the council in charge of monitoring tax collectors and other officials was composed of citizens chosen by lottery. The corruption of officials was unusually low, and as a result the Athenian state was able to extract 10–15 percent of GDP in taxes, more than almost all states prior to the nineteenth century (Ober, 2015, pp. 496, 504). The next important leading edge in high-quality tax administration comes with the Italian city-states (Venice, Florence, Genoa, and Milan were the most prominent) that broke away from the Holy Roman Empire in the eleventh and twelfth centuries and flourished until the fourteenth–fifteenth centuries. European states in this period were ruled by patrimonial monarchs and collected their taxes using various forms of patrimonial administration dominated by aristocratic elites. The Italian city-states, with the Florentine Republic leading the way, had much higher administrative impartiality (and effectiveness) for two main reasons. First, many of them replaced hereditary autocratic rulers with Podesta – foreign rulers without local ties serving very short terms (often one year). This significantly reduced corruption at the top

Premodern taxation  25 of the system (Mungiu-Pippidi, 2013, pp. 1266–1267). The second thing they did was pass laws limiting the ability of aristocratic elites to control politics and administration (the 1293 Ordinances of Justice in Florence is a prominent example).10 As a result, their tax administrations were more effective than those of competing states, and tax collectors were better controlled (Jones, 1997; Mungiu-Pippidi, 2013, pp. 1265–1267). In the early modern era, Britain stands out as the leading edge in administrative effectiveness. After the revolution of 1640–1688, Britain developed aspects of bureaucratic tax administration (especially in excise taxation), prior to other European states (Brewer, 1990; Ertman, 1997), due mainly to its relatively small size and more rapid development of effective communications and transportation systems (Geiger, 1994, p. 19; Szostak, 1991, pp. 55–57), but also due to its early revolution. The revolution was mainly important because it dramatically decreased dominant class control of tax administration, as warfare did in Qin China, and facilitated partial bureaucratization (Kiser & Kane, 2001).

5.

THE END OF PREMODERN TAXATION AND THE TRANSITION TO MODERN TAXATION

Modern systems of taxation are characterized by high total tax revenue, a tax structure that better captures the total wealth created by the economy, and effective centralized bureaucratic tax administration. Other chapters in this volume analyze these and other aspects of modern tax systems, so we will only briefly discuss their origins in this section. 5.1

Origins of Higher Total Tax Revenue

The dramatic increase in total tax revenue extracted by modern states compared to their premodern counterparts was the result of two main causes. The first was the democratizing revolutions in England (1688) and France (1789).11 The early democratic revolution in Britain (1640–1688) paved the way for merchants and producers in towns to gain more control over state policy (Moore, 1966). The power of parliament facilitated the formation of credible commitments in the political and fiscal systems, increasing the rule of law and the predictability of state policy (North & Weingast, 1989; Weber, 1978). These political and fiscal developments laid the foundation for the Industrial Revolution and Britain’s rise to global hegemon. The French Revolution also facilitated bureaucratization in France (Kiser & Kane, 2001), and the Napoleonic conquests swept away aristocratic power and furthered bureaucratization in Prussia (cf. Gorski, 1995; Kiser & Schneider, 1994). Most premodern states relied on inefficient forms of patrimonial administration, so administrative advances are the second cause of increased state revenue. Although the Protestant Reformation brought some administrative improvements in Europe (Becker et al., 2016, pp. 33–38; Ertman, 1997; Gorski, 2003), the main transformation came later in England. The bureaucratization of the British excise administration in the late seventeenth century dramatically increased revenue (Brewer, 1990; Ertman, 1997), the Prussian state increased its efficiency beginning about the same time (although the causes are debated, cf. Gorski, 1995, 2003; Kiser & Schneider, 1994), and the French Revolution ushered in many successful administrative reforms (Kiser & Kane, 2001). By 1850, in part due to the much delayed

26  Handbook on the politics of taxation diffusion of Chinese administrative techniques, centralized bureaucratic administration was in place in most developed states. As a result of these two factors, tax revenue/GDP increased from about 5 percent in most states up to 1700, to about 9 percent by 1900 and 20 percent by 1950 in Organisation for Economic Co-operation and Development countries (Scheve & Stasavage, 2016, p. 10). Tax revenue was now on a historically novel upward trajectory. 5.2

Origins of Modern Tax Structure: The Income Tax

The most important turning point in the history of premodern tax structure, responsible for both linking taxes more tightly to the economy and for dramatically increasing progressivity, is the development of the income tax. Britain is again the leading edge of this transition, experimenting with the income tax in 1798–1802 (to pay for the Napoleonic wars) and instituting it permanently in 1842. The income tax diffused throughout Europe fairly quickly, and by 1920 it was being used in almost all developed European economies (Scheve & Stasavage, 2016). The main virtue of the income tax was that it linked taxation to economic production more tightly than any prior tax, so states could better insure that economic growth produced more tax revenue. Although the income tax did not significantly increase tax revenues in this initial phase, because it was usually limited to the very rich, the development of the income tax is the most significant turning point in the emergence of progressive taxation (estate and capital taxes were also important). There are two main determinants of the origins of the income tax: democracy and war. Democracy is a necessary condition for the development of progressive income taxation.12 As the franchise expands, the average income of voters declines, so the median voter will favor progressive taxation of income. For example, Mehrotra (2004) documents the important role of organized labor in pushing for the United States income tax. Scheve and Stasavage (2010, 2016) show that democracy alone is insufficient to explain the rise of progressive income taxes; mass warfare was another necessary condition. 5.3

Origins of Modern Tax Administration

Tax administration was also transformed in modern states. Most European administrations bureaucratized in the nineteenth century. The first reason for this is that improvements in transportation enhanced monitoring capacity. Land transportation speeds began to significantly increase only with the development of railroads – prior to that time early modern states could move information and officials no faster than they could in the Roman Empire, because all premodern states had to rely on horse relay systems (Braudel, 1995, p. 369; Wachter, 1987, p. 96). The second main cause of bureaucratization was the early modern revolutions. Like the extensive warfare in Qin China, early modern revolutions swept away entrenched elites with interests in blocking reforms. Premodern systems of taxation were dramatically transformed by these changes in the eighteenth and nineteenth centuries. However, the ability of modern states to extract tax revenue, their tax structures, and their tax administrations still bear the imprints of their premodern legacies. The most exciting avenue for future research is to explore the many ways in which premodern taxation has shaped modern fiscal systems.

Premodern taxation  27

NOTES 1.

2. 3.

4.

5. 6.

7.

8. 9. 10.

If we relied solely on these economic and political characteristics and not our temporal demarcation, many contemporary less developed states could also be classified as at least partially premodern. Doing so would expand the scope of this chapter beyond the bounds of a short chapter, and other chapters in this volume already address those contemporary cases (see e.g., Bastiaens, this volume; Seelkopf, Chapter 5, this volume). These three dimensions are highly interrelated – for example, tax structure and the effectiveness of tax administration affect total tax revenue, and the effectiveness of tax administration affects tax structure. Wars always increased spending, but they did not always increase taxation. Often, wars resulted only in temporary increases in taxation, and they were often funded by non-tax revenues (e.g., the confiscations of church lands in sixteenth-century England and Sweden). However, wars did sometimes push taxes up permanently via a “ratchet effect” (Peacock & Wiseman, 1961). The argument that war is the main motor increasing tax revenue in less developed states does not work well outside Europe (see Centeno, 2002 on Latin America and Herbst, 2000 on Africa). Poggi (1978) develops this argument in an interesting way, departing from the standard conflict theory assumption that classes would not cooperate with the rulers of states. He notes that the main conflicts prior to the rise of towns were between nobles and monarchs, and that when towns became powerful they turned a dyadic game into a triad, and became what Simmel (1955) called the “enjoying third” in that triad. Since both monarchs and nobles could gain by having the towns side with them, the question was which would the towns choose? The outcome turned on the primary interest of towns, the protection of trade over long distances. Because monarchs controlled much larger territories than any noble did, they could provide this collective good, and nobles (because they couldn’t solve the collective action problems necessary to do so) could not. The towns thus sided with monarchs and were given positions in voting institutions. Note that this argument, suggesting that state institutions emerge to take advantage of profitable war projects, is similar to some theories of initial state formation in tribal societies (Spencer, 1876; Lenski, 1966; Carneiro, 1970). Bates and Lien (1985) provide a related causal mechanism for the general argument linking economic development and voting in medieval England and France. They argue that taxes on movables facilitated the development of voting institutions, since rulers had to give voting rights to subjects with mobile resources to keep them from concealing their resources or exiting with them. In spite of their utility, many medieval voting institutions (including the French Estates General) eventually declined. The decline of voting institutions is an interesting example of the unmaking of this key part of the state. Weber (1978, pp. 1086–1087) makes the classic conflict theory argument about the decline of voting institutions: when rulers developed bureaucracies they had the power necessary to extract taxes from subjects without negotiation, so they did away with voting institutions. Barzel and Kiser (1997) argue that they declined primarily due to increases in factors that impede cooperation, most importantly heterogeneous voter interests and ruler insecurity. Poggi (1978) argues that as technological and organizational developments began to favor the offense in military conflicts, the value of rapid and effective defense (and hence, quick decision making) increased sharply. In this context, the costs of allowing voting institutions to make decisions about war and taxes for war were simply too high. All forms of decentralization are not patrimonial, of course. Decentralized administration can be run as a small-scale bureaucracy, or can include patrimonial elements like rule by local notables, elected officials, or privatized collection. Other premodern states also had some bureaucratic elements. Pharaonic Egypt was certainly partially bureaucratic, but there are too few documents related directly to their tax administration to say much with certainty (Jursa & Moreno Garcia, 2015, p. 139). This is not surprising, since for most of the period, most of them were dominated not by aristocrats, but by the “popolo grasso” (lawyers, merchants, guilds). Capitalism indeed flourished in this period, as these small city-states had the highest per capita incomes in the world (Stark, 2005). Several scholars have noted that the tax policies of these city-states were important determinants of their economic growth (Greif, 1998; Mungiu-Pippidi, 2013, p. 1269).

28  Handbook on the politics of taxation 11. Karaman and Pamuk (2013) show that the effects of regime type interact with both warfare and economic structure. 12. See Mares and Queralt (2015) for an alternative argument stressing intra-elite conflict.

REFERENCES Acemoglu, D., & Robinson, J. A. (2012). Why Nations Fail: The Origins of Power, Prosperity and Poverty. Crown Publishers. Anderson, P. (1974). Lineages of the Absolutist State. Verso. Bang, P. F. (2015). Tributary empires and the new fiscal sociology: Some comparative reflections. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 537–556. Cambridge University Press. Barzel, Y., & Kiser, E. (1997). The development and decline of medieval voting institutions: A comparison of England and France. Economic Inquiry, 35(2), 244–260. Bates, R., & Lien, D. (1985). A note on taxation, development, and representative government. Politics and Society, 14(1), 53–70. Bean, R. (1973). War and the birth of the nation state. Journal of Economic History, 33(1), 203–221. Becker, G. S., & Stigler, G. J. (1974). Law enforcement, malfeasance, and compensation of enforcers. Journal of Legal Studies, 3(1), 1–18. Becker, S. O., Pfaff, S., & Rubin, J. (2016). Causes and consequences of the Protestant Reformation. ESI Working Paper 16-13. Retrieved from http://​digitalcommons​.chapman​.edu/​esi​_working​_papers/​178 Bendix, R. (1978). Kings or People: Power and the Mandate to Rule. University of California Press. Besley, T., & Persson, T. (2011). Pillars of Prosperity: The Political Economics of Development Clusters. Princeton University Press. Blockmans, W. (1978). A typology of representative institutions in late medieval Europe. Journal of Medieval History, 4, 189–215. Braudel, F. (1995). The Mediterranean and the Mediterranean World in the Age of Philip II. University of California Press. Brenner, R. (1976). Agrarian class structure and economic development in pre-industrial Europe. Past and Present, 70(1), 30–75. Brewer, J. (1990). The Sinews of Power: War, Money, and the English State, 1688–1783. Harvard University Press. Brown, H. (2011). Drinking games: Can Russia admit it has a problem? World Policy Journal, 28(2), 111–121. Carneiro, R. L. (1970). A theory of the origin of the state. Science, 169(3947), 733–738. Centeno, M. A. (2002). Blood and Debt: War and the Nation-State in Latin America. Pennsylvania State University Press. Clark, G. (2007). A Farewell to Alms: A Brief Economic History of the World. Princeton University Press. Ertman, T. (1997). Birth of the Leviathan: Building States and Regimes in Medieval and Early Modern Europe. Cambridge University Press. Fukuyama, F. (2011). The Origins of Political Order: From Prehuman Times to the French Revolution. Farrar, Straus and Giroux. Geiger, R. G. (1994). Planning the French Canals: Bureaucracy, Politics, and Enterprise under the Restoration. University of Delaware Press. Gorski, P. S. (1995). The Protestant ethic and the spirit of bureaucracy. American Sociological Review, 60(5), 783–786. Gorski, P. S. (2003). The Disciplinary Revolution: Calvinism and the Rise of the State in Early Modern Europe. University of Chicago Press. Greif, A. (1998). Self-enforcing political systems and economic growth: Late medieval Genoa. In R. H. Bates, A. Greif, M. Levi, J. L. Rosenthal, & B. R. Weingast (eds), Analytic Narratives, 345–359. Princeton University Press.

Premodern taxation  29 Greif, A. (2006). Institutions and the Path to the Modern Economy: Lessons from Medieval Trade. Cambridge University Press. Herbst, J. (2000). Economic incentives, natural resources and conflict in Africa. Journal of African Economies, 9(3), 270–294. Hintze, O. (1975). Historical Essays of Otto Hintze. Oxford University Press. Hoffman, P. T. (2015). Why Did Europe Conquer the World? Princeton University Press. Huang, R. (1974). Taxation and Governmental Finance in Sixteenth-Century Ming China. Cambridge University Press. Jones, P. J. (1997). The Italian City-State: From Commune to Signoria. Oxford: Clarendon Press. Jursa, M., & Moreno Garcia, J. C. (2015). The ancient Near East and Egypt. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 115–165. Cambridge University Press. Karaman, K., & Pamuk, S. (2013). Different paths to the modern state in Europe: The interaction between warfare, economic structure, and political regime. American Political Science Review, 107(3), 603–626. Kiser, E. (1994). Markets and hierarchies in early modern tax systems: A principal–agent analysis. Politics and Society, 22(3), 284–315. Kiser, E., & Barzel, Y. (1991). The origins of democracy in England. Rationality and Society, 3(4), 396–422. Kiser, E., & Cai, Y. (2003). War and bureaucratization in Qin China: Exploring an anomalous case. American Sociological Review, 68(4), 511–539. Kiser, E., & Kane, J. (2001). Revolution and state structure: The bureaucratization of tax administration in early modern England and France. American Journal of Sociology, 107(1), 183–223. Kiser, E., & Karceski, S. (2017). Political economy of taxation. Annual Review of Political Science, 20, 75–92. Kiser, E., & Levi, M. (2015). Interpreting the comparative history of fiscal regimes. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 557–571. Cambridge University Press. Kiser, E., & Linton, A. (2002). The hinges of history: State-making and revolt in early modern France. American Sociological Review, 67(6), 889–910. Kiser, E., & Schneider, J. (1994). Bureaucracy and efficiency: An analysis of taxation in early modern Prussia. American Sociological Review, 59(2), 187–204. Klein, J. (1920). The Mesta. Harvard University Press. Lenski, G. (1966). Power and Privilege. University of North Carolina. Levi, M. (1988). Of Rule and Revenue. University of California Press. Lieberman, E. S. (2003). Race and Regionalism in the Politics of Taxation in Brazil and South Africa. Cambridge University Press. Lyttkens, C. H. (1992). Effects of the taxation of wealth in Athens in the fourth century BC. Scandinavian Economic History Review, 40(2), 3–20. Mackil, E. (2015). The Greek polis and koinon. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 469–491. Cambridge University Press. Major, J. R. (1960). Representative Institutions in Renaissance France, 1421–1559. Etudes Présentées à La Commission Internationale Pour l’histoire Des Assemblées d’Etats 22. University of Wisconsin Press. Mann, M. (1984). The autonomous power of the state: Its origins, mechanisms and results. European Journal of Sociology, 25(2), 185–213. Mann, M. (1986). The Sources of Social Power, Volume 1: A History of Power from the Beginning to AD 1760. Cambridge University Press. Mann, M. (1993). The Sources of Social Power, Volume 2: The Rise of Classes and Nation-States 1760–1914. Cambridge University Press. Mares, I., & Queralt, D. (2015). The non-democratic origins of income taxation. Comparative Political Studies, 48(4), 1974–2009. Martin, I. W., Mehrotra, A. K., & Prasad, M. (2009). The New Fiscal Sociology: Taxation in Comparative and Historical Perspective. Cambridge University Press.

30  Handbook on the politics of taxation McIlwain, C. H. (1932). Medieval estates. In J. R. Tanner, C. W. Previte-Orton, & Z. Nugent (eds), Cambridge Medieval History, 665–715. Cambridge University Press. Mehrotra, A. K. (2004). More mighty than the waves of the sea: Toilers, tariffs, and the income tax movement, 1880–1913. Labor History, 45(2), 165–198. Monson, A. (2015). Hellenistic empires. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 169–207. Cambridge University Press. Monson, A., & Scheidel, W. (2015). Studying fiscal regimes. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 3–28. Cambridge University Press. Moore, B. (1966). Social Origins of Dictatorship and Democracy: Lord and Peasant in the Making of the Modern World. Beacon Press. Mungiu-Pippidi, A. (2013). Becoming Denmark: Historical designs of corruption control. Social Research: An International Quarterly, 80(4), 1259–1286. North, D. C., (1990). Institutions, Institutional Change, and Economic Performance. Cambridge University Press. North, D. C., Wallis, J. J., & Weingast, B. R. (2009). Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History. Cambridge University Press. North, D. C. & Weingast, B. R. (1989). Constitutions and commitment: The evolution of institutions governing public choice in seventeenth-century England. Journal of Economic History, 49(4), 803–832. O’Brien, P. K. (2012). Fiscal and financial preconditions for the formation of developmental states in the West and the East from the conquest of Ceuta (1415) to the Opium War (1839). Journal of World History, 23(3), 513–553. Ober, J. (2015). Classical Athens. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 492–522. Cambridge University Press. Peacock, A., & Wiseman, J. (1961). The Growth of Public Expenditure in the United Kingdom. Princeton University Press. Pierson, P. (2000). Increasing returns, path dependence, and the study of politics. American Political Science Review, 94(2), 251–267. Poggi, G. (1978). The Development of the Modern State. Stanford University Press. Root, H. (1989). Tying the king’s hands. Rationality and Society, 1(2), 240–258. Scheidel, W. (2015). The early Roman Empire. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 229–257. Cambridge University Press. Scheve, K., & Stasavage, D. (2010). The conscription of wealth: Mass warfare and the demand for progressive taxation. International Organization, 64(4), 529–561. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton University Press. Schumpeter, J. A. (1991 [1918]). The crisis of the tax state. In R. Swedberg (ed.), Joseph A. Schumpeter: The Economics and Sociology of Capitalism, 99–140. Princeton University Press. Simmel, G. (1955). Conflict and the Web of Group Affiliations. Free Press. Skocpol, T. (1979). States and Social Revolutions: A Comparative Analysis of France, Russia, and China. Cambridge University Press. Spencer, H. (1876). The Evolution of Society (selections from Principles of Sociology, Vol 1). Edited with Introduction by Robert Carneiro. University of Chicago Press. Stark, R. (2005). The Victory of Reason: How Christianity Led to Freedom, Capitalism, and Western Success. Random House. Steinmo, S. (2010). The Evolution of Modern States: Sweden, Japan, and the United States. Cambridge University Press. Strayer, J. R. (1955). Western Europe in the Middle Ages, a Short History. Appleton-Century-Crofts. Szostak, R. (1991). The Role of Transportation in the Industrial Revolution: A Comparison of England and France. McGill-Queen’s University Press. Tan, J. (2015). The Roman Republic. In A. Monson & W. Scheidel (eds), Fiscal Regimes and the Political Economy of Premodern States, 208–228. Cambridge University Press. Tarschys, D. (1988). Tributes, tariffs, taxes and trade: The changing sources of government revenue. British Journal of Political Science, 18(1), 1–20. Tilly, C. (1990). Coercion, Capital, and European States, AD 990–1990. Basil Blackwell.

Premodern taxation  31 Wachter, J. (1987). The Roman Empire. Dent and Sons. Weber, M. (1978). Economy and Society: An Outline of Interpretive Sociology, Vols 1 and 2. University of California Press.

3. War and taxation: the father of all things or rather an obsession? Patrick Emmenegger and André Walter

1. INTRODUCTION The pre-Socratic Greek philosopher Heraclitus of Ephesus described war as the father of all things. While this statement might be a bit of a stretch, there can be no doubt that the literature on the politics of taxation emphasizes the importance of war. Next to the long intellectual tradition linking war to taxation (Hintze, 1906; Spencer, 1876–1896; Weber, 1923), Tilly (1975) did probably the most to popularize the hypothesis that war and taxation are closely related. His famous expression “war made the state, and the state made war” (Tilly, 1975, p. 42) ranks among the most cited arguments in the history of the social sciences. The literature’s focus on war has been so stark that Bartelson and Teorell (2018, p. 227) even speak of an “obsession with war.” Yet, while there is agreement that war affects taxation, there is a surprising amount of disagreement as to how exactly and under what conditions war matters. In this chapter, we review the literature on war and taxation. We start by providing definitions of the two main concepts. In a contemporary context, “taxation consists of the obligation to contribute money or goods to the state in exchange for nothing in particular” (Martin et al., 2009, p. 3). Taxes may be levied on workers’ income and corporate profits, but can also be added to the cost of goods, services, or any other transaction. Yet, as Braun (1975, p. 244) notes, “up to the eighteenth century, the traditional concept of taxation, in theory if not in fact, evaluated tax collection as an expedient in times of emergency and even an abuse which as soon as possible should be replaced by income from public property, particularly domains, and by voluntary contributions.” While these times of emergency may refer to all sorts of crisis periods (cf. Limberg, forthcoming), in practice these episodes often referred to war. War may be defined as the occurrence of large-scale violence, measured by a threshold of battle-related deaths. Differences exist with regard to the magnitude of the threshold, the kind of battle deaths (e.g. war combatants versus civilians), and the period during which the battle deaths must occur. For instance, the Correlates of War project employs a 1000 battle death threshold excluding civilians and without any time constraint of when the deaths must have occurred (Sarkees & Wayman, 2010). In contrast, the Uppsala Conflict Data Program uses a lower threshold and counts also civilian deaths but limits the time of occurrence to one year (Gleditsch et al., 2002). In addition, wars may be classified based on the type of actors involved. The most important characteristics are whether wars also involve non-state actors and whether a state fights against non-state actors on its own territory or with another state. The war and taxation literature has traditionally focused on interstate wars only, although newer contributions start to incorporate other types as well (e.g. Dincecco & Wang, 2018; Thies, 2005). This chapter is structured as follows. We first introduce the classic bellicist thesis and discuss the different causal mechanisms offered in the literature. In this context, we also examine 32

War and taxation  33 what implications these mechanisms have for the choice of taxes. Subsequently, we critically review these causal mechanisms and explore the temporal and geographical scope of the bellicist thesis. We conclude by briefly outlining some research avenues that might help to advance the existing literature.

2.

THE BELLICIST THESIS

The core argument of the bellicist thesis is rather straightforward. Military conflict imposes a heavy burden on society. Soldiers have to be mobilized, infrastructure may be destroyed, people may get killed, and the economy is likely to suffer. As a consequence, governments need to mobilize additional resources to finance the war effort and compensate victims. As Figure 3.1 shows for the period 1816–2012, the percentage of states involved in interstate war per year is positively associated with tax revenue as a percentage of gross domestic product (GDP), in particular during the two world wars (1914–1918 and 1939–1945), although the relationship is far from perfect. Empirically, research has examined the relationship between war and taxation – which has often been used as an indicator of the state’s penetration of society – from around 1500 until today. Occasionally, research has even reached as far back as 1130 (Mann, 1986) or republican Rome (Levi, 1988). Overall, this research finds strong support for the bellicist thesis (e.g. Ardant, 1975; Bank et al., 2008; Dincecco & Prado, 2012; Karaman & Pamuk, 2013; Kiser & Linton, 2001; Levi, 1988; Mann, 1986; Tilly, 1990). According to Jenks (1900, p. 73, cited in Carneiro, 1970, p. 734), “historically speaking, there is not the slightest difficulty in proving that all political communities of the modern type [that is, states] owe their existence to successful warfare.” Three mechanisms are typically invoked to explain this relationship. First, wars are expensive. The building of an effective military machine imposes a heavy burden on societies. Most notably, wars require capital, especially as military technology advances (Finer, 1975). By the sixteenth century, success in war was increasingly dependent on the mobilization of the entire country, which is costly (Gennaioli & Voth, 2015). If wars are short, alternative means of revenue generation such as borrowing may suffice (Centeno, 2002; Queralt, 2019). Yet, long and large-scale wars will almost certainly require a higher tax yield to finance the war effort. Moreover, large-scale wars are likely to result in enormous social needs and calls for state interventions to take care of disabled war veterans, surviving dependents, and refugees (Obinger & Schmitt, 2018). In addition, wars are often associated with an economic contraction, which is particularly problematic if countries rely on trade taxation to finance public expenditures (and by implication war efforts). As Figure 3.2 shows, revenue from trade taxation collapsed in almost all countries during the two world wars. Hence, war is not only costly, it also removes some of the alternative extraction options. There is thus a straightforward relationship between war and taxation, because war leads to spending needs – possibly in combination with the drying up of other forms of revenue generation. Second, wars often increase administrative capacity, because governments face massive organizational challenges (e.g. mobilizing soldiers and developing transport infrastructure) and become more interventionist (e.g. organizing supplies and managing wartime production). Of course, such capacity is expensive, but the role of administrative capacity goes beyond that. Almost all major European taxes began as extraordinary levies to finance particular military activities and were subsequently often scaled back (Braun, 1975). Nevertheless, they left their

34  Handbook on the politics of taxation

Source: Data on taxation: Andersson and Brambor (2019); data on war: Sarkees and Wayman (2010).

Figure 3.1

War and tax revenue, 1816–2012

mark on the development of political units. As Tilly (1975, p. 42) notes, capacity building for war produced administrative arrangements, which had the potential to deliver resources to the governments also for other purposes. Most notably, it increased the governments’ capacity to extract revenue also in times of peace, while it provided the government with the means necessary to enforce its will over the taxpayers’ resistance (Ardant, 1975; Finer, 1975; Mann, 1986). Hence, war and taxation are connected through a “virtuous” circle in which taxation influences success in war, while war may help develop fiscal capacity (Besley & Persson, 2009; Dincecco & Prado, 2012; Tilly, 1990). Third, wars may lead to calls for redistribution. In periods of mass warfare, large parts of the population are conscripted into the army. Yet, not all citizens are equally affected by conscription. Young men of lower social classes are particularly likely to be called upon by the state and possibly serve as “cannon fodder.” In this case, citizens may demand that the wealthy bear a disproportionate share of the financial burden in periods of military conflict to establish some equality of sacrifice: the lower classes provide the soldiers, while the higher classes shoulder the financial burden (Scheve & Stasavage, 2016).1 This causal mechanism is interesting because it not only implies an effect of war on taxation, but also offers clear expectations as to what taxes will be prioritized in such periods. While the other two mechanisms point to efficiency (which taxes generate the highest yield?), pragmatism (which taxes are available in a given situation?), and capacity (which taxes are technically possible?), this causal mechanism implies that military conflict should lead to the expansion

War and taxation  35

Source: Andersson and Brambor (2019).

Figure 3.2

Sources of taxation, 1816–2012

of taxes that target the wealthy such as highly progressive income taxes or inheritance taxes, because these taxes are most suited to generate an equality of sacrifice between the social classes (see Figure 3.2). Similarly, Hertel-Fernandez and Martin (2018) argue that such progressive taxes are typically the result of major crises (e.g. war) in countries characterized by few political institutions for consensual policy-making (for a discussion of the relationship between taxation and redistribution, see Limberg, this volume).2 However, unlike Scheve and Stasavage (2016), they stress the conflictual character of these reforms even in crisis periods. Hence, they put more emphasis on the role of war in overcoming domestic resistance to reform rather than its role in creating some sense of equality of sacrifice. However, the type of taxes to be expanded in crisis periods is still the subject of much controversy (cf. Seelkopf et al., 2021). For instance, Morgan and Prasad (2009) offer a different account of the politics of taxation in such periods. Comparing tax reforms in France and the United States around the First World War, they show that the two countries opted for radically different tax reforms in comparable crisis situations. The reasons for this divergence can be found in differences in state–society relationships that preceded the war. Briefly, they argue that nineteenth-century movements of resistance to modernization targeted different developments in the two countries. The rapid concentration of economic power in the United States contributed to the creation of a political movement in support of a tax with clear redistributive purposes. When opportunity struck in the form of war, this movement capitalized on the opportunity and enforced the democratic world’s most progressive income tax system. In

36  Handbook on the politics of taxation contrast, in France, resistance to modernization took the form of opposition to the (further) centralization of state power. Unable to overcome this resistance and implement an effective income tax, the French state had little alternative to the expansion of consumption taxes to meet its revenue needs.3 Alternatively, Haffert (2019) argues that pressure for increases in progressive taxation in mobilizing countries can be offset by allocational concerns in countries whose capital stock has been severely damaged during the war. He notes that tax policy is not only about income redistribution, but also about allocating resources into different sectors of the economy. While such allocation might be often left to the market, governments might feel the need to intervene in case of emergency and dramatic resources shortage, for instance during and following a war effort. If redistributive and allocational concerns do not overlap, governments might be forced to set priorities. He thus argues that “if a country’s capital stock experiences a major hit, this creates a strong argument for lightening the burden on potential investors. In such a situation, even supporters of strong redistribution may be willing to accept a less progressive tax system for allocational reasons” (Haffert, 2019, p. 60). Taken together, these contributions agree that wars affect taxation. Yet, they disagree as to what type of taxes are prioritized. While Scheve and Stasavage (2016) emphasize the difference between high-mobilizing and low-mobilizing countries, Haffert (2019) stresses the difference between countries that send their soldiers into war abroad and those that fight a war on their own soil. Finally, Morgan and Prasad (2009) highlight differences in state–society relationships that precede military conflicts. Hence, more work is needed to identify the relevant causal mechanisms linking war to the specific choice of taxes.

3.

FURTHER QUESTIONS ABOUT THE CAUSAL MECHANISM

While there seems to be little doubt that war matters for taxation, there are plenty of questions about the causal mechanism. We discuss seven questions in the following. First, while existing empirical evidence supports the claim that war resulted in more taxation (Besley & Persson, 2009; Dincecco, 2009; Dincecco & Prado, 2012; Londoño Vélez, 2014; Sabaté, 2016), less discussion has been devoted to the question of how these increases have come about. For instance, previous research has sometimes struggled to show that war indeed fostered the introduction of new taxes (Aidt & Jensen, 2009; Mares & Queralt, 2015; Seelkopf et al., 2021).4 A more consistent finding is that tax rates skyrocketed during wartime (Henrekson & Waldenström, 2016; Scheve & Stasavage, 2016), which suggests that governments rather intensified the exploitation of existing revenue sources instead of expanding the administrative grid to tax new segments of the population. Of course, this pattern also implies that governments are to some extent restricted with regard to achieving efficiency and redistribution goals, because not all taxes lend themselves equally well to efficient revenue generation or redistribution. Second, how long may it take for a war to have an effect on taxation? In periods of war, taxation is a means to an end, i.e. access to financial resources. However, there are alternative means to access finance, for instance through the capital market (Centeno, 2002; Queralt, 2019). Such forms of war finance are likely to result in public debt, which will have to be paid off sooner or later, possibly by means of additional tax revenue. Similarly, improvements in administrative capacity might influence the tax yield only in the long term. Recently, research-

War and taxation  37 ers have begun to explore these long-term effects of war on taxation, assuming that external conflicts may still have an observable effect on state capacity and political performance decades or even centuries later (Besley & Persson, 2009; Dincecco et al., 2019; Dincecco & Prado, 2012). Yet, as the time lag between war and taxation increases, the causal link between the two becomes inevitably weaker, because new financial needs and revenue possibilities have emerged in the meantime. It is thus an open question how long the temporal lag between war and taxation may be. Third, why do wars have a lasting effect on taxation? As wars end, so do the extraordinary financial needs and the justification for equality of sacrifice.5 Why does the tax system not always revert back to its pre-war status? This question is far from trivial, although it is rarely explicitly addressed in the literature. In their classic contribution, Peacock and Wiseman (1961) argue that periods of military conflict provide state makers with the opportunity to fundamentally change the state’s fiscal capacity, because military conflicts create crisis-induced shifts in the taxpayers’ perceptions of what may be tolerable levels of taxation, which makes it easier to raise taxes or overhaul the tax code. In addition, as the new revenue is not exclusively used for military spending but also for the expansion of government activities in areas such as social welfare (cf. Obinger & Schmitt, 2018), these changes may lead to policy feedback effects (Pierson, 1993), as the population adapts its behavior and preferences to the now existing policies. As a result, extraordinary events such as wars may cause long-term changes in fiscal capacity. The empirical implication is that, although public spending will decrease in the post-crisis period, it will likely remain higher than the pre-crisis level, which leads to the continuous growth and expansion of the modern state (Rasler & Thompson, 1985). Yet, importantly, there is no necessity for this feedback process to happen. The effect of war on taxation might only be temporary (Emmenegger & Walter, 2020). The question thus is under what conditions should we be able to observe such a lasting effect? Fourth, Tilly (1975) links the process of state building to a “protection racket.” He portrays early state makers as coercive and self-seeking political entrepreneurs who use wars as windows of opportunity to become dominant in a substantial territory. War-making capacity not only increases the capacity to extract resources from society, it also creates administrative and organizational structures that help check potential rivals and opponents. Of course, these early state makers have to form alliances with specific social classes, which loan resources, provide technical services, or help ensure the compliance of the rest of society. Yet, these social classes do so “in return for a measure of protection against their own rivals and enemies” (Tilly, 1985, p. 183), hence the notion of a protection racket (see also Scott, 2017). Others, most notably North and Weingast (1989), liken the process of state building to a social contract, in which a common good (e.g. external defense) is exchanged for investments in the state’s extractive capacity (see also Besley & Persson, 2009; Timmons, 2005). This line of thought also emphasizes how external threats change the preferences of rulers and citizens regarding levels of taxation. Citizens thus voluntarily comply with the rule to pay taxes and contribute to the state’s revenue. Yet, as with all common goods, there is a concern about free riding, which is why citizens tolerate the state’s right to sanction non-compliers. Levi (1988) refers to this process as quasi-voluntary compliance, because it combines elements of legitimacy and coercion. As Goenaga and von Hagen-Jamar (2018, p. 88) observe, the two mechanisms offer different empirical expectations about the transhistorical validity of the bellicist thesis. While the social contract mechanism seems unaffected by time, the protection racket mechanism

38  Handbook on the politics of taxation suggests an increasingly weaker link between war and taxation, as rulers are able to centralize coercive resources and check internal rivals and opponents. As a result, the protection racket mechanism suggests that the relationship between war and taxation is primarily present in the early stages of state formation. Indeed, the protection racket mechanism seems consistent with most anthropological research on early state building. For instance, Carneiro (1970, p. 734) argues that “only a coercive theory can account for the rise of the state. Force, and not enlightened self-interest, is the mechanism by which political evolution has led, step by step, from autonomous villages to the state.” In contrast, the social contract mechanism may be better positioned to explain the relationship in recent periods. Fifth, the classical bellicist thesis works both through selective and generative processes. On the one hand, as mentioned above, war making is argued to be key in producing administrative structures and centralizing power. In such accounts, wars give rise to more capable states. On the other hand, war also plays a selective role in making less successful states disappear. As Tilly (1975, p. 24) notes, “the reduction of Europe from some five hundred more or less independent political units in 1500 to twenty-odd states in 1900 produced a large number of losers.” Hence, the states we know today are the successful ones, which have managed to survive this war-driven selection process. From a historical point of view, both selective and generative processes seem equally plausible. However, the two mechanisms have rather different implications for the relationship between war and taxation, because according to the selective mechanism, taxation tends to precede war, while according to the generative mechanism, war tends to precede taxation. In any case, with the emergence of an established system of states and the diffusion of the norm of state sovereignty, states rarely disappear by means of war and annexation. Hence, today, the bellicist thesis has to work primarily through pressure for adaptation and structural transformation rather than selection processes (Goenaga & von Hagen-Jamar, 2018, p. 88).6 Sixth, there are important questions as to what exactly constitutes the “right hand side” of the bellicist thesis. For instance, is the actual occurrence of war necessary to increase taxation? While early research has focused almost exclusively on episodes of interstate warfare, recent research has expanded the scope of the bellicist thesis to perceived threats of war, interstate rivalries, and intrastate war (e.g. Dincecco & Wang, 2018; Thies, 2005, 2007). Such an extension seems potentially fruitful, because interstate wars have become rare (Sarkees & Wayman, 2010). Yet, this extension is not without problems. For instance, it may be that actors’ investments in military and state capacity in response to perceived threats of war stop rivalries from escalating into war. In this case, interstate rivalries could be understood as a diminished form of war, which nevertheless affect taxation. However, interstate rivalries are clearly less pressing than actual wars, which might affect domestic politics differently, thus changing or even breaking the link between war and taxation (Goenaga & von Hagen-Jamar, 2018, p. 88). In any case, we should expect war and rivalries to affect taxation differently. The actual occurrence of war should lead to episodes of dramatic structural change in taxation in the form of a “ratchet effect,” i.e. the massive expansion in the war period followed by some limited reduction of state capacity in the post-war period (see Peacock & Wiseman, 1961; Rasler & Thompson, 1985). In contrast, interstate rivalries are more likely to produce slow-moving cumulative transformations (Goenaga & von Hagen-Jamar, 2018, pp. 88–89). The distinction between external and internal wars seems equally important. Besley and Persson (2009) emphasize how internal conflict, unlike external conflict, undermines the incentive to build fiscal capacity. Inspired by the social contract perspective, they argue that

War and taxation  39 in case of internal wars, conflicting groups are primarily interested in redistributing income. Citizens thus have little interest in making investments in the state’s extractive capacity, because these resources will not necessarily be used to create a common good (such as external defense). Similarly, Dincecco and Wang (2018) argue that while constant interstate warfare in Europe gave rise to stronger states, China primarily faced internal threats such as rebellions and civil wars, which did not force Chinese emperors to engage in capacity building through social contracting with Chinese elites in order to fend off these attacks. Clearly, internal and external wars pose different challenges to rulers. Yet, it should be emphasized that from a “protection racket” perspective, internal wars might nevertheless lead to state capacity building, because certain societal groups might be willing to pay for protection. In any case, the analysis of the effect of internal wars on taxation is complicated by the fact that internal wars might aim at destroying the very fiscal capacity (and the coercive apparatus that it sustains) that is the object of this research. Seventh, turning to the “left hand side” of the bellicist thesis, we must ask what exactly taxation is supposed to capture. Much of the literature, in particular the one focusing on the early modern period, focuses on taxation as an indicator of state capacity. From this perspective, the state is conceptualized as a coercive organization that can be distinguished from households and kinship groups by some degree of bureaucratic organization (Vu, 2010). However, due to the lack of comparative data, scholars resort to taxation as an indicator of the state’s ability to penetrate society and extract resources. Indeed, Ardant (1975) argues that state building is inseparable from the history of taxation. Yet, state capacity is a broader concept, covering the extractive, repressive, and control activities of governments (Tilly, 1975, p. 13). Tax data are (more) often available and allow for relatively straightforward comparisons across time and space.7 Yet, by focusing on taxation, there is a risk that indicators are systematically biased, because other aspects of state capacity are not taken into account (Soifer, 2008). Recently, researchers have advanced other indicators of state capacity and then related these indicators to tax outcomes. For instance, Kiser and Kane (2001) examine the bureaucratization of tax administration in England and France, while Dincecco (2009) has developed a measure of fiscal centralization. More recently, D’Arcy and Nistotskaya (2018) have used cadastral records (i.e. the ability of states to gather information needed to monitor individual behavior) to capture state capacity. Finally, Brambor et al. (2020) rely on efforts of states to collect and process information (i.e. regular implementation of a reliable census, the regular release of statistical yearbooks, the introduction of civil and population registers, and the establishment of a government agency tasked with processing statistical information). In general, this literature shows that state capacity has a positive effect on the tax yield.

4.

SCOPE CONDITIONS AND CONDITIONAL EFFECTS

Does the classic bellicist thesis travel? The literature on war and taxation has often focused on Western Europe and North America. Is war an equally important factor in tax politics outside these regions? Tilly (1975, pp. 81–82) already foreshadowed this question in his classic contributions. For instance, he argued that the European experience will not repeat itself, because countries outside these regions face a very different international context. Most notably, they are confronted with an established state system and world markets, which is likely to influence the relationship between war and taxation. Consequently, research has sometimes struggled to

40  Handbook on the politics of taxation find evidence in support of the bellicist thesis in regions such as Africa (Dincecco et al., 2019; Herbst, 2000; Thies, 2007), Latin America (Centeno, 2002; Thies, 2005), or parts of Asia (Barnett, 1992; Dincecco & Wang, 2018; Lu & Thies, 2013). However, in recent years, the scholarly literature has made considerable progress in identifying the reasons why the bellicist thesis does not always travel. In the following, we focus on five factors that condition whether the bellicist thesis applies. First, several researchers emphasize that the effect of war on taxation is conditional on the state’s organizational and administrative capacity (e.g. Centeno, 2002; Kiser & Kane, 2001). They suggest that wars in and of themselves do not influence taxation. Rather, wars simply offer the opportunity for reform. Yet, in the absence of some minimum level of administrative capacity, governments are not well positioned to take advantage of these opportunities, as they do not have the necessary resources to turn these extraordinary situations into fiscal capacity building. The original formulation of the bellicist thesis already foreshadowed this conditional relationship. Most notably, Tilly’s (1975, p. 42) famous expression “war made the state, and the state made war” does not unambiguously answer which came first, states or wars. The direction of causality therefore remains ambiguous, which could be explained by the moderating effect of pre-war levels of administrative capacity.8 Second, research has highlighted the importance of access to external credit and natural resources (e.g. Centeno, 2002; Queralt, 2019). Wars are expensive. These cost pressures explain why states engage in the development of extractive capacity. Yet, if states have access to alternative sources of financing, the development of state capacity is no longer the necessary consequence of warfare. For instance, Centeno (2002) argues that Latin American silver and access to international credit markets freed these states from imposing greater fiscal control over their territories. Similarly, Queralt (2019) argues that the advent of genuinely global capital markets in the early nineteenth century undermined the relationship between war and taxation, which explains why the bellicist thesis struggles to travel to regions characterized by relatively late state development (i.e. late relative to the development of international capital markets). Third, the effect of war on taxation is likely to be conditional on geography and population density. Herbst (2000) argues that low population density meant that traditional warfare in Africa was to capture slaves. Only in the presence of higher population density does warfare focus on territorial acquisition. This argument echoes findings in anthropological research, which emphasizes that if there is “no shortage of land, there was, by and large, no warfare over land” (Carneiro, 1970, p. 735). Defeated groups were therefore not driven off their land. Neither did the victors make any real efforts to establish systems of regular resource extraction (e.g. tribute), because they did not have any effective way to prevent losers from fleeing to distant locations. Similarly, geography matters, because it not only affects whether losers can simply relocate to a distant part of the territory, but also because it structures lines of conflict. Dincecco and Wang (2018) argue that European geography created a highly fragmented system of rival states, which constantly fought for territorial supremacy. Put differently, European states were formed in a system of constant interstate military competition. In contrast, in centralized China, most conflicts took the form of rebellions, while the most significant recurrent foreign attack threat came from Steppe nomads, which altered the consequences of war on state making. Fourth, the industrial revolution is likely to condition the effect of war on taxation. In the early state-building period, military costs were by far the largest item on state budgets (Braun,

War and taxation  41 1975, p. 311). Yet, this began to change with the Industrial Revolution (Ardant, 1975; Steinmo, 1993), which led to new demands for public expenditure in particular in areas expected to have positive economic benefits such as infrastructure development and public education (Beramendi et al., 2019; Emmenegger et al., 2020). In addition, over time industrialization led to the creation of the labor movement, which increasingly demanded public investments in areas such as sanitation and social protection (Steinmo, 1993). Warfare has thus been linked to public spending in areas other than the military, most notably areas linked to the development of an industrial society such as the welfare state (Obinger & Schmitt, 2018). For instance, Allen and Campbell (1994) show in an analysis of effective individual income tax rates of the United States that while war influences taxation, military spending does not, which indicates that military spending loses relevance in comparison to other parts of the public budget. At the same time, industrialization offered states with increasing possibilities of action, because greater production allowed more extensive levying of taxes and because a developed exchange and cash economy made it possible to establish taxes with greater accuracy (Ardant, 1975, p. 166). There were also clear economic limits to taxation before industrialization (see Kiser in this volume). Before industrialization, states mainly relied on the (indirect) taxation of the sale of specific goods (e.g. alcohol) and of transactions, most notably at points of entry or passage that were easy to control (e.g. city ports or bridges). Direct taxes (i.e. taxes imposed directly on persons or organizations) were rarer and mostly targeted property rather than income. Yet, even in the case of property taxation, there were clear limits before industrialization. While tax subjects may own property, they may not necessarily be able to come up with the cash necessary to pay property tax (e.g. in the case of subsistence farming). Property taxes therefore often targeted the more luxurious accoutrements of houses such as a large number of windows (Peters, 1991, pp. 227–228). Thanks to the emergence of an exchange and cash economy, but also the states’ ability to develop the administrative grid necessary to extract from their subjects revenue that was more closely tied to their actual capacity to pay, states could increasingly turn to more effective forms of revenue extraction (Scott, 1999, p. 23). Finally, several researchers have pointed to the conditioning role of ethnic fractionalization. Echoing the social contract arguments reviewed above, Centeno (2002) argues that the capacity of states to extract resources is linked to the willingness of the population to accept these burdens. Such willingness is likely to be greater in the case of a comparatively homogeneous population. Similarly, Taylor and Botea (2008) argue that military pressure leads to fiscal capacity only in the context of ethnic cohesion (such as in Vietnam). In contrast, these pressures have no comparable effect in the presence of high levels of ethnic fractionalization (as in Afghanistan). However, the focus on ethnic fractionalization points to a new endogeneity problem because historical experiences with stateness are linked to lower ethnic homogeneity today (Bleaney & Dimico, 2016). In sum, the bellicist thesis has played and will continue to play an important role in explanations of the politics of taxation. Yet, recent research has done much to clarify and nuance the argument. While Tilly (1975) and his collaborators foreshadowed several of the subsequent debates, their sometimes ambiguous formulations provided generations of researchers with ample opportunities to build on this seminal work. Systematic attempts to examine the scope conditions of the bellicist thesis were particularly fruitful. The result is a set of conditioning variables, which helps explain why the classic bellicist thesis does not always travel to regions outside of Western Europe and North America.

42  Handbook on the politics of taxation

5.

AVENUES FOR FURTHER RESEARCH

Although the literature on war and taxation has progressed considerably, we put forward four suggestions for further research. First, research should increasingly differentiate between different forms and attributes of military conflict. Traditionally, the literature has emphasized interstate wars. Yet, interstate wars have become rare. Although the literature has recently turned to other forms of conflict, in particular intrastate wars and rivalries, further types could be distinguished (e.g. trade wars or resource wars). In addition, the literature should address variation in attributes of war. For instance, Goenaga and von Hagen-Jamar (2018) find that the intensity and duration of war is positively associated with taxation (see also Sabaté, 2016). Finally, the literature has rarely addressed issues such as the effect of war on non-combatants or explored aspects related to temporality (e.g. temporary taxes or lags between war and taxation). Second, we call for a more in-depth examination of how wars affect the preferences of rulers and citizens alike to flesh out the mechanisms that connect war and taxation. Depending on the distributive implications, we suspect that societal groups differ in their preferences towards the mode of war financing (Saylor & Wheeler, 2017). Therefore, the preference formation of ruling coalitions is essential to understand how war shaped fiscal institutions in the long run and resulted in specific institutional choices.9 Similarly important, war has been linked to preference changes of citizens towards higher levels of taxation. Introducing new taxes as well as broadening the scope of existing tax measures requires at least some legitimacy among taxpayers to limit the problems of tax revolts and evasion. However, we lack evidence that war increased the social acceptance of higher levels of taxation both in the short and long run (but see Walter & Emmenegger, 2021). Third, while tax revenue has been at the center of the literature, it is less clear what long-term effect war has on the political economy more generally. Consider the case of redistribution. Scheve and Stasavage (2016) argue that war was the main driver of tax progressivity in the twentieth century. At the same time, however, there seems to be an inverse relationship between progressive taxes and welfare state generosity (Kato, 2003). Clearly, the relationship between war and redistribution is complicated. Although recent research has begun to explore this relationship, more work is needed to get to the bottom of it. Finally, more discussion on the concept-measurement dimension is necessary. On the conceptual level, the distinction between extractive, administrate, and coercive capacity is well established. However, the choice of valid indicators for each dimension as well as their aggregation is less straightforward (Hendrix, 2010; Savoia & Sen, 2014). For instance, is the amount of direct taxes a better indicator of the extractive capacity than consumption taxes if only a small proportion of the population is directly taxed (as it was common in the first decades of new direct taxes)? In addition, if we focus on extraction only, would it not be better to use government revenue in general because the administrative penetration of the state is covered by a different conceptual dimension? Similar concerns apply to the other dimensions because the choice of indicators is based on a number of assumptions that are not always spelled out.

War and taxation  43

ACKNOWLEDGMENTS We thank Per F. Andersson, Lukas Hakelberg, Herbert Obinger, Laura Seelkopf, and all participants at the Bamberg workshop for their helpful suggestions.

NOTES 1. In some countries such as Switzerland, adult men unable to serve in the military had to pay a tax instead. 2. In contrast, Hertel-Fernandez and Martin (2018) argue that countries with strong political institutions for consensual policy-making tend to develop tax reforms based on broad agreements between representatives of business and labor. Given these groups’ conflicting interests, such reforms tend to produce broad-based, but less progressive tax systems, which are used, among others, to finance extensive welfare states (Kato, 2003). 3. At first sight, it seems as if these authors reach diverging conclusions based on the same data. However, there is an important difference. Scheve and Stasavage (2016) examine variation in the highest marginal income tax rates. In contrast, Morgan and Prasad (2009) emphasize that in France, these (high) marginal income tax rates were never properly implemented. As a result, in terms of effective revenue, the French state continued to rely on (regressive) consumption taxes. 4. Seelkopf et al. (2021) show that war is associated with the introduction of personal income and general sales taxes in the 18 Organisation for Economic Co-operation and Development countries, but not in the rest of the world. Seelkopf (Chapter 5, this volume) offers an explanation for this surprising pattern, showing that tax introduction in colonies is positively associated with interstate war involving the metropoles (but not necessarily the colonies). 5. Although war-related debt and additional spending for disabled war veterans and surviving dependents might extend the period of financial needs quite far into the post-war period. 6. This argument also suggests that there might be a relationship between taxation and peace because fiscal capacity considerations linked to military capabilities can make some countries refrain from engaging in warfare. 7. However, historical data on government revenue in the early modern period (and even beyond) are available only for a small number of countries (e.g. England and France). In contrast, there is comparatively little research on this relationship in smaller, more peripheral, or vanished countries, which raises the question whether the relationship might be different for these countries (cf. Scott, 2017). 8. Some researchers have argued that state capacity is causally prior to war making (Gorski, 2003; Sharma, 2015). In these accounts, the state’s administrative capacity enables states to engage in successful warfare. The sources for this capacity are to be found elsewhere, for instance in disciplinary techniques inspired by the Reformation (Gorski, 2003) or dynastic successional practices (Sharma, 2015). While these alternative perspectives add to our knowledge about the factors driving state formation, it seems “hard to deny that war engaged the attention of the leaders of European states once they existed” (Hall, 2015, p. 67). 9. For instance, Poast (2015) provides evidence that central banks were often adopted during wartime to reduce borrowing costs for rulers.

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44  Handbook on the politics of taxation Andersson, P. F., & Brambor, T. (2019). Financing the State: Government Tax Revenue from 1800 to 2012, Vol. 2.0. Lund University. Ardant, G. (1975). Financial policy and economic infrastructure of modern states and nations. In C. Tilly (ed.), The Formation of National States in Western Europe, 218–242. Princeton University Press. Bank, S., Stark, K., & Thordike, J. (2008). War and Taxes. The Urban Institute. Barnett, M. (1992). Confronting the Costs of War: Military Power, State, and Society in Egypt and Israel. Princeton University Press. Bartelson, J., & Teorell, J. (2018). After de-centering: A new research agenda for state making. In J. Bartelson, J. Teorell, & M. Hall (eds), De-Centering State Making: Comparative and International Perspectives, 218–232. Edward Elgar Publishing. Beramendi, P., Dincecco, M., & Rogers, M. (2019). Intra-elite competition and long-run fiscal development. Journal of Politics, 81(1), 49–65. Besley, T., & Persson, T. (2009). The origins of state capacity: Property rights, taxation, and politics. American Economic Review, 99(4), 1218–1244. Bleaney, M., & Dimico, A. (2016). State history, historical legitimacy and modern ethnic diversity. European Journal of Political Economy, 43, 159–170. Brambor, T., Goenaga, A., Lindvall, J., & Teorell, J. (2020). The lay of the land: Information capacity and the modern state. Comparative Political Studies, 53(2), 175–213. Braun, R. (1975). Taxation, sociopolitical structure, and state-building: Great Britain and Brandenburg-Prussia. In C. Tilly (ed.), The Formation of National States in Western Europe, 243–327. Princeton University Press. Carneiro, R. (1970). A theory of the origin of the state. Science, 11(3947), 733–738. Centeno, M. A. (2002). Blood and Debt: War and the Nation-State in Latin America. Pennsylvania State University Press. D’Arcy, M., & Nistotskaya, M. (2018). The early modern origins of contemporary European tax outcomes. European Journal of Political Research, 57(1), 47–67. Dincecco, M. (2009). Fiscal centralization, limited government, and public revenues in Europe, 1650–1913. Journal of Economic History, 69(1), 48–103. Dincecco, M., Fenske, J., & Onorato, M. G. (2019). Is Africa different? Historical conflict and state development. Economic History of Developing Regions, 34(2), 209–250. Dincecco, M., & Prado, M. (2012). Warfare, fiscal capacity, and performance. Journal of Economic Growth, 17(3), 171–203. Dincecco, M., & Wang, Y. (2018). Violent conflict and political development over the long run: China versus Europe. Annual Review of Political Science, 21, 341–358. Emmenegger, P., Leemann, L., & Walter, A. (2020). No direct taxation without new elite representation: Industrialization and the domestic politics of taxation. European Journal of Political Research, June 26. Emmenegger, P., & Walter, A. (2020). The great war and the origins of taxation: Sister republics parting ways. Paper presented at 2020 SASE virtual conference, early view. Finer, S. E. (1975). State- and nation-building in Europe: The role of the military. In C. Tilly (ed.), The Formation of National States in Western Europe, 163–217. Princeton University Press. Gennaioli, N., & Voth, H.-J. (2015). State capacity and military conflict. Review of Economic Studies, 82(4), 1409–1448. Gleditsch, N. P., Wallensteen, P., Eriksson, M., Sollenberg, M., & Strand, H. (2002). Armed conflict 1946–2001: A new dataset. Journal of Peace Research, 39(5), 615–637. Goenaga, A., & von Hagen-Jamar, A. (2018). When does war make states? War, rivalries and fiscal extraction in the 19th and 20th centuries. In J. Teorell, M. Hall, & J. Bartelson (eds), De-Centering State Making: Comparative and International Perspectives, 85–111. Edward Elgar Publishing. Gorski, P. S. (2003). The Disciplinary Revolution: Calvinism and the Rise of the State in Early Modern Europe. Chicago University Press. Haffert, L. (2019). War mobilization or war destruction? The unequal rise of progressive taxation revisited. Review of International Organizations, 14(1), 59–82. Hall, J. (2015). Varieties of state experience. In S. Leibfried, E. Huber, M. Lange, J. Levy, & J. Stephens (eds), The Oxford Handbook of Transformations of the State, 61–74. Oxford University Press.

War and taxation  45 Hendrix, C. (2010). Measuring state capacity: Theoretical and empirical implications for the study of civil conflict. Journal of Peace Research, 47(3), 273–285. Henrekson, M., & Waldenström, D. (2016). Inheritance taxation in Sweden, 1885–2004: The role of ideology, family firms, and tax avoidance. Economic History Review, 69(4), 1228–1254. Herbst, J. (2000). States and Power in Africa. Comparative Lessons in Authority and Control. Princeton University Press. Hertel-Fernandez, A., & Martin, C. J. (2018). How employers and conservatives shaped the modern tax state. In G. Huerlimann, W. E. Brownlee, & E. Ide (eds), Worlds of Taxation: The Political Economy of Taxing, Spending, and Redistribution since 1945, 17–48. Palgrave Macmillan. Hintze, O. (1906). Staatsverfassung und Heeresverfassung. Zahn & Jaensch. Karaman, K. K., & Pamuk, S. (2013). Different paths to the modern state in Europe: The interaction between warfare, economic structure, and political regime. American Political Science Review, 107(3), 603–626. Kato, J. (2003). Regressive Taxation and the Welfare State: Path Dependence and Policy Diffusion. Cambridge University Press. Kiser, E., & Kane, J. (2001). Revolution and state structure: The bureaucratization of tax administration in early modern England and France. American Journal of Sociology, 107(1), 183–223. Kiser, E., & Linton, A. (2001). Determinants of the growth of the state: War and taxation in early modern France and England. Social Forces, 80(2), 411–448. Levi, M. (1988). Of Rule and Revenue. University of California Press. Limberg, J. (forthcoming). Banking crises and the modern tax state. Socio-Economic Review. Londoño Vélez, J. (2014). War and progressive income taxation in the 20th century. Working Paper. Lu, L., & Thies, C. G. (2013). War, rivalry, and state building in the Middle East. Political Research Quarterly, 66(2), 239–253. Mann, M. (1986). State and society, 1130–1815: An analysis of English state finances. Political Power and Social Theory, 1, 165–208. Mares, I., & Queralt, D. (2015). The non-democratic origins of income taxation. Comparative Political Studies, 48(14), 1974–2009. Martin, I. W., Mehrotra, A. K., & Prasad, M. (2009). The New Fiscal Sociology: Taxation in Comparative and Historical Perspective. Cambridge University Press. Morgan, K., & Prasad, M. (2009). The origins of tax systems: A French-American comparison. American Journal of Sociology, 114(5), 1350–1394. North, D. C., & Weingast, B. (1989). Constitutions and commitment: The evolution of institutions governing public choice in seventeenth-century England. Journal of Economic History, 49(4), 803–832. Obinger, H., & Schmitt, C. (2018). The impact of the Second World War on postwar social spending. European Journal of Political Research, 57(2), 496–517. Peacock, A., & Wiseman, J. (1961). The Growth of Public Expenditure in the United Kingdom. Princeton University Press. Peters, B. G. (1991). The Politics of Taxation: A Comparative Perspective. Blackwell. Pierson, P. (1993). When effect becomes cause: Policy feedback and political change. World Politics, 45(4), 595–628. Poast, P. (2015). Central banks at war. International Organization, 69(1), 63–95. Queralt, D. (2019). The legacy of war on fiscal capacity. International Organization, 73(4), 713–753. Rasler, K. A., & Thompson, W. R. (1985). War making and state making: Governmental expenditures, tax revenues, and global wars. American Political Science Review, 79(2), 491–507. Sabaté, O. (2016). Does military pressure boost fiscal capacity? Evidence from late-modern military revolutions in Europe and North America. European Review of Economic History, 20(3), 275–298. Sarkees, M. R., & Wayman, F. W. (2010). Resort to War: A Data Guide to Inter-State, Extra-State, Intra-State, and Non-State Wars, 1816–2007. CQ Press. Savoia, A., & Sen, K. (2014). Measurement, evolution, determinants, and consequences of state capacity: A review of recent research. Journal of Economic Surveys, 29(3), 441–458. Saylor, R., & Wheeler, N. C. (2017). Paying for war and building states: The coalitional politics of debt servicing and tax institutions. World Politics, 69(2), 366–408. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton University Press.

46  Handbook on the politics of taxation Scott, J. C. (1999). Seeing Like a State. Yale University Press. Scott, J. C. (2017). Against the Grain: A Deep History of the Earliest States. Yale University Press. Seelkopf, L., Bubek, M., Eihmanis, E., Ganderson, J., Limberg, J., Mnaili, Y., Zuluaga, P., & Genschel, P. (2021). The rise of modern taxation: A new comprehensive dataset of tax introductions worldwide. Review of International Organizations, 16(1), 239–263. Sharma, V. S. (2015). Kinship, property, and authority: European territorial consolidation reconsidered. Politics and Society, 43(2), 151–180. Soifer, H. D. (2008). State infrastructural power: Approaches to conceptualization and measurement. Studies in Comparative International Development, 43(3–4), 231–251. Spencer, H. (1876–1896). The Principles of Sociology. Williams and Norgate. Steinmo, S. (1993). Taxation and Democracy: Swedish, British and American Approaches to Financing the Modern State. Yale University Press. Taylor, B. D., & Botea, R. (2008). Tilly tally: War-making and state-making in the contemporary third world. International Studies Review, 10(1), 27–56. Thies, C. G. (2005). War, rivalry, and state building in Latin America. American Journal of Political Science, 49(3), 451–465. Thies, C. G. (2007). The political economy of state building in Sub-Saharan Africa. Journal of Politics, 69(3), 716–731. Tilly, C. (ed.) (1975). The Formation of National States in Western Europe. Princeton University Press. Tilly, C. (1985). State formation as organized crime. In P. Evans, D. Rueschemeyer, & T. Skocpol (eds), Bringing the State Back In, 169–191. Cambridge University Press. Tilly, C. (1990). Coercion, Capital, and European States, AD 990–1990. Blackwell. Timmons, J. F. (2005). The fiscal contract: States, taxes, and public services. World Politics, 57(4), 530–567. Vu, T. (2010). Studying the state through state formation. World Politics, 62(1), 148–175. Walter, A., & Emmenegger, P. (2021). Does war exposure increase support for state penetration? Evidence from a natural experiment. Journal of European Public Policy. Weber, M. (1923). Wirtschaftsgeschichte. Abriss der universalen Sozial- und Wirtschaftsgeschichte. Duncker und Humblot.

4. Political institutions and taxation, 1800–1945 Per F. Andersson

1. INTRODUCTION The Austrian sociologist Rudolf Goldscheid famously claimed that the budget is “the skeleton of the state stripped of all misleading ideologies” and that taxation was crucial to understanding the rise of the modern state.1 If he was right, much can be gained from studying taxation during the period from 1800 to 1945, an era that saw dramatic changes not only in public finance, but also in economic and political organization. In the early nineteenth century, states financed themselves mainly with taxes on international trade, on a few goods (like salt), and on traditional land taxes.2 Only rarely were what Seelkopf et al. (2019) call “modern” taxes in place (e.g., those on personal and corporate income). By 1945 – a century and a half later – most states had completely overhauled their tax system. Modern income tax had become the most important source of revenue, with broad-based consumption taxes increasing in importance. During the same time, taxes on property and international trade were no longer key components of governments’ budgets (Andersson & Brambor, 2019).3 Although most previous research has been concentrated on the period after the Second World War, the origins of modern taxation are to be found long before that. In fact, many states had already begun the transition to a modern tax system before the end of the war. And during the same period, the way countries were governed changed radically: from a norm of low participation from ordinary citizens with few civil or political liberties, to the emergence of modern democracies with full suffrage rights and free and fair elections. The number of democratic states in the world increased from only one in 1800 to 12 (or 22 percent) in 1900, and 23 (a third of all states) in 1945.4 Institutional innovations such as the proportional representation electoral systems spread around the world from 1899, and organized labor started to play a role in politics with the first left-wing head of government taking office in Uruguay in 1903. In short, the changes in political institutions during this period were as transformative as were the changes in taxation. Previous historical research on political institutions and taxation typically focuses on one of three factors: institutions regulating participation (such as suffrage limitations), institutions acting as constraints (such as legislative checks on the executive), or government ideology. Literature concerned with the first factor focuses on how democracy, by including the previously disenfranchised “poor masses” in the political system, affects the way states tax as democracies began to rely on a progressive and redistributive taxation structure. Literature concerned with the second dimension emphasizes how some political systems constrain executive power more than others. Building on pioneering work by North and Weingast (1989) this tradition focuses on how institutional constraints help build stronger tax states. A third group of scholars focuses instead on the input side of politics. With the rise of democracy, the incidence of the tax system became linked to the distributive basis for ideological differences between political parties. These differences are related to changes in 47

48  Handbook on the politics of taxation social cleavages as a result of industrialization and are particularly relevant during the period from the early nineteenth century onward (e.g., Lipset & Rokkan, 1967; Mann, 1993). During this period, a new urban working class emerged as a political force, represented by left-wing parties and trade unions. These political factors are particularly important between 1800 and 1945 for two reasons. First, the period from the end of the Napoleonic wars until the First World War was unusually peaceful yet characterized by major tax reforms. Moreover, warfare was associated with very different responses, sparking reform of direct taxation in some countries and increased borrowing and indirect taxation in others (Morgan & Prasad, 2009, see also Emmenegger & Walter, this volume). Second, while modernization theory correctly points out that industrialization led to a more diverse toolbox available to tax policymakers, we need politics in order to explain which tools were ultimately used. More fundamentally, taxation is about the allocation and distribution of economic resources by the government, which is a political decision. However, simple political economy models (e.g., Meltzer & Richard, 1981) fail to capture the complexity of politics.5 The rest of the chapter is structured as follows. It first reviews major themes and recent research linking taxation to participation, constraints, and ideology. It then uses newly available historical data to explore the historical evolution of taxation and the three political factors discussed in the chapter.

2.

INSTITUTIONS AND PARTICIPATION

A common starting point when analyzing the politics of taxation is that demand for redistribution is a main determinant of tax policy (Alt, 1983). This is also the starting point of one of the most influential theories linking institutions to tax policy, which posits that democracy leads to redistribution.6 The argument is based on the median voter theorem and the distribution of income among voters. In a democracy, the median voter determines tax and spending policy, and if the income of the median voter is lower than the mean income, taxation will be redistributive. This means that for a given inequality of income, extending suffrage to the poorer segments of society will lower the income of the median voter and thus increase redistribution (Meltzer & Richard, 1981; Romer, 1975). The first strand of research builds directly on this intuition and focuses on the representational aspect of democracy: democratic states allow a larger set of the population to participate in politics, and given that these previously disenfranchised citizens are poor, democracies should redistribute more. One way of doing this is to tax the rich more heavily, which is usually interpreted as higher taxes on income and wealth. Empirical results from studies focusing on the post-Second World War era are mixed. Some have found support for the Meltzer and Richard hypothesis (e.g., Lee, 2005; Mueller & Stratmann, 2003), while others have found that democracy is unrelated to progressive taxes on income and capital, but instead is associated with increased regressive taxes on consumption (Timmons, 2010). While most studies focus on the last decades of the twentieth century, there is a growing body of more historically oriented research on participation and taxation. Recent work on the origins of income tax finds that extending the franchise actually decreases the probability of adopting an income tax (Mares & Queralt, 2015), at least at low levels (Aidt & Jensen, 2009b).

Political institutions and taxation, 1800–1945  49 Expansion of voting rights has also been linked to a higher share of revenues from direct taxation (Aidt & Jensen, 2009b) (but only when collection costs are low), and a larger government in general (Aidt & Eterovic, 2011), but possibly in a non-linear fashion (Aidt & Jensen, 2013). However, a recent study found no impact on wealth taxation (Scheve & Stasavage, 2010). Historical information on taxation is hard to come by, and a major weakness of previous studies is the small samples, usually constrained to ten or fewer countries in Western Europe. Moreover, tax revenue is often measured in aggregates such as direct and indirect taxes, which is problematic since taxes on farmland, wealth, and income are very different in terms of the political coalitions forming around them. An exception is Andersson (2018a), which studies a global sample of 31 states, with detailed information on tax revenues. The findings suggest that the impact of democratization depends on the urbanization rate: more urban countries shift taxation in line with the tax preferences of the urban poor, increasing income and property taxes, while rural countries instead shift taxation in line with tax preferences of the rural poor by reducing property taxes. Another effort going beyond Western Europe is Brambor (2016), which finds that although democracies are no more likely to introduce income taxes than non-democracies, the taxes they introduce are more efficient: income taxes introduced by democracies generate more revenue than those introduced by autocracies.

3.

INSTITUTIONS AND CONSTRAINTS

A second strand of literature focuses on how institutions constrain executive power. Scholars have argued that constitutions constraining the ruler in autocratic states allow governments to credibly commit to honor promises (related to, e.g., private property rights and loans), thus allowing the state to borrow at a lower interest rate (North & Weingast, 1989; Stasavage, 2002) and attract more private investment (Gehlbach & Keefer, 2011, 2012; Stasavage, 2002).7 Dincecco (2009) also focuses on executive constraints but, in contrast to previous studies, tries to explain differences in tax revenue. Dincecco argues that executive constraints are not enough: for a state to drastically increase public revenues, fiscal centralization is also needed. Using information from 11 European states from 1650 to 1913 he finds that the states able to collect most revenues are indeed those with a centralized fiscal system and executive constraints. One of the drawbacks with his approach is that political institutions are dichotomized (states are either “absolutist” or “limited”), obscuring important variation in how states are governed. Besley and Persson (2011) instead see taxation as an investment in fiscal capacity. Political institutions constraining executive power are more conducive to these investments. In contrast to much of previous research focusing on the power of the legislature, Besley and Persson also include the electoral system, legislative decision rules and independent judiciaries. What they term “cohesive political institutions” are claimed to facilitate spending on public goods and investments in state capacity.8 Empirically, Besley and Persson (2009) find democracy and external conflict to be positively related to fiscal capacity. They also find (Besley & Persson, 2011, chapter 2) that executive constraints (the indicator for “cohesive” institutions) and openness of executive recruitment (from the Polity IV dataset) are both positively associated with fiscal capacity. Unfortunately, the analysis is restricted to the period after 1975.

50  Handbook on the politics of taxation A related challenge to the view that democracy is a driver of tax reform comes from the elite-competition approach. This approach emphasizes how industrialization gave rise to a new economic elite challenging the old agrarian elite, and how the conflict between these groups shaped tax policy. Mares and Queralt (2015) argue that the reason they find no positive impact of suffrage on income tax introduction is that the personal income tax (PIT) can be used by the old elite to check the rising power of their urban competitors. Countries with stronger rural elites (as measured by land inequality) should therefore be more likely to introduce income tax. They find support for this hypothesis analyzing the introduction of income tax in 17 countries between 1815 and 1939. The strength of rural elites is not the whole story, however. Mares and Queralt (2015) demonstrate that in some circumstances income tax can be introduced as the result not of elite competition but as the result of elite cooperation. This is the case since many countries in nineteenth-century Europe required payment of direct taxes as a criterion for voting rights. In the presence of this provision, income tax could be used as a way of excluding the poor from political power. This meant, Mares and Queralt (2015) argue, a common interest for agricultural and manufacturing elites, and in countries with this type of electoral laws the income tax was introduced not as the result of elite competition but as the result of an agricultural manufacturing alliance. Another recent contribution using this approach finds that the impact of elite competition on taxation is different under early and late industrialization. In early industrializing states there was more fierce competition between the old and the new elite. The new elite favored a well-financed state capable of providing more public goods. Since they could neither push for taxes hurting the old elite (e.g., land taxes) nor modern – yet to be invented – consumption taxes (e.g., value-added tax (VAT)), they were left with supporting taxes on themselves, which according to the authors meant “progressive direct taxes.” In late industrializing nations, elite competition was less intense, and industrialization was seen as a means to support rural development. In this context it was possible for the elite to shift the tax burden elsewhere, and these states instead rely more on regressive consumption taxes (primarily VAT) (Beramendi et al., 2019). The authors measure elite competition with a battery of indicators commonly used to measure constraints and democracy (such as competitiveness of executive recruitment and elections, existence of independent opposition, and executive constraints), which makes it possible to interpret the results of the analysis in more than one way. Moreover, while the authors make a theoretical distinction between taxes on property and income, they aggregate these two together in the empirical analysis, which further complicates the interpretation. Emmenegger et al. (2020) also stress the fact that the new economic elite favored a more prominent role of the state, in particular in terms of investing in infrastructure and public education. To fund these programs, the new elite preferred direct taxation over alternatives such as taxes on international trade (which would hurt their economic interests). Importantly, the authors point out that economic influence does not automatically translate into political influence (which is the assumption in previous work). For the new economic elite to affect tax policy it needs to have political power, either directly through representative institutions or indirectly through citizen assemblies or direct democratic institutions. Political influence is important not only as a way to affect tax policy, but also as a way to establish a fiscal contract wherein the new economic elite can make sure that the revenue from taxes falling on them is spent on projects they benefit from. Thus, the expansion of direct taxation in the nineteenth

Political institutions and taxation, 1800–1945  51 century is not the result of the old landed elite seeking to check the power of the new manufacturing elite, but of a new economic elite pushing for tax reform in order to fund public investment programs. Importantly, this link between industrialization and tax reform depends on whether the new economic elite has political influence. Emmenegger et al. (2020) find support for their argument by analyzing novel subnational data from Switzerland. While increasingly popular as an alternative explanatory model, it is unclear how well the elite-competition argument travels. First, using a sample also including cases from outside Western Europe, Andersson (2018b) finds no evidence that elite competition is linked to PIT introduction. Second, recent evidence from Sweden based on probate inventories suggests that many agricultural elites were heavily invested also in the modern economy, which casts doubt on the assumption that there are two well-defined elite groups with radically different tax preferences (Bengtsson & Olsson, 2018).

4.

INSTITUTIONS AND IDEOLOGY

In his seminal Essays on Taxation, Edwin Seligman stressed the importance of conflict between economic classes such as farmers, urban workers, landed elites, and capitalists when explaining tax systems. In fact, Seligman held that “[t]he history of modern taxation is largely the history of these class antagonisms” (1921, p. 14). The final strand of literature follows Seligman and highlights the fact that democracy and constraints alone can only explain so much. In order to explain tax outcomes, we also need to consider the input side of politics: ideology and political parties. It is not enough to grant the poor the franchise; political parties are needed to organize and mobilize voters, and to formulate and make policy. In most countries voters vote for parties, and parties form governments. Does it matter for tax policy if a left-wing or a right-wing government is in power? Does it matter more in some political systems and less in others? These are some of the questions this literature is trying to answer. Interestingly, previous research has found that parties matter, but sometimes in unexpected ways. Scholars have explored a range of topics such as the impact of ideology on the size of government, unemployment, and welfare spending (e.g., Cameron, 1978; Hibbs, 1977; Hicks & Swank, 1992). Among the findings are that left parties are associated with larger governments (Tavits 2004), more redistribution (Bradley et al., 2003; Iversen & Soskice, 2006), and (under some conditions) higher taxes on labor (Beramendi & Rueda, 2007; Cusack & Beramendi, 2006). While this suggests that partisanship matters, others find that government ideology has no impact (see Imbeau et al., 2001 for a meta study). Focusing mainly on the post-Second World War era, several scholars emphasize the co-development of taxation and the welfare state (Beramendi & Rueda, 2007; Bradley et al., 2003; Cusack & Beramendi, 2006; Ganghof, 2006; Kato, 2003; Kemmerling, 2009; Steinmo, 1993). However, the nature of this relationship is contested. Some argue that an efficient tax system (in terms of generating revenue) facilitated a large state (e.g., Kato, 2003), whereas others claim that spending pressure caused the state to increase revenue capacity (e.g., Ganghof, 2006). Others argue that the left is constrained by corporatist interest groups or that the left taxes regressively since it can credibly commit to progressive transfers (Beramendi & Rueda, 2007; Cusack & Beramendi, 2006; Timmons, 2010), commitments that are more readily made in proportional representation systems (Andersson, forthcoming).9

52  Handbook on the politics of taxation Sometimes forgotten in these explanations is that the mix between different types of taxes is persistent and that tax systems are strongly path dependent (Morgan & Prasad, 2009; Kemmerling, 2009), making it important to investigate the origins of divergent patterns observed during the second half of the twentieth century. Although most research focuses on the post-war era, the roots of the modern taxation system are to be found long before that. Another problem with focusing on the post-war era is that this period is very particular with welfare state expansion (far beyond any social programs seen before), advanced economies requiring a much more highly educated workforce, and international organizations such as the International Monetary Fund promoting the adoption of certain taxes (in particular VAT). These are just a few examples of factors that could impact the effect of government ideology. Importantly, these factors were not present in the period before 1945, suggesting that the impact of left-wing influence on taxation might be different historically. Left-wing governments are fairly recent: there was no left-wing head of government before 1903. But already by the 1920s there were frequently five or more governments headed by a left-wing politician (Brambor et al., 2014). Despite the overwhelming majority of scholars focusing on the last decades of the twentieth century, there is a growing historical literature. Aidt and Jensen (2009a) study ten countries in Western Europe from 1860 to 1938 and find that the left-wing seat share in parliament is associated with less taxing and spending, more revenue from customs, and less from market taxes. And others have shown that, contrary to expectations, the first income taxes were adopted by conservatives in political systems with very limited suffrage (e.g., Mares & Queralt, 2015). But in the United Kingdom, the influence of the Labour Party in the late nineteenth century led to increased taxes on land, and in Australia the Labor Party introduced a progressive land tax in 1910 (Barnes, 2011). In contrast, Scheve and Stasavage (2010) find no impact of left-party influence on tax progressivity. Mares and Queralt (2020) explore the origins of income tax in Western Europe, noting that not only was it more commonly introduced by non-democratic states, but that it was also linked to Conservative politicians representing the landed elite. Building on their argument in Mares and Queralt (2015), they claim that the income tax was supported by Conservatives for two reasons. First – following the elite-competition logic – it shifted the tax burden onto the modern economic sector. Second, in countries where voting rights were conditional on tax payments, income tax gave the rich elite an opportunity to keep a tight grip on political power. They demonstrate the plausibility of their causal mechanism with a detailed analysis of an 1891 income tax reform in Prussia using district-level data. A related argument instead stresses alliances between the elite and the poor, focusing on political alliances rooted in trade preferences (Barnes, 2020). Progressive taxation is the result of a compromise in which an elite group supports progressive taxation in exchange for organized labor supporting trade policy preferred by the elite group (as in earlier research using the elite-competition approach, there are two elite groups: the old landed elite and the new urban elite). If the rich elite is divided on trade policy – i.e., the level of protection from international trade – one elite group might find a useful ally in organized labor (if they hold similar preferences). This alliance is only possible, Barnes argues, if a compromise is struck where the poor/ labor supports the preferred trade policy in exchange for progressive tax reform. Importantly, this alliance is not possible if inequality is too high since labor would then demand radical levels of redistribution.

Political institutions and taxation, 1800–1945  53 Testing this argument, Barnes (2020) finds that closeness of labor preferences to one elite group – measured as endowments of land (geographic area), capital (length of railway), and labor (population) – predicts progressivity of the tax system as indicated by the share of direct/ indirect taxes, and top rates of PIT and inheritance tax (INH). Qualitative evidence from Britain between 1903 and 1910 provides additional evidence of the plausibility of the causal mechanism. Electoral coalitions in 1906 between Liberals and Labour were more common in constituencies in favor of free trade, and members of parliament from free trade-leaning constituencies were more likely to vote in support of the progressive “People’s Budget” of 1906. While early contributions were interested in the pure effect of parties, few were concerned with how this effect is mediated by formal institutions (Schmidt, 1996). Lately, this possibility has been explored by scholars who found that the effect of left parties on the size of government is stronger in more majoritarian countries (Tavits, 2004), the effect of partisanship on welfare expenditure is muted by the number of constitutional veto points (Kühner, 2010), and the effect of parties is stronger where the legislature dominates the executive (Cusack & Beramendi, 2006). However, the period before 1945 is less studied, despite there being plenty of variation both in political institutions and ideology of governments in this era. An exception is Andersson (2019), which presents evidence on the conditional impact of ideology from 1870 to 1945. Analyzing a sample of more than 30 countries worldwide, he finds that left governments tax income heavier than consumption in countries using majoritarian electoral systems, while they tax consumption heavier than income in countries using proportional representation systems. This supports the notion that left-wing governments are more likely to increase regressive taxation in systems in which they are more confident they can use the revenue to fund progressive social programs.10

5.

EXPLORING THE DATA

A major weakness in many historical studies is the small samples, often constrained to Western Europe. Fortunately, a number of recent data collection efforts have made it possible to explore patterns beyond the European experience. In this section I use these data to explore patterns of political institutions and taxation. Importantly, the purpose is not rigorous hypothesis testing, but rather to explore the data with respect to the three dimensions reviewed above: participation, constraints, and ideology. I focus on two aspects of taxation: the introduction of key taxes (such as PIT) and the tax mix. Earlier research has focused heavily on the income tax, partly because it is one of the most important tax innovations of the era, and partly because of the difficulty of explaining its introduction using standard political economy models. Thus, I will pay special attention to income taxes in the following section. There are several new historical datasets on politics and taxation which I am able to use in the analysis below. First, I use two datasets on democracy and political institutions. Boix et al. (2012) provide a binary democracy indicator based on participation and contestation. The Historical Varieties of Democracy dataset contains a number of detailed variables on political institutions, among those the extent of the franchise and legislative constraints on the executive which I use below.11 Second, I rely on a newly available dataset on the ideology of heads of government (Brambor et al., 2014). The dataset codes the ideological orientation of the head of government

54  Handbook on the politics of taxation (left, right, or center) in 33 countries from 1870 to 2012. “Left” parties have a strong redistributive platform and include communist, socialist, or social democratic parties. “Center” parties are agrarian and social liberal parties. Coded “right” are conservative, market-liberal, Catholic, Christian democratic, and fascist parties. For example, in the United Kingdom, the Conservatives are coded “right,” the Liberals “center,” and Labour “left.” These three datasets all go beyond the traditional sample of a handful of states in Western Europe. Although the information on government ideology covers fewer countries than the datasets on democracy and political institutions, the sample size is not small considering the number of sovereign states during the period of interest: in the early twentieth century there were only 55 sovereign states in the world (Karatnycky, 2000). There is also new information on taxation – both on when taxes were introduced, and on how much revenue was collected from them. The Tax Introduction Database presents information on tax introductions in 220 jurisdictions between 1750 and 2018 (Seelkopf et al., 2019). The taxes covered by the database are PIT, corporate income tax (CIT), INH, general sales tax, VAT, and social security contributions. The second new historical source on taxation is the Financing the State dataset, presenting data on tax revenues and their compositions in 31 states from 1800 to 2012 (Andersson & Brambor, 2019).12 It provides information on the share of revenue from income, property, excises, consumption, and international trade taxes, as well as total tax revenues normalized by gross domestic product. Previous historical datasets suffer not only from a small geographical sample (mostly focusing on Western Europe), but also from a lack of detail. By presenting information only on aggregates such as total revenues or the share of direct/indirect taxes, important distinctions are lost. For example, taxes on land and taxes on income – both direct taxes – do not affect everyone the same, making it difficult to interpret the politics behind a change in direct taxes as a whole. 5.1 Participation Traditional political economy models predict that countries with broader access to the political system have more progressive tax systems. This implies that states with broader suffrage should be more likely to introduce direct taxes, and also to devise a tax mix relying more heavily on these taxes. Table 4.1 reports suffrage rates at the time three direct taxes were introduced in sovereign states: PIT, CIT, and INH. Generally, suffrage was more widespread than average at introducTable 4.1 Tax

Tax introductions, participation, and constraints Suffrage share

Difference

Constraints

Difference

Sample mean

29

47

Personal income tax

41

12

54

7

51

22

59

12

37

8

46

–1

introduction Corporate income tax introduction Inheritance tax introduction

Source:

Tax introduction dates: Seelkopf et al. (2019); suffrage and constraints: Coppedge et al. (2017).

Political institutions and taxation, 1800–1945  55

Source:

Suffrage: Coppedge et al. (2017); tax introduction year: Seelkopf et al. (2019).

Figure 4.1

Suffrage and personal income tax introduction

1tion dates. This was especially so for CIT, where the average rate of suffrage was 51 percent at introduction, compared to the overall average of 29 percent. The average suffrage rate at the introduction of PIT and INH were 41 and 37 percent, respectively. The adoption of PIT has generated considerable attention in the literature. One of the main puzzles has been the failure to find a link between PIT introduction and suffrage levels. Interestingly, when extending the sample beyond Western Europe to which previous research has been constrained, a different picture emerges. Figure 4.1 plots the year of PIT introduction against the extent of the suffrage in the same year.13 Contrary to previous findings, there is no pattern emerging suggesting that low-franchise countries introduce PIT earlier. Austria, Britain, and Italy stand out as introducing the tax unusually early while also severely restricting the franchise. Among the rest of the countries there is no discernible pattern: low-suffrage countries introduce PIT both early and late. Figure 4.1 clearly illustrates that once we include countries outside of Western Europe into our analysis, a different picture than emphasized by previous research emerges: low-suffrage countries are not pioneering PIT.14 In fact, the figure suggests there is no clear pattern between PIT adoption and the extent of suffrage, indicating that neither the orthodox view – linking PIT to democratization – nor the alternative view – emphasizing the non-democratic origin of PIT – have much traction on a global scale. While these are purely descriptive findings and should be taken as such, they do encourage looking more closely at other explanatory factors such as executive constraints, war, or elite competition. It has been common among scholars to equate democracy with suffrage rights (closely following the Meltzer and Richard model). However, democracy is about more than the right to vote. It is common for non-democratic regimes to allow voting while restricting competition in other ways, such as banning some parties from running, limiting freedom of the press, and outright electoral fraud. Instead, political scientists often use broader definitions of democracy that take into account aspects such as competition and free and fair elections.

56  Handbook on the politics of taxation

Source:

Taxation: Andersson and Brambor (2019); democracy: Boix et al. (2012).

Figure 4.2

Democracy and income tax revenue

A dataset using a broader conceptualization of democracy than suffrage alone is the Complete Data Set of Political Regimes (Boix et al., 2012), which provides a simple democracy indicator based on participation and contestation. For a country/year to be classified as democratic a majority of the population must have the right to vote and the executive needs to be directly or indirectly elected in free and fair elections. The dataset covers 219 countries from 1800 to 2007.15 Using the tax revenue data from Andersson and Brambor (2019), Figure 4.2 indicates that even though democratization might not be responsible for the introduction of income tax, it is associated with a marked increase in the share of income tax in the overall budget. As countries democratized they moved to a more progressive tax mix, which is in line with the orthodox view that democracies tax more progressively. In sum, the descriptive evidence here – based on a wider sample than previous research – suggests two tentative conclusions. First, there is no clear pattern between the extent of suffrage and the timing of income tax introductions, contrary to both the orthodox view and the elite-competition approach. Second, as expected, countries shifted to a more progressive tax mix after democratization. 5.2 Constraints An alternative to the democracy-causes-taxes view is that what matters is not how institutions regulate political participation, but how they regulate constraints on executive power. The Historical V-Dem dataset provides unprecedented coverage both in time and space, with 80 countries covered from 1789 to 2017. The level of detail of its democracy-related variables is unmatched. For the descriptive exercise below, I use an indicator from V-Dem measuring legislative constraints on the executive (which is close in spirit to what is meant by constraints in the literature cited above).16 The variable is an index from 0 (low) to 1 (high) measuring to what extent the legislature and government agencies are capable of questioning, investigating, and exercising oversight over the executive.17 Table 4.1 shows the mean values of legislative constraints when countries introduced three direct taxes, compared to the overall mean. On average, taxes on individuals’ and corpora-

Political institutions and taxation, 1800–1945  57

Source:

Taxation: Andersson and Brambor (2019); constraints: Coppedge et al. (2017).

Figure 4.3

Constraints and income tax revenue

tions’ income were introduced by countries with higher legislative constraints. Interestingly, for INH, the pattern is the opposite: this tax was introduced by countries with below-average legislative constraints. A similar pattern emerges when considering the timing of tax introductions (which is stressed by previous literature): countries with more executive constraints introduced PIT and CIT earlier, while there is no clear pattern with respect to INH (see graphs in the online appendix).18 Analyzing the correlation between legislative constraints and revenue from different taxes is another way of probing the ideas mentioned above. A tax might just exist on paper and governments may only be able to extract significant revenues from existing taxes once constraints are in place. Figure 4.3 shows the index of legislative constraints on the executive on the horizontal axis and the share of tax revenues from income tax on the vertical. Countries/years with higher constraints also extract relatively more from income tax than countries/years with low constraints. Interestingly, no such pattern appears when considering overall tax revenues as a share of gross domestic product, or the share of property tax, illustrating the importance of disaggregating direct taxes (figures available in the online appendix). In sum, exploring a global sample we find that PIT and CIT were introduced by countries with above-average legislative constraints on the executive. These states also introduced income taxes earlier, and generated a larger share of revenues from them. 5.3 Ideology The third dimension of politics and taxation highlighted by previous research is the ideology of governments. While left-wing power has been predicted to lead to more progressive tax systems, both modern and historical research has often found the opposite. Table 4.2 uses the Tax Introduction Database and the Ideology of Heads of Government datasets to show what types of government introduced what taxes. As before, focus is on direct taxes. In line with previous studies of smaller samples, PIT was adopted more often by right-wing governments (although not overwhelmingly so). The pattern is clearer for CIT,

58  Handbook on the politics of taxation Table 4.2

Ideology and tax introduction Personal income tax

Corporate income tax

Left

6

3

Inheritance tax 0

Center

9

4

6

Right

9

11

7

Source: Year of tax adoption: Seelkopf et al. (2019); ideology: Brambor et al. (2014).

where 11 out of 18 introductions were by conservative governments. In the sample there were no instances of a left-wing government introducing INH, most likely since INH was introduced early in most countries while left-wing governments did not exist until the early twentieth century.19 This pattern reveals a more fundamental problem with earlier research into tax introductions and ideology: if a tax is already implemented, it cannot be introduced anew by an incoming left-wing government. Thus, if one is interested in how the ideology of government affects tax policy (as opposed to the determinants of a specific tax) tax revenue is a better indicator. Figure 4.4 depicts the tax mix of left and non-left (conservative and centrist) governments averaged over the period 1870 (the starting year of the Heads of Government dataset) and 1945. Left-wing governments generate more revenue from income tax and less from property tax than non-left governments. They also differ from conservative and centrist governments with respect to indirect taxation: left-wing governments rely relatively more on broad-based consumption taxes and relatively less on taxes on international trade. There is no great difference in revenues from excise taxes.

Source:

Taxation: Andersson and Brambor (2019); ideology: Brambor et al. (2014).

Figure 4.4

Ideology and tax revenue

In sum, the link between ideology of governments and taxation is different for tax introductions and tax revenues. While left-wing governments rarely introduced progressive taxes, they were associated with a progressive change in the tax mix. Most markedly, left-wing governments relied more on income tax. The evidence from the tax mix data also reveals the importance of differentiating between different direct taxes: while left-wing governments relied more on income tax, they relied less on property taxes. This interesting finding suggests

Political institutions and taxation, 1800–1945  59 that only looking at the sum of all aggregate direct taxes (as e.g., Beramendi et al., 2019; Barnes, 2020) hides potentially important aspects of the politics of taxation. 5.4 Summary This exploration of new data sources going beyond the experience of Western Europe has both validated some of what earlier scholars have found and also unearthed new patterns. First, while PIT was introduced by both democracies and non-democracies, it was more common in the former (in line with previous findings). However, the pattern for tax revenues is different: countries generated more revenue from income tax after democratization. Second, countries with stronger legislative constraints on the executive were more likely to introduce PIT and CIT, and did so earlier. Stronger constraints were also linked to higher revenues from income taxes. Third, direct taxes such as inheritance and income taxes were more often adopted by centrist or conservative governments than by left-wing governments. However, the tax revenue data suggest that although left-wing governments did not introduce income taxes to a large extent, they did rely more on revenue from these sources than other governments. Tax revenue data also suggest there are interesting patterns to explore at a lower level of aggregation: for example, left-wing governments relied less on property taxes and tariffs and more on broad-based consumption taxes than centrist and right-wing governments.

6. CONCLUSION The links between political institutions and tax policy are not always straightforward. For example, while countries with inclusive suffrage rights and left-wing governments were not associated with early introductions of progressive taxation, they generated more revenue from these taxes. Constraints on the executive on the other hand were found to be consistently linked to both the introduction of and revenue from progressive taxes. Compared to previous research, the short descriptive exercise above suggests that the politics of taxation globally is different from the experience of Western Europe. For example, while the non-democratic adoption of PIT seems to be a particular European experience, executive constraints appear to matter also in a global sample. Another important finding was that focusing only on aggregates such as direct taxes might be misleading. For example, left-wing governments increase income tax revenue but lower property tax revenues, an important pattern that is obscured by focusing on the sum of all direct taxes only. One fruitful avenue for further research is to explore the interaction between the three dimensions highlighted in this chapter. For example, are the effects of suffrage expansion and left-wing rule different depending on how power is organized between legislatures and executives?20 The new historical datasets recently made available also provide new possibilities for scholars, such as exploring sequences of tax introductions and revenues. Another possibility is to analyze in more detail regional differences in the evolution of political institutions and taxation. There are still very few in-depth case studies outside of the Western world. Finally, future research should start investigating the emergence and expansion of tax administrations. Previous research focuses on outcomes in terms of legislation and revenues,

60  Handbook on the politics of taxation leaving out the important aspect of implementation. In order to expand fiscal capacity, countries need a well-educated, efficient, and impartial bureaucracy. Crucially, the creation of an efficient and powerful tax administration is a political decision, and often a controversial one since, for example, a functioning income tax requires individuals and corporations to provide information to the government.

NOTES 1. Quoted in Schumpeter (1991 [1918]), p. 100. 2. See also Kiser (this volume) on taxation in pre-modern states. 3. Based on a novel dataset covering 31 countries in Europe, the Americas, Australia, New Zealand, and Japan. 4. Using the data and definition of democracy in Boix et al. (2012). 5. I am implicitly assuming that political institutions have an impact on taxation and not the other way around. But this is not necessarily the case since taxation can lead to popular mobilization in support of democracy and thus turn the causal arrow in the opposite direction (e.g., Bates & Lien, 1985; Herb, 2005; Moore, 2004; Ross, 2004). It is also important to note that this chapter only concerns taxation and not redistribution since the latter also involves government expenditure. 6. For an early version of this argument see Wicksell (1958 [1896]). 7. This aspect of institutions has also been identified as important when explaining the taxation in early modern Europe (Karaman & Pamuk, 2013). 8. Their ultimate goal is to explain divergent outcomes in economic development and in their 2011 book they provide a general theory of development clusters. In this chapter I focus only on the aspects relevant to taxation. 9. For a longer discussion of related literature see Haffert (this volume) and Kemmerling and Truchlewski (this volume). 10. Andersson (2022) explores the causal mechanism in more detail by analyzing reforms to consumption taxes in Britain and Sweden during the post-Second World War period. 11. I describe these in more detail in the relevant sections. 12. Available online at: perfandersson​.com/​data. 13. In contrast to previous studies that focus only on male suffrage, I include both male and female suffrage in the indicator used. The pattern in Figure 4.1 is similar if one focuses only on male suffrage. The clustering of countries around the 0.5 mark indicates that most states introduced personal income tax while having full male but not female suffrage. 14. Similarly, there is no pattern of low-suffrage countries introducing the corporate income tax earlier. The only discernible pattern is that inheritance tax was introduced earlier by states with low suffrage. See graphs in online appendix. 15. The datasets provide two versions of the indicator: one in which the suffrage requirement is based on male population only, and one classifying countries based on suffrage rights for both male and female. Figure 4.2 is based on the first one. 16. The focus on legislative constraints is natural given that most states in the period 1800–1945 had some type of legislature in place. However, they varied widely in how much influence they had over the executive. 17. For a detailed description of the variable, see the V-Dem codebook. 18. https://​www​.perfandersson​.com/​research​.html 19. The first left-wing head of government in the database is José Batlle Ordonez in Uruguay in 1903 (Brambor et al., 2014). 20. Andersson (2018a, 2019) and Brambor (2016) have started to explore some of these interactions.

Political institutions and taxation, 1800–1945  61

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62  Handbook on the politics of taxation Emmenegger, P., Leemann, L., & Walter, A. (2020). No direct taxation without new elite representation: Industrialization and the domestic politics of taxation. European Journal of Political Research, June 26. Ganghof, S. (2006). Tax mixes and the size of the welfare state: Causal mechanisms and policy implications. Journal of European Social Policy, 16(4), 360–373. Gehlbach, S., & Keefer, P. (2011). Investment without democracy: Ruling-party institutionalization and credible commitment in autocracies. Journal of Comparative Economics, 39(2), 123–139. Gehlbach, S., & Keefer, P. (2012). Private investment and the institutionalization of collective action in autocracies: Ruling parties and legislatures. Journal of Politics, 74(2), 621–635. Herb, M. (2005). No representation without taxation? Rents, development, and democracy. Comparative Politics, 37(3), 297–316. Hibbs, D. A. (1977). Political parties and macroeconomic policy. American Political Science Review, 71(4), 1467–1487. Hicks, A. M., & Swank, D. H. (1992). Politics, institutions, and welfare spending in industrialized democracies, 1960–82. American Political Science Review, 86(3), 658–674. Imbeau, L. M., Pétry, F., & Lamari, M. (2001). Left-right party ideology and government policies: A meta-analysis. European Journal of Political Research, 40, 1–29. Iversen, T., & Soskice, D. (2006). Electoral institutions and the politics of coalitions: Why some democracies redistribute more than others. American Political Science Review, 100(2), 165–181. Karaman, K. K., & Pamuk, S. (2013). Different paths to the modern state in Europe: The interaction between warfare, economic structure, and political regime. American Political Science Review, 107(3), 603–626. Karatnycky, A. (2000). A century of progress. Journal of Democracy, 11(1), 187–200. Kato, J. (2003). Regressive Taxation and the Welfare State. Cambridge University Press. Kemmerling, A. (2009). Taxing the Working Poor: The Political Origins and Economic Consequences of Taxing Low Wages. Edward Elgar Publishing. Kühner, S. (2010). Do party governments matter after all? Executive ideology, constitutional structures and their combined effect on welfare state change. Journal of Comparative Policy Analysis: Research and Practice, 12(4), 395–415. Lee, C.-S. (2005). Income inequality, democracy, and public sector size. American Sociological Review, 70(1), 158–181. Lipset, S. M., & Rokkan, S. (eds) (1967). Party Systems and Voter Alignments: Cross-National Perspectives. The Free Press. Mann, M. (1993). The Sources of Social Power: The Rise of Classes and Nation-States, 1760–1914, Vol. 2. Cambridge University Press. Mares, I., & Queralt, D. (2015). The non-democratic origins of income taxation. Comparative Political Studies, 48(14), 1974–2009. Mares, I., & Queralt, D. (2020). Fiscal innovation in nondemocratic regimes: Elites and the adoption of the Prussian income taxes of the 1890s. Explorations in Economic History, 77, 101340. Meltzer, A. H., & Richard, S. F. (1981). A rational theory of the size of government. Journal of Political Economy, 89(5), 914–927. Moore, M. (2004). Revenues, state formation, and the quality of governance in developing countries. International Political Science Review, 3, 297–319. Morgan, K. J., & Prasad, M. (2009). The origins of tax systems: A French-American comparison. American Journal of Sociology, 114(5), 1350–1394. Mueller, D. C., & Stratmann, T. (2003). The economic effects of democratic participation. Journal of Public Economics, 87(9–10), 2129–2155. North, D. C., & Weingast, B. R. (1989). Constitutions and commitment: The evolution of institutions governing public choice in seventeenth-century England. Journal of Economic History, 49(4), 803–832. Romer, T. (1975). Individual welfare, majority voting, and the properties of a linear income tax. Journal of Public Economics, 4(2), 163–185. Ross, M. L. (2004). Does taxation lead to democratization? British Journal of Political Science, 34, 229–249.

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5. The colonial tax state Laura Seelkopf

1. INTRODUCTION The development of the modern tax state is closely related to the development of the nation state itself. As Joseph Schumpeter, one of the fathers of fiscal sociology, put it at the end of the First World War: “The spirit of a people, its cultural level, its social structure, the deeds its policy may prepare – all this and more is written in its fiscal history, stripped of all phrases. He who knows how to listen to its message here discerns the thunder of world history more clearly than anywhere else” (Schumpeter, 1918, p. 7). Also in more recent times, scholars continue to see taxation as a core state power (Genschel & Jachtenfuchs, 2018) and use it to gauge state capacity in developing countries (Rogers & Weller, 2014). Given the close link between taxation and the state itself, it is no surprise that many scholars have studied the development of the state via taxation (Dincecco, 2015; Besley & Persson, 2009; Tilly, 1975). Hereby, a majority of studies focus on the experience of European nation states in the nineteenth and early twentieth centuries and adopt a very domestic focus of explaining the development of the modern tax state (for earlier tax developments see Kiser, this volume). The literature argues that the modernization of Western tax states is driven by three – mostly domestic – factors: economic development, democratization and war. This focus on the Western experience and domestic explanations seems not surprising when we look at where the majority of scholars publishing in leading journals stem from or reside (see Hakelberg & Seelkopf, this volume). Yet, it is puzzling when considering that the majority of the world population lives in countries that were former colonies, whose fundamental tax politics were dictated by representatives of the metropole. In fact, many of today’s modern taxes have their roots in colonial introductions (Seelkopf et al., 2019). Given that “how fiscal systems develop depends significantly on how they started” (Zolt & Bird, 2005, p. 1649), a more historical account of colonial tax systems and their developments is essential. This chapter aims to fill part of this gap by bringing together scholarship in economic history with more recent studies in economics and political science. I will illustrate the development of modern taxes in the colonial context via a new worldwide historical dataset on modern tax introductions (TID, Genschel & Seelkopf, 2019; Seelkopf et al., 2019). I define modern taxes as those taxes covering a broad base of income, consumption, or wealth, whose rates vary with the amount of income owned or price of products or services consumed. More precisely, I focus on six major taxes: personal and corporate income taxes (PIT and CIT), general sales tax (GST) and value-added tax (VAT), as well as inheritance taxes (INH) and social security contributions (SSC; for a more detailed definition see Genschel & Seelkopf, 2019). The next section summarizes the main findings from the academic debate on taxation, which is predominantly focused on Western modernization, and highlights its weaknesses. I then move to the colonial tax state and illustrate the extent and variety of colonial tax histories. In a next step, based on the existing literature and the new TID data, I discuss how much 64

The colonial tax state  65 the drivers of tax modernization in Europe apply to colonial tax developments. The chapter ends with a discussion of post-independence tax policies and avenues for future research.

2.

THE DRIVERS OF TAX INNOVATION IN THE WEST

Taxes are compulsory payments to the state “in exchange for nothing in particular” (Martin et al., 2009, p. 3). While taxes have existed for millennia, they have only started to fiscally matter in the last two to three centuries. A tax to gross domestic product (GDP) ratio of over 30 percent as is common in developed democracies today was unthinkable for most of the time during human development. This is due to two reasons. First, most societies lived at subsistence levels, so there was very little to tax (Kiser & Karceski, 2017). Second, even if the state could have – and wanted to – raise more revenue, it very often lacked the capacity to do so. Rather than raise taxes on a broad base with few exceptions as modern taxes do today, governments relied on plunder, monopolies, or specific excises such as salt or wine taxes to generate income (see Seelkopf et al., 2019; Kiser, this volume). These income sources were relatively easy to tax, but also distorted the economy and raised relatively little revenue. It was only with the introduction of modern taxes that the state had the instruments to tax a broad base with relatively few distortions. In this section, I discuss which disciplines analyze the development of the modern tax state, what they see as the drivers of this development and what the weaknesses of the literature are. Simplifying greatly, extant research on the causes and consequences of tax introductions can be associated with three broad disciplines: economics, sociology and political science. Various factors have been discussed to explain changes in levels and structures of taxation (e.g. Kenny & Winer, 2006; Kiser & Karceski, 2017; Genschel & Seelkopf, 2016; Steinmo, 2003; Kato, 2003; Scheve & Stasavage, 2016). Three have attracted particular attention: modernization, war and democracy. I discuss the mechanisms behind each in turn. 2.1 Modernization As the German economist Adolph Wagner conjectured in the late nineteenth century – and more recent studies have shown – states’ revenue ratio tends to grow with economic development (Wagner’s law; see Wagner & Weber, 1977): as societies get richer, states tax more (e.g. Kiser & Karceski, 2017). The economy offers more income, wealth and consumption that can be taxed after the basic needs of the population have been satisfied (Hinrichs, 1966, p. 8). In poor agricultural societies, states can tax only primary production. With wealth comes the development of industry, finance and trade. As new tax handles emerge, the taxable surplus grows (Webber & Wildavsky, 1986, p. 333). When and why do governments introduce modern taxes to tap into this surplus and realize higher revenues? Three main causal mechanisms have been theorized in the literature. Administrative complexity Administrative sophistication tends to increase with wealth (Tilly, 1990). Rich countries tend to have better staffed, better educated and more capable public bureaucracies than poor countries. Their societies tend to be more monetized, formalized, industrialized and urbanized. As a consequence, both tax administrators and taxpayers are better able to handle complicated

66  Handbook on the politics of taxation taxes (Besley & Persson, 2013, pp. 78–79). Higher state capacity, in turn, reinforces economic performance, ultimately fostering wealth accumulation (Dincecco & Katz, 2016). Hence, as societies grow richer, governments introduce modern taxes because they have the state capacity to handle them. Revenue capacity It is often assumed that rich countries have to spend more, absolutely and relatively, than poor countries. Partly this is because wealth facilitates political mobilization for more public goods and services (Hinrichs, 1966, p. 8). Partly it reflects Baumol’s cost disease (Baumol, 1993): government is labor-intensive; labor-intensive industries tend to have lower productivity gains than more capital-intensive businesses; as a consequence, the government has to spend more on the provision of labor-intensive public services in order to keep the ratio of these services constant with the rising output of income and wealth by the more capital-intensive private sector. Hence, as societies grow richer, their governments have to introduce modern taxes in order to meet their escalating revenue requirements efficiently (Dincecco & Katz, 2016). Redistribution Economic modernization and growth tend to change the distribution of income, wealth and consumption between classes, sectors and activities. Governments introduce modern taxes in order to address some of the distributive demands raised by these changes. For instance, the process of industrialization in nineteenth-century Europe created new commercial and financial wealth that largely escaped pre-modern taxes, with their focus on land and fixed assets (Webber & Wildavsky, 1986, p. 133). The adoption of modern income taxation helped to bring new forms of income and wealth into the tax net, thereby decreasing the tax burden on land. Hence, it was old landowning elites which perhaps surprisingly supported PIT introductions in pre-mass democracy Europe during the nineteenth century (Mares & Queralt, 2015). 2.2 War It is almost a truism in political science and fiscal sociology that war is “the usual reason for imposing new taxes and increasing old ones” (Spencer, 1898, p. 567; see also Emmenegger & Walter, this volume for a more in-depth overview). Several mechanisms are invoked to explain this. Revenue capacity Wars are expensive. Governments need to find extra revenue to fund them (Peters, 1991, p. 232; Dincecco & Prado, 2012; Gennaioli & Voth, 2015; Kiser & Linton, 2001; Zielinski, 2016). If wars are short and small-scale, borrowing, currency debasement, emergency duties and a rise in existing taxes may do (Ames & Rapp, 1977, p. 177). Yet, expensive and protracted conflicts may require the introduction of new, revenue-efficient taxes. Austria, for instance, introduced the first modern INH in 1759 to service its debt from the Seven Years war (Moser, 2013, p. 101); France introduced GST in 1920 to pay back the debt of the First World War (Lynch, 2013). Once adopted, these new taxes tend to stick around long after the financial exigencies of war have subsided (Peacock & Wiseman, 1961).

The colonial tax state  67 Administrative complexity War requires organization. Governments have to mobilize soldiers, weapons and machinery. They have to organize supplies, improve transport infrastructures and manage wartime production. Mass wars thus create incentives to increase administrative capacity (Ardant, 1975; Besley & Persson, 2009, p. 1218, 2011; Brewer, 1990; Dincecco & Prado, 2012; Hoffman, 1994; Tilly, 1990, p. 75). This capacity, in turn, facilitates tax administration and allows for the introduction of more complicated taxes. Without major military challenges, governments may lack incentives to modernize their administration, thus slowing down tax innovation. Redistribution War requires commitment from the soldiers fighting it. More often than not, these soldiers are relatively young and poor. Their commitment to letting themselves be shot at on the battlefield depends crucially on the feeling that their sacrifice is not exploited by fat cat capitalists at home benefiting from the war economy. Thus, the “universal conscription” of young men during the First World War led to political demands for a compensatory “conscription of wealth” that ushered in more progressive taxation, including PIT, CIT and INH (Scheve & Stasavage, 2016). 2.3 Democracy There is considerable debate in political science about the effects of regime type on taxation (see Andersson, this volume for a more in-depth overview). Some argue that democracy and the extension of the suffrage facilitate higher and more progressive taxation (Acemoglu & Robinson, 2006; Boix, 2003, Seelkopf & Lierse, 2020). Others contend that non-democracies tend to introduce progressive income taxes earlier than democracies (Mares & Queralt, 2015). Others still find that regime type is largely irrelevant for tax progressivity (Scheve & Stasavage, 2010). The debate focuses on three causal mechanisms. Redistribution According to the median voter theorem, the extension of the franchise to lower classes fuels political demand for redistributive government (Meltzer & Richard, 1981). The idea is simple, but the empirical implications are ambiguous. On the one hand, the extension of suffrage should bring demands for redistributive taxation (i.e. PIT, CIT, INH, perhaps SSC) in its wake as the voting power of poor strata of society increases (Peters, 1991; McCarty & Pontusson, 2011). On the other hand, anticipating this outcome, autocratic regimes may adopt redistributive taxation as a defensive strategy to quell demands for universal suffrage (Acemoglu & Robinson, 2001). It is not entirely clear, therefore, whether we should expect higher adoption rates of progressive taxes in democracies or autocracies. Revenue capacity To the extent that the extension of the franchise reduces the relative income of the median voter it should also increase demand for big government (Meltzer & Richard, 1981). Since the poor usually benefit more from public goods and services than the rich, who can pay for private provision, the political empowerment of the poor should usher in higher government spending (Acemoglu & Robinson, 2001; Boix, 2003; Borge & Rattsø, 2004; Gouveia & Masia, 1998). Hence, the extension of voting rights may also fuel the introduction of regres-

68  Handbook on the politics of taxation sive but revenue-efficient taxes such as GST and VAT. Conversely, autocratic governments may adopt revenue-efficient taxes in order to appease potentially rebellious masses through social spending. Again, the effect here is ambiguous. Administrative complexity The extension of the suffrage may indirectly increase the administrative capacity of the state by enhancing the “quasi-voluntary compliance” of citizens and taxpayers (Levi, 1989). If people feel that as voters they have a voice in government, they are more willing as taxpayers to cooperate with the revenue authorities (Alm et al., 1993; Tilly, 2009; Wahl et al., 2010). This facilitates tax administration and allows for the imposition of harder-to-monitor taxes. In this way, the extension of the suffrage should unambiguously facilitate the adoption of modern taxes. The extant research on tax innovation has complementary strengths and weaknesses: much of the work in the economic perspective is broad in geographical scope but lacks historical depth. By contrast, tax policy analyses in fiscal sociology or political science often include historical depth but tend to focus narrowly on a small group of prominent Western countries in Europe and North America. Other weaknesses are common across different streams of the literature including, perhaps most importantly, the relative neglect of SSC and GST. Work on direct taxation tends to focus on PIT and, albeit to a lesser extent, CIT and INH, even though SSC often raises significantly more revenue than any of these taxes. Work on indirect taxation concentrates on the determinants of VAT diffusion. This is unfortunate, because in many cases the first tax on general consumption was GST and VAT just served to modernize it. With these weaknesses in the empirical scope of analysis comes a weakness in analytical focus. All three major explanations of historical tax development are domestic. Even war – per definition an international event – is only seen through the lens of effects it has on the demand and support for taxation within a tax state. Yet as the next section will show, many tax systems started to modernize under colonial rule.

3.

THE DEVELOPMENT OF THE COLONIAL TAX STATE

This section discusses the development of the colonial tax state. I start with a short overview of pre-modern taxation in the colonial setting, before I illustrate the extent and huge variety of colonial tax states. In the early period of colonization (until around 1850), Western influence in the Americas was relatively developed, but only extended to a few trading ports in Africa and Asia. Taxation was still driven by local conditions that varied considerably, from no taxation in the nomadic tribal societies of Equatorial Africa to an established land tax system in India. This changed with the first wave of globalization. As settlers spread throughout the empires and started to export commodities from the colonies, infrastructure needed to be built and the rule of law maintained. All this required money. In this sense, very similar to the logic in the West, the “fiscal system … formed the backbone of the colonial state” (Frankema & Booth, 2020, p. 3). The type of taxes and their function was also similar to pre-modern taxation in the West (see Kiser, this volume). Different to today, the more benign – and also more affluent – colonial tax states were those that generated most of their revenues from trade taxes on their exports.

The colonial tax state  69 Other forms of pre-modern taxes were much less benign. They included very regressive hut or poll taxes that had to be paid independently of how much a family earned, and even taxes in kind such as forced labor, which is probably the most coercive type of all taxes (Frankema, 2011). Also, hut taxes often served as instruments of repression, as non-compliance led to the burning of the hut or as an instrument to force people into labor (Gwaindepi & Siebrits, 2020). Again similar to pre-modern taxation in Europe (see Kiser, this volume), tax administration varied widely. Some colonial administrators relied on local elites, whereas others tried to implement their own systems. As the next section will show, the huge variety of the colonial tax state is no surprise given how many territories were colonized. 3.1

Varieties of the Colonial Tax State

As we have seen, most of the literature on the development of the modern tax state is based on the experiences of a handful of mostly European countries. It therefore should come as no surprise that the histories of the vast majority of states differ widely. As Figure 5.1 shows, only 42 of today’s 203 states were never colonized. And even this is a conservative estimate. Different datasets focus on different countries and even within the same dataset (Hensel, 2018) it is not clear how to define a colony. If we count every country that has ever been ruled by a different state, this covers most of the world including Eastern Europe. If we only focus on countries that have actually undergone decolonization – as I do in Figure 5.1 – we ignore countries that were clearly colonized such as Venezuela or Australia but came into existence via another independent state (Great Colombia in the case of Venezuela) or via dominion status (in the case of Australia). This already previews some of the difficulties and the need for future comparative research when it comes to the colonial state.

Source: Genschel and Seelkopf (2019); Seelkopf et al. (2019).

Figure 5.1

Tax introductions around the world

Within the colonized world, I distinguish two different groups. Those countries that never introduced any of the six modern taxes or did so after independence and those countries where at least one of the modern taxes was introduced during colonial rule and kept upon independence. As we can see from Figure 5.1, a slight majority of colonies (87) fall into the

70  Handbook on the politics of taxation second group, whereas 74 former colonies did not modernize their tax systems under colonial rule. I will discuss the variation in the latter group before I turn to the colonial modernizers and explore the development of modern tax introductions during colonial occupation in more detail in the next section. 3.2

Post-Independence and Non-Introductions

Settler colonies The first group of countries that were colonies, but modernized after independence, are settler colonies. These were not only independent (or governed by self-rule) much earlier than their counterparts in Africa and Asia, but tax developments in pure settler colonies such as the United States (US), Canada, Australia or New Zealand also differed widely in their logic. While these countries were British colonies, they were perceived as empty lands, in which European settlers would create new countries by driving out or outright killing the native population (Shoemaker, 2015; see Elkins & Pedersen, 2005 for a discussion of less pure settler colonies in the twentieth century). This led to a very different fiscal contract than in the majority of colonies, in which a minority of settlers exploited the native majority. Interestingly, there has probably been written as much if not more about colonial taxation in the settler colonies – especially the US (see e.g. Rabushka, 2008) – than in the rest of the colonies. Whereas taxation was internationally imposed by the metropole, the mechanisms for tax modernization were very similar. The taxpayers were white settlers and the money was spent on these settlers (and partly on financing the empire). This type of taxation was much less coercive and driven by similar logics as in Europe. In fact, the phrase “no taxation without representation” that so succinctly summarizes the fiscal contract theory (see Andersson, this volume) was coined in the US. Despite their colonial origins, most scholars have treated these original settler colonies as similar to their European counterparts. Accordingly, many of the studies that I summarized in Section 2 are actually based on evidence from these countries. Early-independent colonies A second group of former colonies that are often treated in a similar way, although they are underrepresented in the literature, are the former Spanish colonies in the Americas. Owing to their early independence from Spain, following the imprisonment of the Spanish King by Napoleon in 1808, they were already sovereign nation states when modern taxes became popular. The only exceptions are Argentina and Brazil, where INH was introduced shortly before independence. 1 Given their basically independent introduction of modern taxes, authors often extend the European arguments and test them in the Americas; especially bellicist theories (see e.g. Centeno, 2003; Thies, 2005; Queralt, 2019; Emmenegger & Walter, this volume). When their findings differ (war seems to play a less prominent role in Latin American fiscal development), they focus on different economic structures or intensities of war, but mostly ignore the colonial past. Yet, pre-modern tax systems were extensive. Spanish colonies collected much more revenue than for instance the US states and redistribution within the empire was high (Grafe & Irigoin, 2006, p. 251). This system imploded with the end of the empire. Yet, there are at least two important legacies. First, the empire split into new countries precisely according to the treasury boundaries (Grafe & Irigoin, 2006, p. 261). Second, the tax systems that the new smaller republics inherited and fought over distinguished between settlers and natives

The colonial tax state  71 – similar to many tax systems in African and Asian colonies. Further research into how these colonial tax legacies have shaped the newly independent nation states and their tax systems until today would be certainly very interesting. Non-introducers Whereas the first two groups became independent before modern taxes swept around the world, the last group often never introduced them – not before and often not even after independence. This group consists of mostly small territories under British control that could survive on trade taxes as their main economic activity was acting as ports. After independence, they took advantage of the British financial dominance and legal systems they inherited. They turned themselves into tax havens to keep the money of the colonizing elites or attract even more from the former empire (Ogle, 2020). Some of these are still British territories and have actively opted against independence to take advantage of their semi-independent status on the Euromarket and attract foreign capital with very low to no tax rates (Palan, 2015). These states and territories have very different fiscal contracts than all other colonial or sovereign countries as they finance themselves mostly via fees from foreign companies (see Crasnic & Hakelberg, Hearson & Rixen, this volume for more insights on tax havens). In sum, slightly less than half of all former colonies have never experienced the introduction of modern taxes while they were under colonial rule. Whereas settler colonies resemble sovereign states in their tax development, Latin American colonies and smaller island colonies often had similar experiences to African and Asian colonies when it came to pre-modern taxation. Here, a small minority of settlers used rather repressive tax instruments to exploit the natives and forced them to finance their own subjugation. Yet, different to their Asian and African counterparts, these territories became self-governed and then chose based on their own domestic political process if, when and which modern taxes to introduce. While international factors such as access to international capital markets or international tax aid (see Bastiaens, this volume) played a bigger role than in the West, they modernized their tax states independently. I now turn to the majority of former colonies, which could not choose to do so, but whose first modern taxes were imposed by their metropolitan rulers. 3.3

Colonial Tax Introducers

Before I discuss the drivers of modern tax adoption in a colonial setting, I provide some descriptive illustrations on the majority of colonies that actually introduced modern taxes. When it comes to modern taxes, we see both differences and similarities across sovereign and colonial adoptions. Figure 5.2 shows how many of the six different taxes were introduced under sovereign and colonial rule.2 Before highlighting the differences, I would like to focus on one remarkable similarity. The timing of tax introduction is actually almost the same when comparing European and colonial tax introductions. While the colonial economies were much less developed, they introduced modern taxes at around the same time as their European counterparts. The colonial administration for instance introduced the first PIT in British India in 1886, only 40 years after PIT was introduced in Britain and more than 20 years earlier than Germany or France. CIT arrived in British India (1916) even half a century earlier than in the metropole (1965) (Genschel & Seelkopf, 2019; Seelkopf et al., 2019). Yet, there are two important differences. First, the type of tax introduced varies. Whereas European states had introduced SSC and INH very early and followed these up with income

72  Handbook on the politics of taxation

Source: Genschel and Seelkopf (2019); Seelkopf et al. (2019).

Figure 5.2

Tax introductions by tax and mode

taxes (PIT and CIT) as well as GST around 1920, internal indirect taxes played practically no role in the colonial territories. Given that internal markets were very small and the economy geared towards exports, this makes a lot of sense. The colonies (and their independent successor states sometimes even today) relied on trade when it comes to indirect taxation. When GST was introduced it happened mostly after the Second World War, shortly before independence. Also INH and SSC were less prevalent, whereas the administrators very often introduced PIT and CIT. Again, this is not too surprising as these taxes tapped into the income of big mining cooperations, for instance. A second important difference is the dualization of modern tax systems in colonies. Whereas modern taxes, especially on income and wealth, de facto only applied to the richer parts of societies in Europe, de jure they applied to all. If there were differences – such as with much early SSC – they were based on occupations or economic sectors. In colonies, modern taxes often only applied to settlers or elites in the big cities. The majority of the population was not part of the modern fiscal contract, but was taxed under the old system of hut taxes or forced labor – from which settlers, and sometimes also immigrants from third countries, were excluded (Schlichte, 2020, p. 11). Upon independence, most of the newly independent countries kept the modern taxes introduced by their former rulers and gradually widened them to the whole population. But this took some time. In Uganda, for instance, it was only in 2005 that the graduated personal tax, a successor of the colonial poll tax, was finally abolished, ending the dualization of the income tax more than 40 years after independence (Schlichte, 2020, p. 20).

The colonial tax state  73

4.

THE DRIVERS OF COLONIAL TAX INTRODUCTIONS

Widening the empirical scope of analysis to colonial dependencies has already brought important insights into the similarities and differences of tax modernization across the globe. In a second step, I will now analyze what factors drove colonial tax introductions. Whereas the Western story is firmly rooted in domestic explanations, the earlier colonial literature focused on international differences. They argued that different empires followed different colonial strategies, which affected colonial (and indirectly also postcolonial) institutions and growth. Usually, British indirect rule is seen as more benign than French or Spanish rule (see Frankema & van Waijenburg, 2014 for an overview). This international account of colonial blueprints has been challenged in the more recent literature (Frankema & van Waijenburg, 2014; Grafe & Irigoin, 2006; Frankema & Booth, 2020). Scholars show that variation within empires is much stronger than variation across. But is this due to the three prominent drivers identified in the (Western) literature – modernization, war and democratization? And do they work in a similar fashion? I discuss each driver in turn to see whether the drivers of tax modernization in the West travel to the colonial world. 4.1 Modernization Figure 5.3 plots the association of economic development and INH, PIT and VAT introductions over time. Economic development is proxied by the ratio of the GDP per capita of the introducing country to global average GDP per capita. Ratios larger than 1 indicate that a country is richer than the global average; ratios smaller than 1 indicate a poor country relative to the global average. In all three plots there is a downward trend for independent introductions. Relatively rich countries are somewhat more likely to adopt early.

Source: Gapminder (2015); Seelkopf et al. (2019); Genschel and Seelkopf (2019).

Figure 5.3

Economic development and tax introduction

This trend is more prominent for INH introductions than for PIT and after the first decade no longer visible for VAT introductions.3 But it does not exist for colonial introductions. Consider INH introductions, for example. All countries and colonies introducing the INH before the First World War tend to be either richer than the global average (e.g. the Netherlands), or at least close to it (e.g. Brazil). After the First World War, by contrast, the majority of countries and colonies introducing INH tend to be poorer than average (e.g. Kenya). Over the entire

74  Handbook on the politics of taxation period of observation, sovereign countries introducing INH tend to be richer than colonies simultaneously introducing the same tax. Hence, in a worldwide comparison, economic modernization does not seem to play a role. The very poor colonies with large informal sectors and very little state capacity often introduced modern taxes at the same time as their independent counterparts. Does this mean the economic structure of colonies plays no role for tax modernization? Not when we compare within the colonial sample. As in the West, the economic structure mattered greatly for colonial taxation. Colonies with many commodities to export, which were conveniently located at the coast, relied to a very large extent on export duties. They raised the largest revenues and had the most progressive tax systems. It was also the colonies with relatively modern and monetized cities that introduced modern taxes. Colonies that were either landlocked or had large hinterlands could not raise taxes this easily. At the same time, they needed more money to police the territory and to invest in infrastructure such as railways to bring products to markets. Hence, they had lower tax takes, which were generated via much more coercive means such as hut taxes, and also spent much less progressively4 (Frankema & van Waijenburg, 2014). In sum, colonial tax systems were more modern than their non-colonial counterparts at the same level of overall economic development. Yet, the economic structure of the individual colonies drove much of the tax system implemented in the colonies just as it did in the West. Interestingly, the colonial administrations seem to have been much more attuned to the individual economic conditions in the different territories than the cookie-cutter policies the IMF introduced via soft coercion in the 1980s (see Swank, this volume). 4.2 War The picture is very different for the most researched driver of tax innovation: war. Whereas bellicist accounts of state modernization are the norm for the West, their application to the rest of the world is much more debated (see Emmenegger & Walter, this volume). Given that almost all comparative databases of war focus on independent states (and until now also most tax databases), it is difficult to test the bellicist hypothesis for colonial states in the same manner as has been done for Europe. Yet, there is evidence that war matters also for colonial tax introductions – but in a very different manner. The link between violence in the colonies itself, i.e. domestic accounts of war and taxation, is very different to the European story. Europeans fought wars against each other and introduced new taxes in a rally-around-the-flag dynamic to fight foreign foes or compensate for war sacrifices afterwards. Natives in the colonies fought wars against their colonial oppressors. Here, taxes imposed by the metropole were very often the reason for increased violence, rallying the native population against the colonial flag (Ziltener et al., 2017). Unlike in Europe, taxation actually led to war rather than the other way round. Interestingly, there is a second bellicist mechanism at work when it comes to colonial tax development. As Figure 5.4 illustrates, there is some evidence that war in the metropole actually led to tax developments in the colonies. Most of the modern taxes in colonies were introduced while Britain and France fought in the two world wars. The wars created huge revenue demand in the metropoles and forced the colonies to become even more fiscally self-reliant than they already were. On top of this, the plummeting of global trade during wartime led to a large loss of revenue from trade taxes for the colonial state, while revenue needs increased

The colonial tax state  75

Note: The light gray bars signify the years between the First and Second World Wars. Source: Genschel and Seelkopf (2019); Seelkopf et al. (2019).

Figure 5.4

The world wars and tax introduction

with the number of soldiers from the colonies fighting in European trenches (Frankema & Booth, 2020, p. 5). Hence, while violence in the colonies was driven by more taxation, wars in the metropole spurred tax development in the colonies. Interestingly, the returning colonial soldiers made similar redistributive arguments as their European comrades, which led to more progressive spending after the wars and ultimately to independence (Frankema & Booth, 2020, p. 14). 4.3 Democracy While bellicist arguments are already difficult to assess, the effect of more or less democratic institutions on taxation across colonies is almost impossible to analyze. Although there were differences in the strictness of colonial rule and in the degree to which local elites were incorporated into colonial governments, all colonies were de facto occupied territories ruled by the metropole. Hence, any sort of legitimation via fiscal contract was impossible. The only way taxation affected the social contract was by uniting natives against colonial rule. The prime example is the US, where British taxation led ultimately to independence, nation building and democratic rule. Where independence was impossible (most Asian and African colonies until the Second World War), taxation followed the needs of metropoles or settlers instead of native populations. Formal political disputes happened only between settlers as the native population was excluded from institutionalized politics. Interestingly, political regimes also play a role here. As Gwaindepi and Siebrits (2020) show for the British Cape Colony (today’s South Africa),

76  Handbook on the politics of taxation authoritarian government structures among the white settlers allowed a small coalition of very rich diamond miners to go against the farming majority of settlers that wanted to introduce CIT for the mining industries. This decreased fiscal capacity and put the full weight of colonial taxation once more on the native population. What about democratization in the metropole? Different to war, this was a double-edged sword for colonial taxation. Given that colonial empires benefited mostly wealthy merchant elites in the metropoles, democratization at home meant opposition to colonial expansion and its financing. Hence, the extension of the franchise put more pressure on colonial self-financing. On the other hand, democratization also led to a change in norms – both at home and on the international stage. The foundation of the International Labour Organization, for instance, put pressure on colonial administrations to end taxation via forced labor and modernize their tax systems (Frankema & Booth, 2020). After independence, however, democratization unfolded a stronger effect on tax introductions by former colonies than in Europe, especially for progressive taxes (Seelkopf et al., 2019; Seelkopf & Lierse, 2020). In sum, colonial taxation followed the revenue needs of the colonizers rather than the native population. The introduction of new taxes was driven by the metropoles’ wars and their unwillingness to pay for colonial occupation. Most of the revenues were spent on the subjugation of the native population. They only financed public goods for the native population in a few exceptional cases or in an effort to stave off independence in the very late stages of colonialism (Frankema, 2011). As a whole, colonial taxation was highly repressive and regressive. So the fiscal contract mirrored the general relationship between rulers and ruled also in the colonies. Redistribution took place from the native populations towards the settlers and the metropoles. As in pre-modern Europe, trade taxes were actually the most benign types of taxes, as hut taxes and forced labor were even more regressive. Different to Europe, tax administrations were quite advanced in coastal ports and major settlements, but often struggled to penetrate the hinterlands. Low capacity also explains differences in tax systems for settlers and natives and the continued existence of pre-modern taxes long after the introduction of modern taxes.

5. CONCLUSION In comparing the colonial experience to the European story, we see some striking differences and similarities. The economic structure determined the tax structure in similar ways as in Europe, although at much lower levels of economic development. Modern taxes were introduced by colonial administrations around the same time as they began to spread around developed economies. Whereas modernization drove the introduction of taxes in the colonial world in similar ways as in Europe, war and democratization work very differently in the former setting. Instead of driving tax innovation at the domestic level like in the West, tax innovations led to violent upheaval and ultimately independence in the colonies. Unlike local wars and democratization, however, wars and democratization in the metropoles did have an effect on colonial taxation. Future analyses should therefore transcend the purely domestic focus of most current accounts of tax development and study the effect of violence and political change across hierarchies. As we have seen, especially direct taxes were often introduced by colonial rulers and kept upon independence. The fact that these tax introductions were so sticky and survived different oppressive regimes, as well as territorial and political changes, illustrates again the relevance

The colonial tax state  77 of the study of fiscal history. PIT in British India was not only kept after independence, but also is the root for PIT in Bangladesh and Pakistan. Yet, we have almost no accounts of how these colonial tax systems, which were built upon coercive rather than cooperative fiscal contracts, affect decolonized nations and their societies. Future research should not only analyze the long-term effects of colonial taxation for today’s states, but also provide a much more comparative account of colonial taxation. So far, most research is based on individual case studies due to the difficulties in making data comparable, but also due to the nature of history as a discipline that favors in-depth case analyses over comparative studies. The studies summarized here, which are more comparative in nature, focus often on one empire. But as we have learned, this might be the wrong typology for colonial taxation. Fruitful avenues for future research might be accounts that follow differences in settler intensity or economic purpose in the “compulsory process of globalisation” (Hopkins, 2002, pp. 6–7, cited in Frankema & Booth, 2020, p. 3). Lastly, we need to end the artificial distinction between accounts of tax and state development in the West and the rest. Not only is this intellectually lazy, it also hides the fact that some of today’s advanced democracies were former colonies that were much less developed at the time their modern tax systems came into existence than some of today’s emerging economies. Hence, we are in need of an overarching political economy of worldwide tax development that takes domestic and international drivers into account.

ACKNOWLEDGMENTS This chapter is based on a larger research project, which I have directed together with Philipp Genschel and which was financed by the European University Institute, both of whom I would like to thank. I would also like to express my gratitude to Lukas Hakelberg and the IR Kolloquium at the Geschwister-Scholl-Institute, LMU Munich, for their helpful insights.

NOTES 1. The Caribbean is different. Here colonialism reigned much longer and as such some taxes were introduced during colonial times. Interestingly, some of these, such as the inheritance tax in the Bahamas, was introduced and repealed during colonialism, but never introduced after independence. Many of these small island states became tax havens as the next paragraph illustrates. 2. The difference in the overall number of countries across taxes stems from differences in missing data, as well as the fact that some taxes such as the inheritance tax were more often not introduced at all. The colonial tax introductions might well underestimate the real number as TID only counts taxes introduced as colonial that were kept upon independence. 3. Value-added tax was invented around the First World War and only became popular in the 1960s. Hence, all countries were already independent when introducing it. It would nevertheless be interesting to see if colonial histories also affect the introduction and effectiveness of the value-added tax. 4. Colonial spending, especially later social spending on health or education, seems to be slightly more driven by colonial blueprints than taxation. Yet also here taxation matters as colonies had to finance these themselves and as such the potential tax base limited spending.

78  Handbook on the politics of taxation

REFERENCES Acemoglu, D., & Robinson, J. A. (2001). A theory of political transitions. American Economic Review, 91(4), 938–963. Acemoglu, D., & Robinson, J. A. (2006). Economic Origins of Dictatorship and Democracy. Cambridge University Press. Alm, J., Jackson, B. R., & McKee, M. (1993). Fiscal exchange, collective decision institutions, and tax compliance. Journal of Economic Behavior and Organization, 22(3), 285–303. Ames, E., & Rapp, R. T. (1977). The birth and death of taxes: A hypothesis. Journal of Economic History, 37(1), 161–178. Ardant, G. (1975). Financial policy and economic infrastructure of modern states and nations. In C. Tilly (ed.), The Formation of National States in Western Europe, 164, 164–218. Princeton University Press. Baumol, W. J. (1993). Health care, education and the cost disease: A looming crisis for public choice. Public Choice, 77(1), 17–28. Besley, T., & Persson, T. (2009). The origins of state capacity: Property rights, taxation, and politics. American Economic Review, 99(4), 1218–1244. Besley, T., & Persson, T. (2011). Pillars of Prosperity: The Political Economics of Development Clusters. Princeton University Press. Besley, T., & Persson, T. (2013). Taxation and development. In A. Auerbach & M. Feldstein (eds), Handbook of Public Economics, Vol. 5, 51–110. Elsevier. Boix, C. (2003). Democracy and Redistribution. Cambridge University Press. Borge, L.-E., & Rattsø, J. (2004). Income distribution and tax structure: Empirical test of the Meltzer– Richard hypothesis. European Economic Review, 48(4), 805–826. Brewer, J. (1990). The Sinews of Power: War, Money, and the English State, 1688–1783. Harvard University Press. Centeno, M. A. (2003). Blood and Debt: War and the Nation-State in Latin America. Penn State Press. Dincecco, M. (2015). The rise of effective states in Europe. Journal of Economic History, 75(3), 901–918. Dincecco, M., & Katz, G. (2016). State capacity and long-run economic performance. The Economic Journal, 126(590), 189–218. Dincecco, M., & Prado, M. (2012). Warfare, fiscal capacity, and performance. Journal of Economic Growth, 17(3), 171–203. Elkins, C., & Pedersen, S. (2005). Introduction. Settler colonialism: A concept and its uses. In C. Elkins & S. Pedersen (eds), Settler Colonialism in the Twentieth Century: Projects, Practices, Legacies, 1–19. Taylor & Francis. Frankema, E. (2011). Colonial taxation and government spending in British Africa, 1880–1940: Maximizing revenue or minimizing effort? Explorations in Economic History, 48(1), 136–149. Frankema, E., & Booth, A. (eds) (2020). Fiscal Capacity and the Colonial State in Asia and Africa, c. 1850–1960. Cambridge University Press. Frankema, E., & van Waijenburg, M. (2014). Metropolitan blueprints of colonial taxation? Lessons from fiscal capacity building in British and French Africa, c. 1880–1940. Journal of African History, 55(3), 371–400. Gapminder (2015). Income per person (fixed PPP$). Version 17. www​.gapminder​.org/​data/​(accessed May 31, 2021). Gennaioli, N., & Voth, H.-J. (2015). State capacity and military conflict. Review of Economic Studies, 82(4), 1409–1448. Genschel, P., & Jachtenfuchs, M. (2018). From market integration to core state powers: The Eurozone crisis, the refugee crisis and integration theory. JCMS: Journal of Common Market Studies, 56(1), 178–196. Genschel, P., & Seelkopf, L. (2016). Did they learn to tax? Taxation trends outside the OECD. Review of International Political Economy, 23(2), 316–344. Genschel, P., & Seelkopf, L. (2019). Codebook – Tax Introduction Dataset (TID), Version May 2019. Florence: European University Institute. Gouveia, M., & Masia, N. A. (1998). Does the median voter model explain the size of government? Evidence from the states. Public Choice, 97(1–2), 159–177.

The colonial tax state  79 Grafe, R., & Irigoin, M. A. (2006). The Spanish Empire and its legacy: Fiscal redistribution and political conflict in colonial and post-colonial Spanish America. Journal of Global History, 1(2), 241–267. Gwaindepi, A., & Siebrits, K. (2020). “Hit your man where you can”: Taxation strategies in the face of resistance at the British Cape Colony, c. 1820 to 1910. Economic History of Developing Regions, 35(3), 171–194. Hensel, P. R. (2018). ICOW Colonial History Data Set, Version 1.1. https://​dataverse​.harvard​.edu/​ dataset​.xhtml​?persistentId​=​doi:​10​.7910/​DVN/​5EMETG (accessed May 15, 2021). Hinrichs, H. H. (1966). A General Theory of Tax Structure Change during Economic Development. Law School of Harvard University. Hoffman, P. T. (1994). Early modern France, 1450–1700. In P. T. Hoffman & K. Norberg (eds), Fiscal Crises, Liberty, and Representative Government, 1450–1789, 226–52. Stanford University Press. Hopkins, A. G. (2002). Globalisation In World History. Pimlico. Kato, J. (2003). Regressive Taxation and the Welfare State: Path Dependence and Policy Diffusion. Cambridge University Press. Kemmerling, A. (2009). Taxing the Working Poor: The Political Origins and Economic Consequences of Taxing Low Wages. Edward Elgar Publishing. Kenny, L. W., & Winer, S. L. (2006). Tax systems in the world: An empirical investigation into the importance of tax bases, administration costs, scale and political regime. International Tax and Public Finance, 13(2–3), 181–215. Kiser, E., & Karceski, S. M. (2017). Political economy of taxation. Annual Review of Political Science, 20(1), 75–92. Kiser, E., & Linton, A. (2001). Determinants of the growth of the state: War and taxation in early modern France and England. Social Forces, 80(2), 411–448. Levi, M. (1989). Of Rule and Revenue. University of California Press. Lynch, F. (2013). The Haig-Shoup mission to France in the 1920s. In W. E. Brownlee, E. Ide, & Y. Fukagai (eds), The Political Economy of Transnational Tax Reform: The Shoup Mission to Japan in Historical Context, 61–85. Cambridge University Press. Mares, I., & Queralt, D. (2015). The non-democratic origins of income taxation. Comparative Political Studies, 48(14), 1974–2009. Martin, I. W., Mehrotra, A. K., & Prasad, M. (eds) (2009). The New Fiscal Sociology: Taxation in Comparative and Historical Perspective. Cambridge University Press. McCarty, N., & Pontusson, J. H. (2011). The political economy of inequality and redistribution. In W. Salverda, B. Nolan, & T. M. Smeeding (eds), The Oxford Handbook of Economic Inequality, 665–92. Oxford University Press. Meltzer, A. H., & Richard, S. F. (1981). A rational theory of the size of government. Journal of Political Economy, 89(5), 914–927. Moser, P. D. (2013). Erben und Erbschaftssteuer in Österreich aus rechtlicher Sicht. In H. P. Gaisbauer, O. Neumaier, G. Schweiger, & C. Sedmak (eds), Erbschaftssteuer im Kontext, 99–113. Springer-Verlag. Ogle, V. (2020). “Funk money”: The end of empires, the expansion of tax havens, and decolonization as an economic and financial event. Past and Present, 249(1), 213–249. Palan, R. (2015). The second British Empire and the re-emergence of global finance. In R. Palan & S. Halperin (eds), Legacies of Empire: Imperial Roots of the Contemporary Global Order, 46–68. Cambridge University Press. Peacock, A. T., & Wiseman, J. (1961). The Growth of Government Expenditures in the United Kingdom. Princeton University Press. Peters, B. G. (1991). The Politics of Taxation: A Comparative Perspective. Blackwell. Queralt, D. (2019). War, international finance, and fiscal capacity in the long run. International Organization, 73(4), 713–753. Rabushka, A. (2008). Taxation in Colonial America. Princeton University Press. Rogers, M., & Weller, N. (2014). Income taxation and the validity of state capacity indicators. Journal of Public Policy, 34(2), 183–206. Scheve, K., & Stasavage, D. (2010). The conscription of wealth: Mass warfare and the demand for progressive taxation. International Organization, 64(4), 529–561. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton University Press.

80  Handbook on the politics of taxation Schlichte, K. (2020). From hut to VAT: Trajectories of taxation in Uganda and Senegal. In P. Genschel & L. Seelkopf (eds), Global Taxation: How Modern Taxes Conquered the World, 99–121. Oxford University Press. Schumpeter, J. (1918). Die Krise Des Steuerstaats. Leuschner and Lubensky. Seelkopf, L., Bubek, M., Eihmanis, E., Ganderson, J., Limberg, J., Mnaili, Y., Zuluaga, P., & Genschel, P. (2019). The rise of modern taxation: A new comprehensive dataset of tax introductions worldwide. Review of International Organizations, 16, 239–263. Seelkopf, L., & Lierse, H. (2020). Democracy and the global spread of progressive taxes. Global Social Policy, 20(2), 165–191. Shoemaker, N. (2015). A typology of colonialism. Perspectives on History, October 1. Spencer, H. (1898). Principles of Sociology. D. Appleton & Company. Steinmo, S. (2003). The evolution of policy ideas: Tax policy in the 20th century. British Journal of Politics and International Relations, 5(2), 206–236. Thies, C. G. (2005). War, rivalry, and state building in Latin America. American Journal of Political Science, 49(3), 451–465. Tilly, C. (1975). The Formation of National States in Western Europe. Princeton University Press. Tilly, C. (1990). Coercion, Capital, and European States, AD 990–1990. Blackwell. Tilly, C. (2009). Extraction and democracy. In I. W. Martin, A. K. Mehrotra, & M. Prasad (eds), The New Fiscal Sociology: Taxation in Comparative and Historical Perspective, 173–182. Cambridge University Press. Wagner, R., & Weber, W. (1977). Wagner’s law, fiscal institutions, and the growth of government. National Tax Journal, 30(1), 59–68. Wahl, I., Kastlunger, B., & Kirchler, E. (2010). Trust in authorities and power to enforce tax compliance: An empirical analysis of the slippery slope framework. Law and Policy, 32(4), 383–406. Webber, C., & Wildavsky, A. (1986). A History of Taxation and Expenditure in the Western World. Simon and Schuster. Zielinski, R. C. (2016). How States Pay for Wars. Cornell University Press. Ziltener, P., Künzler, D., & Walter, A. (2017). Research note: Measuring the impacts of colonialism: A new data set for the countries of Africa and Asia. Harvard Dataverse. Zolt, E. M., & Bird, R. M. (2005). Redistribution via taxation: The limited role of the personal income tax in developing countries. UCLA Law Review, 52(September), 1627–1695.

PART II COMPARATIVE TAX POLITICS A: THE BASICS

6. The domestic determinants of tax mixes Achim Kemmerling and Zbigniew Truchlewski

1.

MAIN FEATURES OF DOMESTIC TAX MIXES

Why do tax mixes differ between countries and vary over time? By tax mixes, we mean the composition of tax revenues of a state and by implication the type of taxes that citizens have to pay. In some countries, citizens pay more indirect taxes and social security contributions, while in others their tax bill mostly contains personal income tax. Why is that so? Variation in time and space refers to how tax mixes morph into a different shape over time while variation in space points to convergence or divergence between countries. What are the political forces that would lead to change and divergence/convergence among countries? Variations in tax mixes are crucial for voters. Some tax mixes are more progressive (i.e. the tax increases proportionally with the sum taxed) while others are more regressive (i.e. the tax does not increase proportionally with the sum taxed). Whether a tax mix is progressive or regressive depends among other things on whom it falls: if labour, as opposed to capital, pays most of the tax mix, the mix is, all other things being equal, more regressive, because people with capital are in general wealthier than people who only receive income from labour. Think for instance of a mix with a huge share of indirect taxes. In as much as these are regressive, the overall burden of taxation falls relatively heavily on poor people, who consume a larger share of their income than rich people. Early approaches in the political economy of taxation mainly focussed on the size of the tax state (Meltzer & Richard, 1991; Przeworski & Wallerstein, 1988). For two reasons the politics of taxation has shifted gradually from whom to tax (capital or labour) to how to tax (labour) in advanced industrialized countries. First, higher levels of taxation make it increasingly necessary for politicians to twist and tweak the system. Second, higher debt and more internationalization imply more and more restrictions on increasing the budget envelope. Thus, politicians nowadays face the question, which type of taxation to use (see also von Haldenwang et al., this volume), as restrictions on raising new revenues become harder. This article summarizes the state of the art on the comparative politics of choosing how to tax. Given that the literature explaining the political genesis of taxes is enormous, we start with a couple of necessary demarcations guiding the reader through what we propose to cover and what not. First, and as stated above, we focus more on the tax mix than on the general tax level. Our main interest lies in looking at tax policy decisions, deciding between different forms of taxation, while holding the level of taxation constant. We distinguish between the three largest forms of taxation: (personal and corporate) income taxes, payroll taxes (including social security contributions) and consumption taxes (including value-added taxes (VAT)). These three taxes constitute the lion’s share of all tax revenue in Organisation for Economic Co-operation and Development countries. For this reason, we decided not to include property taxes. We will also be very short on specific consumption taxes such as excises, since in the last 40 years or 82

The domestic determinants of tax mixes  83 so, VAT has clearly overshadowed them and is now in many countries the most important, or most dynamic, source of government income. The mix of these three major forms of taxes varies both over time and between countries. Figure 6.1 shows tri-dimensional plots for tax forms as a percentage of all tax revenues (OECD, 2019) for the years 1978 and 2018, respectively. Comparing the two plots, we see a shift towards the lower left corner, i.e. social security contributions and consumption taxes (mainly VAT) have increased in importance relative to income taxes. We also see some (weak) signs of convergence, so that countries have become slightly more similar over time. Further, we mainly look at approaches that explain discretionary changes in tax policies rather than automatic processes of stabilization or tax “creep,” i.e. the automatic change in taxation when other variables like inflation increase taxable income (Adam & Kammas, 2007). Other chapters in this volume deal with structural explanations that account for changes in the generation of tax income; the relevance of economic structures on the politics of taxation (Haffert & Mertens, 2019; Haffert, this volume); international influences such as international tax competition (Lierse, this volume) or policy diffusion (Swank, this volume).

Note: inc = income tax revenues, ssc = social security contributions, con = consumption taxes. Source: Own graphics on the basis of Organisation for Economic Co-operation and Development (2019).

Figure 6.1

Triplots for the three main forms of taxation as a percentage of total tax revenues in the years 1978 and 2018

The three forms of taxation are often related to the classic conceptual distinction in political economy between capital, labour and consumption taxes. The main tax forms map onto these economic sources, but imperfectly. Income taxes, for instance, include both taxes on labour and capital income. More importantly, the real incidence is a different question. For instance, employers often roll over contributions to employees (Hamermesh, 1993), by adjusting wages in response to these contributions. This effectively converts a tax that nominally falls on capital into a tax on labour. Alternatively, employers might raise product prices, in which case the incidence would fall on consumption rather than on capital.

84  Handbook on the politics of taxation Against this background, there is an important, but somewhat underappreciated long-term trend in the real incidence of taxation: while in the nineteenth century most nominal (and conceptual) forms of taxation fell on land (and wealth), nowadays most of the tax burden falls on labour (Hamermesh, 1993). For instance, up to 90 per cent of social security contributions de facto fall on employees (Melguizo & Gonzalez-Paramo, 2013) and typically much more than half of capital taxes also fall on labour (Bach et al., 2016). Internationally mobile firms are particularly sensitive to higher capital taxes and respond by rolling over the tax onto workers (e.g. Fuest et al., 2018). The political implication is that most relevant political conflicts nowadays play out within labour taxation (Kemmerling, 2014): for instance, even if governments officially increase capital taxation, it might still mean that labour ends up paying the bill. This is the fundamental difference between the contemporary politics of taxation and its political contestation in the nineteenth century (see Andersson, this volume), a time when most of the real incidence fell on capital (and land) owners. One of the key reasons for this change is increased international mobility of capital. More fundamentally, wages were simply not high enough to serve as a basis for taxation (Kemmerling, 2009). Thus, one might say that most contemporary tax forms are taxes on labour. This would mean that the scope of tax-based redistribution is more limited. However, the tax mix still differs in politically relevant dimensions (Kemmerling, 2009). Typically, only income taxes allow for some degree of tax progressivity (Kemmerling, 2009; Prasad & Deng, 2009). Even if the actual degree differs from country to country, income taxes need to play a substantive role as a necessary if not sufficient condition for a “progressive” tax mix. Second, only social security contributions tend to have a direct link to benefits and social insurance. This has important political implications where the politics of redistribution shifts towards a politics of insurance (Truchlewski, 2016, 2020). Third and finally, the tax base differs in all three cases. Here the link to economic sources is very relevant. Income taxes are based on official income and hence restrict taxation to the formal sector, to those with sufficient income and to those willing to report it. The tax base for payroll taxes is often even smaller, focussing only on salaried employees, excluding both (very) high and low wages.1 This makes them a very different source, with different dynamics of cleavage building and evolution of political support (Kemmerling, 2014; Truchlewski, 2016, 2020). The tax base for consumption, especially general consumption, is typically the largest. This has implications for visibility, mobilization against it, but also for depoliticization. With these distinctions in mind, we are ready to survey the literature. To cut through the thick forest of different approaches, we rely on the classic trichotomy in the comparative and international political economy: interests, institutions and ideas.

2.

INTERESTS: PARTIES, SPECIAL INTEREST GROUPS AND THE TAX MIX

Starting with “interest” as the first approach, this largely falls into two categories: partisan interests and interest group politics. Of the two, partisan approaches have arguably taken the prime seat in the politics of taxation for a long time.

The domestic determinants of tax mixes  85 2.1

Partisan Politics

A simple starting point is the idea that left parties not only want to maximize tax revenues, but also care about progressivity – taxing the rich more, to put it bluntly (Marx, 1989). For several reasons left parties would care (more) about progressivity: for starters, financing welfare has a cost. The left can be more popular if it shifts this cost onto other constituencies. Also, shifting this cost can redistribute income from the top to the bottom. Progressive taxation is one way to achieve this goal. By contrast, the right wants to limit the overall tax burden, for instance to increase the competitiveness of the country or to promote saving and investment. From a (neo)liberal perspective, more investment is supposed to increase growth, which eventually should “trickle down” to the masses. The right thus tends to choose regressive tax forms. Such a view is not very different from a guiding idea in political economy: the equality–efficiency trade-off, where the left favours equality and the right promotes efficiency (Okun, 1975; Boix, 1998). This simple partisan argument not only implies that the left will prefer more taxation, but also more income and more capital taxation. Conversely, one would expect the right to use more indirect instruments such as consumption taxes, as these are considered regressive, efficient forms of taxation (but see below). Another idea is that the (moderate) right prefers social security contributions if they represent specific types of highly qualified workers (Mares, 2003a; Kemmerling, 2009). It should be quite clear from the start, however, that this simple partisan model is, to paraphrase an aphorism by the famous statistician G. E. P. Box (1976), probably wrong but a useful benchmark for the following discussions. It is important to look at the partisan effect in the mix of nominal or theoretical tax forms. Do political parties change the balance between different taxes raised once in government? For instance, does the left make taxes more progressive? If we focus on the income tax revenues in the tax mix, then Sakamoto (2008) suggests that this is the case: while right-wing parties tend to decrease the share of personal income taxes in the tax mix, left-wing governments do the opposite. If we focus on the ratio of labour to capital taxation, then the answer is that the left does increase (income) capital taxation (Angelopoulos et al., 2012).2 Overall, there is evidence for partisanship affecting the domestic tax mix, even though the meta-analysis casts some shadow on its robustness. Similar findings hold for corporate income tax: according to some studies (Osterloh & Debus, 2012),3 left governments tend to increase it more than right governments. However, they only find this until the mid-1990s from when on partisan differences wash out. This would suggest that nowadays globalization and tax competition dampen the partisan effect on corporate income taxes (Lierse, this volume). However, the results are sensitive to measurements of the predictor and outcome variable. For instance, Devereux et al. (2008) use a dummy variable to code left–right partisanship and do not find an impact of partisanship on the tax rate. When we switch from the relative importance of income tax to effective tax rates on capital, there is some evidence that the political strength of the left matters (Angelopoulos et al., 2012; Swank & Steinmo, 2002; Boix, 1998). But, as Przeworski and Wallerstein (1988) have long argued, eventually all types of government depend on capital. Hence, other factors seem to shape the prevalence of capital income taxes. Ganghof (2006a), for instance, argues that even in countries with very progressive wage taxes there can be low taxes on capital. As a result, the total effect can be regressive.

86  Handbook on the politics of taxation Looking at labour taxes, Angelopoulos et al. (2012) find that the left has no impact on labour taxes. Others even find that left governments increase labour taxes (Cusack & Beramendi, 2006): in countries with strong legislatures (as opposed to strong executives), the left also tends to tax labour more. The reason behind this counter-intuitive result is that taxing labour finances the welfare state (see below). Next, let us look at taxes on consumption. Angelopoulos et al. (2012) indicate that left-wing governments tend to increase taxes on consumption more than right-wing governments. Some authors (e.g. Beramendi & Rueda, 2007)4 confirm this finding but add that the effect is particularly pronounced in countries with high corporatism. Sakamoto (2008) also finds that under left-wing governments, revenues from taxes on consumption increase (while revenues from taxes on social security tend to decrease). When we put all these pieces of evidence together, we find that the partisan story is a complex one when looking at both total taxation and the tax mix. For one thing, external factors such as tax competition (Lierse, this volume) play an important role. Taxing income (and capital) is progressive, but a priori it can become quickly counter-productive in a globalized economy because taxpayers can simply vote with their feet: they can either move away (although see Young 2017 for weak evidence on this issue)5 or hide their wealth (Zucman, 2015; Crasnic & Hakelberg, this volume).6 To finance the welfare state, parties may turn to taxing labour (because it is less mobile than capital) through social security contributions or VAT for instance (Genschel, 2002).7 Again, this shows how far we have come away from defining tax politics as fighting over different forms of capital taxation in the nineteenth century to fighting over different forms of labour taxation in the twentieth and early twenty-first centuries. An alternative approach looks at taxation as an issue of credible commitments and tax-for-revenue deals (Timmons, 2010). If the focus of left versus right lies on the progressive spending side – that is transfers and services dedicated to the poor – left parties might be willing to “stomach” regressive revenues. In general, if parties in power target spending to their constituents, they also have tacit approval from them to tax them, thus forming a “fiscal contract” (Timmons, 2005): “people who pay for government obtain the bulk of its benefits.” Timmons (2010) confirms this finding, arguing that parties in power usually tax those who benefit most from the taxes raised by government. It is quite telling that where the left eschews this “fiscal contract” and attempts to form a more progressive, income tax-based schedule, it fails to generate enough revenues to spend on the welfare state. Conversely, when the right goes on to use regressive taxes, it generates more revenue than the left. This counter-intuitive finding was demonstrated for Latin America (Hart, 2010). So even despite globalization, partisanship still makes a difference, but in an unexpected manner. The right wants to stimulate growth through lower taxation of capital and shifts the burden of taxation on efficient tax instruments such as VAT. For reasons of equity, the left tries to give up easily harnessed revenues from VAT for harder to capture revenues from personal income taxation. 2.2

Special Interest Group Politics

The second main form of interest-based explanations focusses on interest group politics. Do different interest groups influence tax mixes, and if so how? Clearly, interest groups such as employer associations and trade unions have an incentive to shape tax mixes and shift the tax burden onto others (Mares, 2006). For instance, employers may wish to limit taxes on income

The domestic determinants of tax mixes  87 because of their negative effect on investment and growth. Therefore, they prefer to push the tax burden onto labour and consumption. Why do they succeed to do this in some countries (e.g. Denmark) but not in others (e.g. the United States (US))? After all, American business is known for being powerful and for convincing their governments that, to (mis)quote Charles Ewin Wilson, what is good for business is good for the country. At the same time, businesses are constrained by powerful trade unions and dominant social democratic parties in Nordic countries. Quite puzzlingly, though, it is in the latter group of countries that the tax mix is apparently most regressive, if we look only at the type of tax instrument being used. To answer this puzzle, let’s analyse the parameters under which interest groups may influence tax policy (Peters, 1991). First, interest groups often influence the tax mix at the margins precisely because it is a technical topic (Steinmo, 1993; Hettich & Winer, 1999). This would be especially relevant for powerful, yet narrow interest groups representing specific sectors such as finance. This brings us deeply into the domain of discussions about the visibility of different forms of taxation and taxation by stealth. We will come back to this below. Second, Steinmo (1993) also reminds us that the influence of interest groups on the tax system is conditional on political institutions. In Westminster democracies, interest groups will most likely face a winner-takes-all single-party government that does not have to compromise with other parties. As a result, interest groups will have more incentives to curry favour with government. By contrast, in a consensus democracy with a proportional representation (PR) system (where election results mirror voter divisions), interest groups will most likely face coalition governments where parties in power have to compromise to govern. In these countries, the policy process integrates larger interest groups such as trade unions following the logic of coalition building and incrementalism. Third and related to this, small groups such as specialized business interest will yield more influence over the tax mix than bigger ones when it comes to loopholes (Olson, 1965). Third, one needs to understand that neither employers nor trade unions represent a coherent support base. The very fact that the real incidence of much taxation nowadays lies on labour would suggest that the different forms of taxation affect different types of employees (and employers)8 very differently. For that reason, questions remain about whether, for instance, social security should be financed by wage earners only, or by all consumers as well. This would then pitch (poor) consumers against (unionized) employees, with the latter being better organized than the former (Kemmerling, 2009). Taken together, these parameters help us understand why in some countries employer associations work with trade unions to shape the tax mix in a counter-intuitive way (more regressive taxes and more redistribution) and why in other countries employer associations get stuck in conflicts with trade unions (Mares, 2003a, 2003b, 2006; Martin, 2015; Martin & Swank, 2012). In addition, if the polity embedding interest groups fosters coordination, then socialization effects and information sharing may facilitate social pacts between capital and labour. Coordination and socialization will encourage employers to agree to taxes, especially if these taxes are strongly linked to (social) benefits (Truchlewski, 2020). Martin (2015) shows how in the majoritarian US, a culture of winner takes all and of business opposing any taxation fostered a climate of class warfare. To contrast, in Denmark, a culture of coordination between business and labour helped to generate consensus on taxation that involved taxing labour and consumption in exchange for the welfare state and greater investment in skills. Institutions thus mediate the power of interest groups and the power of political parties. Where institutions create competitive outcomes (such as majoritarian (MAJ) electoral

88  Handbook on the politics of taxation systems), interest groups have less of an incentive to cooperate, while in polities that favour repeated cooperation and power sharing (such as PR systems) interest groups have more of an incentive to cooperate. Thus, we have to spend some more time on the role of political institutions.

3.

INSTITUTIONS AND THE TAX MIX

The second big “I” in comparative political economy is “institutions.” Since the literature mainly deals with national institutions, we will focus on those. We cannot discuss lower-order forms of institutions such as the type or independence of tax authorities, or other, richer types of institutionalisms analysed by fiscal sociology (Morgan & Prasad, 2009). In the previous section, we suggested that institutions mediate the impact of parties or interest groups on the tax mix. These political institutions create several interesting hypotheses on their own – especially when they interact with each other. The first type of institution is the electoral system, which we briefly touched upon in our aforementioned discussion on interest groups: the literature pits MAJ systems against PR ones. As seen above, PR systems tend to rely on payroll and indirect taxation, whereas MAJ systems often have a sizeable income tax component (e.g. Iversen & Soskice, 2006). Several mechanisms are at play for different taxes, the tax mix or even the total tax burden: in short, electoral institutions can affect the stability of a tax mix, distribute power differently and thus affect the tax mix itself, affect the level of redistribution and thus the tax mix, and in the end affect the shape of the tax mix. A first mechanism is about how electoral institutions may or may not foster stability. Steinmo (1993) shows how tax policy in MAJ countries such as the United Kingdom (UK) can become very unstable as majorities succeed each other and undo their predecessors’ policies. In matters of taxation, this creates deep inconsistencies. Timmons (2010) corroborates this hypothesis: partisan turnover determines whether a tax system is stable or not. If turnover is high, political parties in government cannot durably affect the tax mix and cannot provide services to their political base. In contrast, when turnover is low and governments are stable, this becomes possible. In PR countries such as Sweden, electoral coalitions succeed each other with much less dramatic policy swings, and tax policy builds incrementally on negotiations and evolutions. A second mechanism deals with how electoral institutions distribute power. Hays (2003) suggests that because PR gives more voice to small groups, these then become disproportionately influential. These small groups are part of large consensus coalitions and use this fact to their advantage to lower the tax burden on incomes (especially corporate ones). Additionally, PR systems include many more players in coalitions – a fact that increases their capacity to internalize the total effect of their tax measures (Crepaz, 1996). By contrast, in MAJ countries, parties will target the median voter who prefers to maximize revenue from capital taxation. For these reasons, PR countries will tax capital less than MAJ countries. As a result, Hays argues, there is a convergence of capital taxation rather than a race to the bottom (Lierse, this volume). This convergence on capital taxation happens between liberal countries with MAJ electoral systems (those are usually big countries that have high capital taxation because they are capital abundant) and corporatist countries with PR systems. At the same time, MAJ tends

The domestic determinants of tax mixes  89 to tilt the tax mix towards more regressive forms of taxation – at least in big countries like the UK (Hall, 1986; Rhodes, 2000). But this is not the whole story. A third mechanism argues that as PR systems tend to redistribute more on the spending side (Iversen & Soskice, 2006), they can afford to be more regressive on the revenue side9 (Beramendi & Rueda, 2007). They may even tax labour more than capital (Cusack & Beramendi, 2006): even though PR usually results in more left-leaning governments, which strongly support the welfare state, their executive role is quite constrained as compared to MAJ. A fourth, more subtle, mechanism explains why PR countries have a higher tax burden in total hence also affecting regressive taxes. In PR countries coalition governments tend to overfish the common pool of tax resources (as opposed to single-party MAJ governments where over-taxation is easily blameable) to satisfy their constituencies. Because it is also harder to cut spending then (which in these countries tends to be allocated to a well-developed welfare state), over time the incentive is to raise taxation to match spending (Hallerberg, 2004; Hallerberg et al., 2009). Another major distinction in political institutions deals with the relationship between the executive and the legislative branches of government, especially the distinction between parliamentary and presidential systems (Lijphart, 1999). In parliamentary systems, heads of government are chosen by the legislature, need the confidence of the latter to stay in power and share their power through parliamentary cabinets. In presidential systems, heads of government are chosen by popular vote for a fixed term and control power as individuals. These differences in political systems can have lasting effects on tax mixes. As mentioned above, PR systems as parliamentary systems tend to expand the welfare state and the taxes that go with it (payroll, social security contribution, consumption). Presidential systems tend to pit interest groups against each other because they seek to directly access the head of government. For instance, the US Congress system creates a tax code filled with loopholes, in stark contrast to the UK and Sweden (Steinmo, 1993) or Canada (Hettich & Winer, 1999, chapter 11). The US case as interpreted by Steinmo is interesting because it shows how a decentralized system with checks and balances can yield an inefficient, low revenue-generating tax mix simply because such a system is more responsive to specific rather than general interest politics. In centralized states such as Sweden, progressive tax mixes survive because there is a broader fiscal contract between the government and workers (Steinmo, 1993) – a theme that we have already explored in the context of partisan politics and interest groups. Presidentialism could also explain why the tax intake in Latin America is so low and why it tilts the balance against income taxation (Hallerberg & Scartascini, 2017). A third institutional variation that can influence the tax mix is whether a country is centralized or federal, and how many veto points it has (Tsebelis, 2011). There is comparatively little research on veto points and the tax mix, but it appears that some veto points like a Constitutional Court (as in Germany) can pre-empt radical tax reforms and focus partisan actors on incremental solutions (Ganghof, 2006b). Fiscal federalism, on the other hand, can lead to fiscal competition within countries (Oates, 1999), although it does not always do so (Hallerberg, 1996; Gilardi & Wasserfallen, 2016). Finally, non-linearities make the picture even more complicated: Steinmo and Tolbert (1998) found a curvilinear relationship between electoral institutions and the tax burden: the tax burden is higher where electoral institutions yield majority coalitions and it is lower where they yield a one-party MAJ government or a coalition minority government. Steinmo and

90  Handbook on the politics of taxation Tolbert (1998) go further and show that other economic institutions matter: centralized labour organization correlates strongly with higher tax burdens, while decentralized labour organizations have lower tax burdens. All this analysis still assumes that actors know their preferences and act in an unbiased manner. We will turn to this assumption now.

4.

IDEAS AND THE POLITICS OF TAXATION

Ideas are the third “I” in political economy after interests and institutions. Since the 1990s, the literature on ideas has seen a renaissance in various subfields of political economy (Hall, 1993; Cox, 2001; Hay & Rosamond, 2002). Ideational approaches can have very different epistemological and methodological predispositions. This often leads to parallel literatures on related issues rather than a coherent body (see below). For this reason, this subsection begins with an overview of the concept of ideas, before we move to some applications for the politics of taxation. A few basic distinctions are helpful for understanding the notion of ideas. Some authors, for instance, would restrict ideas to explicit utterances of arguments, frames and concrete thoughts as opposed to underlying, implicit frames, assumptions and biases (Campbell, 1998). Examples of the former would be ideological tenets (“state intervention harms the economy”) or explicitly mentioned arguments (“VAT is bad for growth”); examples of the latter are implicit biases and deeper (less conscious) frames. Depending on where to draw the line, ideas in political economy include more than discourses and texts and link up with political psychology. Given that the implicit and explicit dimensions of ideas are not easy to separate, we will include both types of arguments in the following. A second differentiation goes deeper by looking at meta-theoretical positions when scientists talk about ideas (e.g. Meseguer, 2005). Here the spectrum ranges from bounded rational or biased forms of learning found in often individualistic and quantitative contributions in (rationalist) political economy and political psychology to different variants of discursive, social constructivist or even postmodern lenses. It is hard to do justice to all of these variants, but it is very instructive to compare these different approaches to see what unites and disunites the field in the politics of taxation. For instance, which meta-theoretical position you take informs the notion of causality and the type of causal mechanisms and the methods chosen (discourse, frames, cognitive biases, etc.). A third differentiation is less controversial, but very important for practical purposes: do we focus on ideas shared by members of the elite (politicians, policy experts, important stakeholders such as trade unions and employers) or do we focus on ideas shared by all (public opinion, voters, etc.)? This distinction is important because one can develop a very instrumental approach of ideas as an ideological weapon (Blyth, 2001) for members of the elite, while arguing that the masses indeed have some form of cognitive, ideological or normative implicit bias that skilful politicians can exploit. A fourth, but arguably most frequent differentiation is between types of ideas ranging from higher levels of abstraction to very specific ideas. Famously, Peter Hall (1993) uses Thomas Kuhn’s notion of paradigm to distinguish three orders of change: change in “basic instruments,” “hierarchy of goals” and paradigmatic or “third-order change.” Hall uses the shift from Keynesian to monetarist macro-economic policy making in the UK and the US of the late 1970s as an example for such a paradigmatic shift.

The domestic determinants of tax mixes  91 A similar heuristic is visible in Goldstein and Keohane’s (1993) distinction of ideas: (1) cause-and-effect relationships, (2) principled beliefs and (3) worldviews and ideologies. This distinction also implies a ladder of abstraction from more specific claims (1), to more abstract normative ones (2) and larger sets of ideas (3). While a lot of structuralist and some critical approaches would give priority to (3), in some instances it is clear that arguments about (1) can overrule arguments about (3) (see below). In the following, we will use this heuristic to look at specific ideational contributions to the literature on the politics of taxation. 4.1

Tax Policy Ideas as Worldviews

Starting with the highest level, big paradigmatic changes in economic policy making have inspired a lot of research. For instance, while many rationalist approaches focus on the changing costs of taxation for policy makers due to economic openness, some ideationalist approaches would highlight the discursive or perceived nature of globalization (Hay & Rosamond, 2002; Cox, 2001; Blyth, 2001), sometimes mediated through political institutions (Schmidt, 2002). This literature links up to specific arguments about how “neoliberalism” has allowed or forced policy makers to shift away from progressive direct to regressive indirect taxation (Swank, this volume). The literature on international policy diffusion has argued that often cross-border contagion occurs to more or less biased forms of learning, from Bayesian updating to deeper social emulation and imitation of peers (e.g. Meseguer, 2005). Appel and Orenstein (2013) use such a biased form of learning to explain the adoption of the flat tax in several Eastern European countries as part of a larger policy package consistent with the Washington Consensus after 1990. More specifically, Steinmo (2003) shows how the paradigms of taxation first shifted from simple arguments about redistribution towards Keynes-inspired arguments about taxes managing in the economy in the 1930s, and further towards the neoclassic paradigm of efficiency and distortion in the 1970s. Similarly, Christensen (2013) shows how New Zealand’s neoliberal tax reforms came about as ideas permeating less into political parties rather than bureaucratic agencies of the country. While all of these arguments are very plausible, there are profound challenges on the highest level of abstraction. In as much as these ideas are “global” in geographic and cognitive scope, they are both hard to refute and hard to test in their causal power. Neoliberalism is a contested concept in itself, even among critical scholars (Ferguson, 2010). Easier to trace are discursive or socially constructed imperatives (especially where they contradict other types of neoclassic economic arguments). But here challenges are often methodological. For example, just at the time when Cox (2001) published his article about how discourses differ between Germany and Denmark (with Germany being more resilient to globalization), Germany leap-frogged Denmark with a series of (neo)liberal welfare states and tax measures. 4.2

Tax Policy Ideas as Principled Beliefs

On a second, less abstract level, ideas about taxation take the form of principled beliefs and norms. A lot of traditional literature on the politics of taxation follows the idea that people, parties and interest groups differ in their degree of inequity aversion and social justice (Limberg, this

92  Handbook on the politics of taxation volume). This is one way to explain why some parties favour progressive forms of taxation such as income taxes over indirect and often regressive consumption taxes (Kemmerling, 2017). However, such arguments are naturally overdetermined, since other political economy models would argue that it is less the belief in normative ideas and more the material interest of those represented that matters. To dig deeper one would have to show that such normative ideas overrule material interests, e.g. when liberal politicians in the late nineteenth century argued in favour of poor un-enfranchised people (Kemmerling, 2014). Another interesting way to show how norms can be decisive is when we contemplate the role of actors for which normative arguments usually have more relevance than economic arguments. Steffen Ganghof (2006b) illustrates the importance of “horizontal” as opposed to “vertical” tax neutrality in the influential cases of the German Federal Supreme Court and how this affected the general politics of German income taxation (for the role of the European Court of Justice see Genschel and Jachtenfuchs, 2010). Another mechanism how ideas can matter is when ideas work through expert groups. For instance, it is clear that expert groups matter a lot in shaping the politics of fiscal policies, including important fields of taxation (Helgadóttir, 2016). By the very nature of “taxation” as a policy area, economists are very influential experts, and among them perhaps those coming from specific schools of thought. For instance, Randazzo and Haidt (2015) show that economists have moral intuitions about fairness that differ in many respects from the rest of the population. This could explain why they have fewer inhibitions against regressive taxes such as VAT than other experts. However, this argument is empirically not always convincing. Caplan (2007, p. 57) shows for US economists in the late 1990s that they, in fact, were less concerned about the efficiency effects of taxation and more against tax cuts than ordinary citizens. Moreover, it is not always clear whether norms and principled beliefs, at the margins, have much power. Baumgartner et al. (2008), for instance, show that the recent decline in capital punishment in the US was less related to a shift in principled beliefs (is the death sentence humane?), but more in cause–effect ideas about the efficacy of capital punishment (does it (also) kill innocent people?). There is evidence that such conflict-displacing frames also play more of a role in tax policy making (see below). 4.3

Tax Policy Ideas as Cause-and-Effect Statements

Perhaps the most prolific area in recent years looks at ideas as cause-and-effect statements in the politics of taxation. An ideational perspective breathes new life in the old debate about the visibility of different tax forms. Here, the locus classicus is Wilensky (1975, 2002), who argues that some taxes are less visible, because they tax incrementally (e.g. sales taxes) and they do not show much of a link to benefits as opposed to social security contributions (Truchlewski, 2016, 2020). Prasad (2012) points out that both survey experiments and narrative evidence such as Kato’s (2003) support this. However, Steinmo (1993) and Daunton (2002) have shown how the invisibility of certain taxes can itself be politicized. Another important cause-and-effect idea is efficiency. This comes in several forms, but one argument is that some taxes are better for growth (less distortionary, less vulnerable to evasion, etc.). The aforementioned flat tax revolution in Eastern Europe can be interpreted in this way (Appel & Orenstein, 2013). With a changing context, the power of such ideas can shift. For instance, still in the 1970s Germans thought VAT to be Konjunkturgift (poison for the business cycle), whereas nowadays VAT is praised as the most efficient tax of all. Hence,

The domestic determinants of tax mixes  93 cause-and-effect statements as frames still need more structure to help our understanding. Kemmerling (2017), for instance, argues that the power of a frame depends on its resonance among the expert (and general) public. He shows that the shift in framing VAT away from a tax bad for growth to a tax good for the economy happened much more in Germany, where the fear of unemployment struck at the heart of shifting taxation away from labour towards consumption (allegedly). This shift happened less in the UK, where the most salient socio-economic problem tends to be inequality rather than unemployment. The politics of framing (Polletta & Kai Ho, 2006; Druckman & Chong, 2007) seems a fertile area for inserting ideational arguments about taxation (Bell & Entman, 2011).

5. CONCLUSION The literature on the politics of taxation has come a long way, from relatively stylized functional or partisan arguments to dealing with the substantive complexities of the tax mix. Differentiating between the official tax forms and the real incidence of these taxes helps us understand some of these controversies. To reiterate, the tax burden nowadays lies predominantly on labour (broadly defined), since capital and consumption taxes are usually rolled over. Because of this, we find that partisan and interest group contestations have become much more complex: employers and trade unions occasionally act as coherent representatives of capital and labour when facing each other, but very often they differ internally in opinions, especially on how to tax labour. The set of political institutions further shapes the interest group logic of taxation. Different macro institutions such as the electoral system or the difference between parliamentary and presidential institutions filter interests differently and therefore tilt the balance towards or against tax-for-revenue deals in general and for or against progressive mixes in particular. It is important to emphasize, however, that we barely scratch the surface of political institutions let alone political regimes (see von Haldenwang, this volume). Further complexity arises from the question of how far the difference between the nominal and real incidence of taxation is subject to interpretation and social construction. The ideational politics of taxation question some of the assumptions of rationalist approaches to interests and institutions. The complexity in the tax mix and the uncertainty with which we measure all types of incidence gives rise to politically biased perceptions and ideological debates among politicians and expert groups.

NOTES 1. There are exceptions, however, such as the French CSG (generalized social contribution) or the Swedish payroll taxes. 2. They analyse 16 countries from 1970 to 2000. 3. Thirty-two countries from 1980 to 2006. 4. Their sample includes 16 countries for the period 1965–1995. However, they empirically conflate two dimensions stated in the Introduction: the demand for higher tax revenue in total, and the demand for higher labour taxation specifically. 5. For a high-profile example: in 2013, Gérard Depardieu renounced his French nationality and became a Russian citizen and resident of Saransk, Mordovia.

94  Handbook on the politics of taxation 6. However, some researchers have found that net of this international competition, partisan politics still play a role in the tax mix (Ganghof, 2006c), while others find the same for capital taxation (Boix, 1998; Garrett, 1998). 7. Other cleavages than partisanship also play a role, for instance religion (van Kersbergen, 1995; van Kersbergen & Manow, 2009) but for lack of space we do not look into them here. 8. For different tax policy preferences of employers see, for instance, Haffert and Mertens (2019). 9. Note that the concept of regressivity is very limited here since it only takes into account the tax side. Once social spending is included, systems with wider redistribution are much less regressive. It can also be that some tax mixes relying on seemingly progressive taxes become regressive, as in the UK (Prasad & Deng, 2009).

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The domestic determinants of tax mixes  97 Truchlewski, Z. (2016). The social sources of austerity: The politics of fiscal consolidation in the UK and France, 1978–2014. PhD Thesis, Central European University. Truchlewski, Z. (2020). “Oh, what a tangled web we weave”: How tax linkages shape responsiveness in the United Kingdom and France. Party Politics, 26(3), 280–290. Tsebelis, G. (2011). Veto Players: How Political Institutions Work. Princeton University Press. van Kersbergen, K. (1995). Social Capitalism: A Study of Christian Democracy and the Welfare State. Routledge. van Kersbergen, K., & Manow, P. (2009). Religion, Class Coalitions, and Welfare States. Cambridge University Press. Wilensky, H. (1975). The Welfare State and Equality: Structural and Ideological Roots of Public Expenditure. University of California Press. Wilensky, H. (2002). Rich Democracies: Political Economy, Public Policy, and Performance. University of California Press. Young, C. (2017). The Myth of Millionaire Tax Flight: How Place Still Matters for the Rich. Stanford University Press. Zucman, G. (2015). The Hidden Wealth of Nations: The Scourge of Tax Havens. University of Chicago Press.

7. Size and structure of the tax state in comparative perspective Lukas Haffert

1. INTRODUCTION On the most abstract level, the comparative political economy of tax systems is concerned with two main questions: how much revenue do different tax systems raise? And from what sources do they raise this revenue? In both regards, there is a lot of variation between advanced capitalist democracies. Some countries raise almost 50 percent of gross domestic product in terms of public revenue, while others only raise about 35 percent. In some countries, indirect taxes are the most important source of revenue, while the United States does not even have a value-added tax (VAT). While taxes on wealth and inheritance account for more than 10 percent of tax revenue in Canada and the United Kingdom, other countries hardly tax property at all. Explaining such variation is the bread and butter of comparative political economy and comparative political economists often rely on a number of typologies in order to make sense of this kind of variation between countries. These typologies cluster countries according to their welfare state regimes, their production regimes or their growth models (most prominently Baccaro & Pontusson, 2016; Esping-Andersen, 1990; Hall & Soskice, 2001). In the area of taxation, however, these typologies play a surprisingly minor role – as does taxation in their construction. Instead, these typologies mainly focus on the labor market and the welfare state. When they pay attention to other policy fields (like education and training systems or corporate governance), this usually happens with the aim of improving the understanding of labor markets and welfare states. Analyses of taxation in turn usually arrange countries along a single linear dimension (of size, corporatism, trade openness or the like), but rarely cluster them into different coherent types (but see Wagschal, 2015). Against this background, this chapter argues that the literatures on different models of capitalism and on the politics of taxation would benefit from greater cross-fertilization. Analyses of tax politics and policies would benefit from greater attention to how the institutional context conditions and modifies the role of certain explanatory factors. For example, the tax policy preferences of individual or collective actors may differ depending on their institutional context. Moreover, this context affects how likely these preferences are to shape actual policies. At the same time, typologies of contemporary political economies would also benefit from paying greater attention to taxation. After all, the response of different countries to contemporary economic challenges is heavily constrained by their fiscal capacity. For example, whether a country reacts to austerity pressures by raising taxes or by cutting expenditure will not least depend on the structure of the tax system that it has in place (Truchlewski, 2020). Similarly, whether countries can switch from an export-driven to a more domestic-driven growth model partly depends on whether their government is able to finance an expansion of public invest98

Size and structure of the tax state in comparative perspective  99 ment and consumption. Conversely, whether a country in a monetary union is able to raise its export competitiveness depends, among other things, on whether it is able to engineer a “fiscal devaluation” by changing its tax mix (Farhi et al., 2014). The chapter thus argues that tax policy should be analyzed as both a cause and an effect of changes in the institutional setup of different political economies. It develops this argument in three steps. In a first step, it reviews the main explanations that comparative political economists have developed in order to explain the variation in tax systems. Most of these explanations start from a distributional perspective, in which the main effect of different tax policies is to redistribute income from some citizens to others. In accordance with the literature, this section emphasizes the links between the tax system and the welfare state. In a second step, the chapter introduces a sectoral perspective on political economies, which underlies large parts of the comparative capitalisms literature and which somewhat contrasts with the distributional perspective developed before. After introducing the fundamental argument, the section reviews the growing literature on how sectoral conflict has shaped both the origins and the further development of modern tax systems. Moreover, it discusses potential feedback effects between tax policies and national growth models. The final section concludes and discusses avenues for future research. It discusses the limitation of the presented approaches to traditional Organisation for Economic Co-operation and Development (OECD) economies and calls for a greater integration of research on comparative capitalisms and research on tax policy.

2.

THE TAX STATE AND THE WELFARE STATE

Most accounts of the differences between different tax systems and of their origins explicitly or implicitly start from a distributional perspective. These accounts typically classify different taxes by their distributional profile, that is, whether they are progressive or regressive. Moreover, they conceptualize political conflict about taxation as distributional conflict and focus on the struggle between different classes or income groups. This focus on distributional questions is most obvious in a simple rational choice account. In this model, the size and structure of public revenue should be a function of the level of economic inequality (Limberg, this volume). Poorer voters as net beneficiaries of public redistribution should favor a more progressive tax system, whereas richer voters should reject tax progressivity. The more unequal a society, the higher the share of net beneficiaries and the more support for redistribution (Meltzer & Richard, 1981). The most important prediction of this model is that a decline in the relative economic position of the median voter should lead to more redistribution, that is, to a more progressive tax system. This decline of the economic position of the median voter may occur because a poorer person becomes the median voter (e.g. due to an expansion of the franchise), or because economic inequality increases. No matter what causes the shift, a relatively poorer median voter should call for more redistribution. However, since the publication of the Meltzer–Richard model in 1981, scores of empirical studies have demonstrated that this simple empirical prediction is not borne out in reality (see Limberg, this volume). While democracies may indeed redistribute more than autocracies, among developed democracies, more equal societies tend to have more regressive tax systems (Prasad & Deng, 2009).

100  Handbook on the politics of taxation Since there is no universal relationship between inequality and tax progressivity, the literature has sought to establish specific conditions under which such a relationship may still exist. Kenneth Scheve and David Stasavage (2016), for example, argue that the effect of inequality on the tax system depends on the sources of inequality. Only if inequality is perceived as the unfair result of an unequal treatment by the state, greater inequality will result in more progressive taxation. If inequality is seen as legitimate, by contrast, it will not lead to more redistribution. Empirical evidence for this argument comes from the effect of mass warfare and of financial crises on top income tax rates. Scheve and Stasavage analyze the mass mobilization of large parts of the male population as the quintessential example of unequal treatment by the state (Scheve & Stasavage, 2010, 2012). Hence, mass warfare leads to “compensatory” calls for a more equal sharing of the war burden by raising taxes on war beneficiaries and those who do not have to fight. Relatedly, Julian Limberg demonstrates that countries that were severely affected by the Great Financial Crisis of 2008 and 2009 raised top income tax rates more than less-affected countries (Limberg, 2019). That people consider the sources of inequality when forming their tax policy preferences is also indicated by micro-level evidence. Ballard-Rosa et al. (2017) show that Americans who believe that economic success is the result of luck are more supportive of high taxes on the rich than those who believe it is the result of hard work. Similarly, Limberg (2020) demonstrates that the Great Recession increased preferences for tax progressivity most strongly in those countries that were most heavily affected by the crisis. Generally, though, this literature has demonstrated that a direct link between inequality and progressive taxation only exists under very specific circumstances (for a more extensive review of these debates, see Limberg, this volume). It thus echoes the longstanding finding that less unequal countries typically have less progressive tax systems. This finding is partly explained by differences in pre-tax inequality. However, it mainly has to do with the fact that the relatively regressive tax systems of countries with strong welfare states raise a lot of revenue, which can then be spent progressively. The redistribution simply occurs on the spending side and less on the revenue side. In other words: to permit major reductions in inequality, tax states have to be big but not necessarily progressive. This is, then, the most fundamental stylized fact in the comparative political economy of advanced tax systems: that bigger tax states tend to be less progressive. Raising more than 40 percent of gross domestic product in terms of public revenue is not possible by mainly relying on the taxation of the wealthy. Instead, these states need to substantially burden their middle classes in order to generate that much revenue. This relationship is illustrated by Figure 7.1, which plots total revenue from taxes and social security contributions against the revenue share that comes from income taxes, corporate taxes and property taxes, that is, from the potentially progressive elements of the tax system. Obviously, this is a very coarse measure of tax progressivity, since the fact that these taxes can potentially be progressive does not yet guarantee that they are indeed progressive. However, the available evidence suggests that the income tax is still quite progressive across OECD countries, even if it used to be much more progressive in the past (Gerber et al., 2018). With this caveat in mind, Figure 7.1 clearly shows that those countries that generate the highest revenue do not use taxes on income and wealth for doing so but rather rely on non-progressive revenue sources (that is social security contributions and/or consumption taxes). The big exception here is Denmark, which generates most revenue from the income

Size and structure of the tax state in comparative perspective  101

Source:

OECD tax database.

Figure 7.1

Size and composition of OECD tax states in 2017

tax, even though it has one of the biggest tax states in the world. However, Denmark is not an exception to the rule that big tax states cannot be built by simply increasing the burden on the rich, since the Danish income tax generates a lot of revenue from the middle class (Ganghof, 2007). Thus, even the Danish case supports the conclusion that the development of big tax states has only been possible by burdening medium incomes. How can this negative relationship between size and progressivity be explained? As already mentioned, the standard account emphasizes the close link between the structure of the tax system and the size of the welfare state. After all, the revenue that bigger tax states generate from relatively regressive taxes is largely used to fund generous welfare states. While this empirical observation of a link between bigger welfare states and more regressive tax systems is widely accepted, there is much more debate about the causal order of these phenomena. Is the existence of a capable tax state the precondition for the expansion of the welfare state, or does the decision for a strong welfare state necessitate the development of a powerful revenue machine? This debate has mainly focused on the role of consumption taxes. The first position argues that only those countries that had early on developed a highly elastic and easily expandable source of revenue in the form of the VAT were able to finance the big expansion of the welfare state in the 1970s (Kato, 2003). These countries could use the VAT as a “money machine” by increasing this relatively invisible but highly productive tax. Countries that did not yet have a VAT, by contrast, had a much harder time to raise tax revenue. Hence, welfare expansion was heavily constrained by the lack of available financial resources.

102  Handbook on the politics of taxation The alternative position reverses this causal ordering of revenue and expenditure (Ganghof, 2006; Lindert, 2004). In this account, expenditure decisions come first and generate revenue needs, which then drive the adoption and expansion of taxes. The tax mix is then selected based on the macroeconomic effects of different taxes. In this framework, the increasing mobility of production factors has increased the deadweight loss of taxing capital and labor and has called for a shift to less mobile tax bases, in particular to indirect taxes. Accordingly, many studies have analyzed higher trade exposure and increased capital mobility (Genschel & Schwarz, 2011; Swank & Steinmo, 2002) and Europeanization (Kemmerling, 2010) as important sources of changes in the size and composition of government revenues (see Lierse, this volume). In this perspective, bigger welfare states’ reliance on regressive taxes is simply a functional imperative: after the decision to expand the welfare state has been made, a regressive tax system is the only way to finance it without inflicting too much damage on the economy. While this argument sounds rather mechanistic, the political efficacy of such an efficiency frame depends on the macroeconomic context. When economic conditions are bad, for example when unemployment is high, even left parties may see tax policy through this lens (Kemmerling, 2017). When economic conditions are good, or when inequality appears as the bigger economic problem, the need for a shift to less distortive taxes may appear less evident. Moreover, the salience of such questions is partly endogenous, as interest groups actively seek to shape the public perception of tax policy proposals. Business interests, for example, seek to play down fairness concerns and to draw particular attention to their potential consequences for the economy (Emmenegger & Marx, 2019). Independently of the causal ordering of revenue and expenditure decisions, however, both approaches present the link between tax state and welfare state as an explicit or implicit deal, in which higher public spending is exchanged for higher revenue (Timmons, 2005, 2010). This raises the questions as to which actors are willing to strike such a deal and how this deal can be made credible. In terms of the actors, most attention is paid to labor and social democrats (Andersson, 2017; Beramendi & Rueda, 2007; Cusack & Beramendi, 2006). After all, conservatives are unlikely to expand the welfare state in the first place. Social democrats, by contrast, ideally would like to finance welfare state expansion through progressive taxation. When this is not possible, they may become willing to accept regressive taxation in order to finance redistribution on the expenditure side. Yet, even if social democrats were willing to strike such a bargain, there is the question of how they can make it stick. After all, there is always the danger that a future conservative government will use the revenue from indirect taxes for cutting progressive taxes or for non-welfare spending, e.g. on the military. This points to a crucial role of institutions, which allows making long-term commitments credible. At the same time, these institutions can be understood in two very different ways. They can either be seen as constraining, as they prevent governments from pursuing other, more attractive tax policies. However, they can also be seen as enabling, as they allow for long-term commitments which would otherwise not be possible. Two types of institutions play a particularly prominent role in the literature: the type of democracy, often seen as related to the electoral system, and corporatism (for more systematic summaries, see Andersson, this volume; Kemmerling & Truchlewski, this volume). Regarding the former, consensus democracies, in which elections are held through proportional representation, are said to constrain political majorities and their capacity to shift the burden of

Size and structure of the tax state in comparative perspective  103 taxation to a minority – that is, capital owners (Hays, 2003). At the same time, these institutions also constrain a country’s capacity to adapt its tax system, for example to globalization pressures (Hallerberg & Basinger, 1998; Swank, 2016). They should thus slow down the process of tax reform. Depending on the broader economic context, consensus institutions can thus constrain the preferred policies of both the left and the right. However, they can also enable such policies by allowing more credible long-term bargains. Majoritarian institutions, by contrast, lead to strong reversals in the direction of economic policy and thus make it difficult to strike such bargains (Andersson, 2017; Hertel-Fernandez & Martin, 2018; Steinmo, 1993; Steinmo & Tolbert, 1998). While these arguments emphasize the role of parties as crucial drivers of tax policy, a second argument emphasizes the role of organized interests. In this view, governments can be constrained by corporatist commitments to business associations and/or labor unions (Beramendi & Rueda, 2007). Again, however, these constraints can be seen as beneficial, since they allow governments to tie their own and their successors’ hands to the mast. Even if the government changes, corporatist actors will ensure that the government still keeps its promises. Such a bargain, for example, allowed corporatist countries to adopt the VAT early (Helgason, 2017). The corporatist bargain is typically seen as a bargain between social democratic governments and labor unions. However, corporatism may also ensure the support of business interests for an expansion of the welfare state by giving these interests an influence over the design of the tax system (Hertel-Fernandez & Martin, 2018). Cathie Jo Martin (2015), for example, compares corporate preferences in Denmark and the United States and argues that Danish businesses consented to a strong growth of government because they were assured that most of the tax burden would fall on labor. The corporatist institutions helped to make such a promise credible. Most analyses of a link between tax systems and welfare states thus focus on domestic politics and domestic institutions (Kemmerling & Truchlewski, this volume). However, it might also be that the welfare state and the tax system are linked by the third factor of economic openness. According to the compensation hypothesis, more open economies develop bigger welfare states. Moreover, indirect taxes are widely seen as relatively trade-friendly taxes (Benzarti & Tazhitdinova, 2019). Hence, economic openness may be the background factor that accounts for both the growth of the welfare state and the growth of regressive taxation. Indeed, in a global perspective, the VAT, the welfare state’s supposed money machine, was primarily introduced by more open economies (Seelkopf et al., 2016). In Europe, its emergence was also closely related to the ambition for greater economic integration within the European Economic Community (Haffert & Schulz, 2020). That said, the literature on the supposed race to the bottom in capital taxation and corporate taxation clearly shows that such international trends are always mediated by domestic political institutions (Hallerberg & Basinger, 1998; Hays, 2003; Swank, 2016).

3.

TAXATION AND GROWTH REGIMES

The underlying theoretical paradigm in the tax state-welfare state literature is distributional conflict between different classes. The fundamental question is whether the poor and the

104  Handbook on the politics of taxation middle classes can make the rich pay for the welfare state, or whether they have to shoulder the burden of the welfare state themselves. This type of approach is also representative of the longstanding approach to comparative political economy that is associated with power resource theory (emblematically represented by Esping-Andersen, 1990). The literature that can be summarized as operating in a comparative capitalisms framework, by contrast, emphasizes the role of sectoral conflict (Baccaro & Pontusson, 2016; Hall & Soskice, 2001; Thelen, 2014). In this perspective, economic policies are not purely distributional and, as a consequence, preferences about these policies are not entirely class-based but are to an important extent sector-based. For example, welfare state programs are not simply a device to redistribute income between income groups or generations, but also shape which qualifications individuals obtain and which strategies firms pursue (Estevez-Abe et al., 2001). Accordingly, political struggles about these policies are more complex than a simple distributional logic would suggest. In this perspective, cross-class coalitions between employers and employees in the same sector play a crucial role for the development of economic policies. The fundamental mechanism explaining the emergence of these coalitions is asset specificity: since employees cannot easily transfer their human capital to other sectors, they have a strong interest in the economic success of their own firm or sector. Hence, they become the natural allies of capital owners who also have made specific investments in this sector. Such a sectoral perspective can also be applied to analyses of the politics of taxation. Compared to the distributional perspective, it conceptualizes both the economic effects of different taxes and the political conflict about taxation somewhat differently. With regard to the economic effects, the crucial question is not how they affect different income groups – their progressivity or regressivity – but how they affect different types of economic activity. Tax policies can affect the fortunes of different sectors both on the supply side and the demand side. They can increase (or restrict) the supply of different goods or services by making them relatively cheaper/more expensive to produce, e.g. by affecting the relative costs of their inputs. Alternatively, they can increase/reduce the demand for these goods or services by changing their relative price or the availability of their substitutes. This latter effect is most obvious for sector-specific taxes such as sin taxes on alcohol and tobacco or green taxes on energy consumption, and for targeted tax exemptions such as the mortgage interest deduction. However, it also matters for taxes with a much broader tax base. In particular, it helps to disentangle the politics of VAT and social security contributions, which are both relatively regressive sources of public revenue (and implicitly lumped together as non-progressive in Figure 7.1). However, they target different economic activities: while the VAT is a tax on consumption, and thus affects the demand for different goods and services, social security contributions burden the use of labor in production and increase costs on the supply side of the economy.1 With regard to political conflict, the sectoral perspective emphasizes that people do not only consider their position in the income distribution when developing their tax policy preferences. Instead, they also take into account the sources of their income and how different tax policies affect these sources. This leads to a sectoral, cross-class conflict about tax policy. In this perspective, the size, but even more so the structure of the tax state is thus not just a matter of the balance of power between capital and labor, but is also shaped by the balance of power between different sectoral coalitions.

Size and structure of the tax state in comparative perspective  105 This general perspective is far from new. How policymakers actively use the tax system as an instrument for shaping the development of national growth models, and for supporting or restraining the growth of certain economic sectors, plays an important role in Sven Steinmo’s seminal analysis of the development of the American, British and Swedish tax systems. As Steinmo noted, “raising revenue, redistributing income, encouraging savings, stimulating growth, penalizing consumption, directing investment, and rewarding certain values while penalizing others are just some of the hundreds of goals that any modern government tries to promote with its tax system” (Steinmo, 1993, p. 3). Similarly, the widespread use of tax expenditures has always had the dual purpose of redistributing income and of supporting specific sectors (Howard, 1997). Moreover, such a sectoral perspective does not only help to elucidate the behavior of governments, but also the formation of preferences among interest groups. As Cathie Jo Martin demonstrated 30 years ago, sectoral interest groups have shaped corporate tax reforms in the United States with very different goals in mind (Martin, 1991). In her account, three different groups of industries, namely finance and housing, small businesses and services and manufacturing, can be distinguished as having distinct preferences in corporate tax reform (Martin, 1991, p. 37). It would thus be mistaken to assume that “business” forms a unified front in matters of tax policy. While sectoral arguments thus have a venerable tradition in the tax policy literature, in recent years, new data collection efforts have made it possible to analyze a much wider set of questions from this perspective. In particular, an analysis of sectoral conflict has proven to be very insightful in studies of the emergence of modern tax systems. Before the arrival of mass democracy, sectoral conflict about taxation was mainly a conflict between competing economic elites. A number of historical studies have demonstrated how conflict between agricultural elites and industrial elites affected the timing and the form of the introduction of the income tax (Beramendi et al., 2018; Mares & Queralt, 2015, 2019). From a sectoral perspective, the early income tax was not primarily a progressive tax, but an instrument to shift the burden of taxation to the cities and the newly emerging industries. Accordingly, when Great Britain introduced this tax in 1842, it was mainly supported by politicians representing agricultural interests, while politicians representing industrial interests opposed the reform (Mares & Queralt, 2015). A very similar pattern also characterized the adoption of the income tax in Prussia in 1891 (Mares & Queralt, 2019). While sectoral conflict in these cases directly revolved around the economic effects of the tax, tax policy could also be employed to forge coalitions when the core of the conflict was about different policies. This dynamic is illustrated by Barnes (2020), who analyzes the role of tax policy in the conflict about free trade. As her historical evidence shows, when elites were split on the issue of trade, free traders were willing to accept progressive taxes in order to enlist labor’s support for their free trade agenda. Thus, the new tax was not used directly to shift the economic burden to competing elites but was used as a bargaining chip to further sectoral interests in a different field of economic policy. As in the case of distributional conflict, however, the lines of conflict and the balance of power were not identical across countries but depended on the specific national context. From a comparative perspective, Beramendi, Dincecco and Rogers argue that the timing of industrialization affected the power balance between agricultural and industrial interests. In late-industrializing countries, agricultural interests retained their political dominance and could thus shape the tax system according to their preferences (Beramendi et al., 2018).

106  Handbook on the politics of taxation Andersson extends this argument to the urban and rural masses and demonstrates that democratization in more rural countries led to a tax system that shifted a large part of the tax burden to the consumption of city dwellers, whereas democratization in more urban countries led to higher taxes on land and income (Andersson, 2018). Monica Prasad, finally, puts forward a similar, but somewhat modified argument from a historical sociology perspective. As she demonstrates, agrarian interests shaped the peculiar development of the American political economy, including the American tax system (Prasad, 2012). In contrast to landed interests in Europe, which were heavily protectionist, American agriculture was confronted with a problem of overproduction and thus in perennial search for new sources of demand. This made farmers supportive of free trade – and staunchly opposed to any tax policy proposals that threatened to reduce the growth of domestic consumption. These detailed historical studies demonstrate that analyses of sectoral conflict need to pay careful attention to the actual preferences of different sectors, as well as to their political power. For example, it is not a priori self-evident whether landed interests favor or oppose the taxation of consumption. This depends on the position of the agricultural sector in the world market. More generally, the balance of power between different sectors varies from country to country and depends on its level of economic development as well as on the structure of its political and economic institutions. An analysis of sectoral conflicts not only sheds new light on the emergence of modern tax systems and their cross-national differences, but also helps to understand their further development. As discussed above, the two world wars were the most important catalyst of the transformations of the tax systems that had been established in the nineteenth and early twentieth centuries (Emmenegger & Walter, this volume). The wars caused an enormous increase in the size of the tax state and made the tax system much more progressive (Scheve & Stasavage, 2016). As Haffert (2019) argues, however, this was again mediated by sectoral conflict, in particular after the Second World War. In continental European countries, the war had destroyed important parts of the capital stock. This strengthened the political position of capital owners, since the need for reconstruction restricted the room for progressive taxation of capital. In Anglo-Saxon countries, by contrast, the war had been much less destructive and capital was thus relatively abundant. Whereas the distributional push for compensatory taxes was thus largely uncontested in Anglo-Saxon countries, it was restrained by concerns about capital allocation in continental Europe. Similarly, a sectoral perspective can shed new light on the question of the adoption of VAT, the welfare states’ supposed money machine. Haffert and Schulz study the introduction of VAT in the European Community in 1967 and show that this important reform had little to do with the welfare state. Instead, big export-oriented German firms pushed the German government to throw its weight behind this reform on the European level, since they hoped that the reform would improve their competitiveness within the emerging common market. Domestic firms, for whom competitiveness was less of a concern, were rather critical of the reform (Haffert & Schulz, 2020). While analyses based on the idea of sectoral conflict have thus improved our understanding of the origins of modern tax systems, they have so far less often been applied to analyses of contemporary tax policy conflict. The literature that exists has, again, mostly focused on the politics of consumption taxation. As Haffert and Mertens (2019) show, the development of consumption taxes since the 1970s was characterized by a sector-based conflict between domestically oriented and export-oriented interests. They demonstrate a systematic relation-

Size and structure of the tax state in comparative perspective  107

Source:

OECD tax database, comparative political dataset.

Figure 7.2

Trade orientation and consumption tax revenue, 2017

ship between the strength of the consumption sector and the effective rate of consumption taxation: countries with a more consumption-driven growth model have been much more reluctant to tax consumption than countries in which the export sector has played a more prominent role in the growth model. This relationship between export-sector strength and consumption taxation is illustrated in Figure 7.2. Haffert and Mertens thus link their finding to the idea that policymaking in different growth models is shaped by different “dominant social blocs” which succeed in adapting economic policies to their needs and preferences (Baccaro & Pontusson, 2016). A very similar conflict is described by Richard Eccleston, who discusses the repeated but failed attempts to introduce VAT in the United States (Eccleston, 2007): while export-oriented business interests supported such a reform, it was heavily opposed by domestically oriented sectors (Eccleston, 2007, p. 161). These analyses of the politics of consumption taxation thus show that an analysis of cross-class coalitions in different sectors can improve our understanding of struggles about contemporary tax reforms. Moreover, it highlights the close relationship between the tax system and the broader institutional structure of different political economies. To put it very simply: an export-oriented economy will typically have an export-friendly tax system, while the tax system of a domestically oriented economy will favor domestic consumption. Of course, this relationship should hold not just for consumption taxes, but for the entire tax mix. For example, the tax treatment of mortgage interest is arguably a crucial instrument for furthering or restraining credit-driven domestic consumption (Fuller, 2015).

108  Handbook on the politics of taxation An advantage of this sectoral perspective, thus, is that it explicitly takes the feedback effects between tax policies and economic structure into account. The structure of the economy, such as the size and dynamic of different sectors, has an effect on the tax policies that are being adopted, but these policies also affect the further sectoral development of the economy. This suggests that taxation is not just a crucial element of redistribution but also plays an important role in matters of pre-distribution. The politics of taxation do not only react to market outcomes (with winners of the market trying to defend their gains and losers of the market seeking compensation through the tax and transfer system). Instead, an important part of the politics of taxation revolves around the question as to what the market outcomes are going to be. Indeed, such feedback effects are increasingly being analyzed in distributional accounts. Piketty et al. (2014), for example, argue that a main effect of very high top income tax rates is not to redistribute income from the highest income earners, but rather to reduce their pre-tax income in the first place. Thus, what appears to be the ultimate tool of redistribution is largely a tool of pre-distribution. However, the most important feedback effects arguably affect the sectoral dynamics of an economy and not its distributional profile. From this perspective, the tax system appears to be part of the wider set of institutions and policies that underpin different national “growth models” or “growth regimes” (Baccaro & Pontusson, 2016; Hall, 2020; Johnston & Regan, 2017). Just like the welfare state or the education system, the tax system encourages or discourages firms to invest in certain economic activities, and it encourages or discourages workers to pursue certain careers. For example, throughout the postwar era, continental European tax systems actively attempted to suppress consumption and to encourage investment as part of these countries’ investment-led growth models (Aldcroft & Morewood, 2013; Eichengreen, 2007). Compared to the more institutional factors, however, the tax system is rather malleable. While institutional factors are thus characterized by long historical continuities, tax systems can be employed to engineer major shifts in national growth strategies, as demonstrated by the wave of major tax reforms that have swept across the developed world since the 1980s. In the Anglo-Saxon economies, for example, these reforms arguably supported the increasing financialization of their growth models by massively lowering the tax burden on the very high salaries that are being paid in the financial sector (Bivens & Mishel, 2013). While many authors recognize such links between tax systems and growth models, however, they have so far been less systematically explored than the links between the tax state and the welfare state. As discussed above, most sectoral analyses of tax policy focus on the historical emergence of modern tax systems and less on contemporary developments. A more systematic analysis of the way different growth models affect tax policy choices thus appears to be a promising avenue for future research.

4. CONCLUSION The size and the structure of the tax state are intimately linked. In particular, bigger tax states rely more heavily on taxing consumption than smaller tax states. Associations like this can be analyzed as an expression of class conflict, in which the subject of political struggle is how the burden of taxation is shared between capital and labor. However, it can also be analyzed

Size and structure of the tax state in comparative perspective  109 as an expression of sectoral conflict which pits cross-class alliances in different sectors of the economy against each other. This chapter has summarized the main implications of these alternative perspectives for the group of traditional OECD member countries: the countries of Western Europe, Japan and the anglophone countries of North America and Oceania. However, the same logic should in principle also be useful to analyze the politics of taxation in other capitalist democracies such as in Central and Eastern Europe. That being said, such extensions would of course have to take the historical and institutional specificities of these countries into account. For example, the “embedded neoliberal” Visegrád countries have flirted with a flat tax just as much as the “neoliberal” Baltic countries (Bohle & Greskovits, 2012), even if most of them abandoned their pure flat tax in the years after the financial crisis. This points to a more general lesson from the comparative analysis of tax systems: different actors’ preferences cannot simply be deducted from a general theoretical model but need to be analyzed in their specific context. This is demonstrated by a number of examples discussed above. Some parties on the left of the political spectrum have consistently opposed consumption taxes because of their regressivity, while similar parties in other countries have embraced them as a “money machine” or because they helped to reduce the burden on labor in the export sector. Similarly, agricultural interests in the nineteenth century differed in their tax policy preferences, depending on their position in the world market. These differences can only be understood by taking the broader institutional and economic context in which actors operate into account. This broader context is at the center of the literatures on comparative capitalisms and different national growth models. Against this background, the chapter has argued that the analysis of contemporary tax policies would benefit from greater integration with these literatures. However, it is not just the analysis of tax policy that would benefit from such an integration. The literature on comparative capitalisms would also benefit from greater attention to questions of tax policy. This could be particularly the case for the growth model perspective, which shifts the focus from the supply side to the demand side of the economy (Baccaro & Pontusson, 2018). While different authors disagree about the details of this shift, they agree that a demand side-oriented perspective will play a much greater role than it did in recent decades (Hope & Soskice, 2016). This demand-side turn will entail a greater role for the public finances, as fiscal policy in general, and tax policy in particular, are an essential tool of demand management. For example, tax policies may affect the credit demand of private households. Analyses of consumption-driven growth models often link private consumption to an expansion of credit (Baccaro & Pontusson, 2016; Hassel & Palier, 2021). This demand is closely linked to the housing market and to mortgages. Here, the tax system plays an important role through the tax deductibility of mortgage interest payments, the lack of taxation of imputed rents or the taxation of the ownership and the transfer of housing (including the taxation of capital gains) (Fuller, 2015). This is just one example of the manifold ways in which the tax system is an important element of the broader institutional and political setup that encourages or discourages certain types of economic activities and economic growth. A better understanding of the institutional underpinnings of different growth models, as well as of the political coalitions supporting them, could thus certainly benefit from greater attention to the comparative political economy of taxation.

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NOTE 1.

Of course, the value-added tax ultimately also falls on income. However, due to differentiated rates and exemptions, it affects the demand for different goods and services, and thus the fortunes of different economic sectors, differently.

REFERENCES Aldcroft, D., & Morewood, S. (2013). The European Economy since 1914. Routledge. Andersson, P. F. (2017). Essays on the Politics of Taxation. Lund University. Andersson, P. F. (2018). Democracy, urbanization, and tax revenue. Studies in Comparative International Development, 53, 111–150. Baccaro, L., & Pontusson, J. (2016). Rethinking comparative political economy: The growth model perspective. Politics and Society, 44, 175–207. Baccaro, L., & Pontusson, J. (2018). Comparative Political Economy and Varieties of Macroeconomics. MPIfG Discussion Paper 18/10. Ballard-Rosa, C., Martin, L., & Scheve, K. (2017). The structure of American income tax policy preferences. Journal of Politics, 79(1), 1–16. Barnes, L. (2020). Trade and redistribution: Trade politics and the origins of progressive taxation. Political Science Research and Methods, 8(2), 197–214. Benzarti, Y., & Tazhitdinova, A. (2019). Do Value-Added Taxes Affect International Trade Flows? Evidence from 30 Years of Tax Reforms. NBER Working Paper 26195. Beramendi, P., Dincecco, M., & Rogers, M. (2018). Intra-elite competition and long-run fiscal development. Journal of Politics, 81(1), 49–65. Beramendi, P., & Rueda, D. (2007). Social democracy constrained: Indirect taxation in industrialized democracies. British Journal of Political Science, 37(4), 619–641. Bivens, J., & Mishel, L. (2013). The pay of corporate executives and financial professionals as evidence of rents in top 1 percent incomes. Journal of Economic Perspectives, 27(3), 57–78. Bohle, D., & Greskovits, B. (2012). Capitalist Diversity on Europe’s Periphery. Cornell University Press. Cusack, T. R., & Beramendi, P. (2006). Taxing work. European Journal of Political Research, 45, 43–73. Eccleston, R. (2007). Taxing Reforms: The Politics of the Consumption Tax in Japan, the United States, Canada and Australia. Edward Elgar Publishing. Eichengreen, B. (2007). The European Economy since 1945: Coordinated Capitalism and Beyond. Princeton Unviersity Press. Emmenegger, P., & Marx, P. (2019). The politics of inequality as organised spectacle: Why the Swiss do not want to tax the rich. New Political Economy, 24(1), 103–124. Esping-Andersen, G. (1990). The Three Worlds of Welfare Capitalism. Princeton University Press. Estevez-Abe, M., Iversen, T., & Soskice, D. (2001). Social protection and the formation of skills: A reinterpretation of the welfare state. In P. A. Hall & D. Soskice (eds), Varieties of Capitalism: The Institutional Foundations of Comparative Advantage, 145–183. Oxford University Press. Farhi, E., Gopinath, G., & Itskhoki, O. (2014). Fiscal devaluations. Review of Economic Studies, 81(2), 725–760. Fuller, G. W. (2015). Who’s borrowing? Credit encouragement vs. credit mitigation in national financial systems. Politics and Society, 43(2), 241–268. Ganghof, S. (2006). Tax mixes and the size of the welfare state: Causal mechanisms and policy implications. Journal of European Social Policy, 16(4), 360–373. Ganghof, S. (2007). The political economy of high income taxation. Comparative Political Studies, 40, 1059–1084. Genschel, P., & Schwarz, P. (2011). Tax competition: A literature review. Socio-Economic Review, 9, 339–370.

Size and structure of the tax state in comparative perspective  111 Gerber, C., Klemm, A., Liu, L., & Mylonas, V. (2018). Personal Income Tax Progressivity: Trends and Implications. IMF Working Paper 18/246. Haffert, L. (2019). War mobilization or war destruction? The unequal rise of progressive taxation revisited. Review of International Organizations, 14(1), 59–82. Haffert, L., & Mertens, D. (2019). Between distribution and allocation: Growth models, sectoral coalitions and the politics of taxation revisited. Socio-Economic Review. https://​doi​.org/​10​.1093/​ser/​ mwz038 Haffert, L., & Schulz, D. (2020). Consumption taxation in the European Economic Community: Fostering the common market or financing the welfare state? Journal of Common Market Studies, 58(2), 438–454. Hall, P. A. (2020). The electoral politics of growth regimes. Perspectives on Politics, 18(1), 185–199. Hall, P. A., & Soskice, D. (eds) (2001). Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. Oxford University Press. Hallerberg, M., & Basinger, S. (1998). Internationalization and changes in tax policy in OECD countries: The importance of domestic veto players. Comparative Political Studies, 31(3), 321–352. Hassel, A., & Palier, B. (2021). Tracking the transformation of growth regimes in advanced capitalist economies. In A. Hassel & B. Palier (eds), Growth and Welfare in Advanced Capitalist Economies: How Have Growth Regimes Evolved?, 3–56. Oxford University Press. Hays, J. C. (2003). Globalization and capital taxation in consensus and majoritarian democracies. World Politics, 56, 79–113. Helgason, A. F. (2017). Unleashing the “money machine”: The domestic political foundations of VAT adoption. Socio-Economic Review, 15, 797–813. Hertel-Fernandez, A., & Martin, C. J. (2018). How employers and conservatives shaped the modern tax state. In G. Hürlimann, W. E. Brownlee, & E. Ide (eds), Worlds of Taxation: The Political Economy of Taxing, Spending and Redistribution since 1945, 17–48. Palgrave Macmillan. Hope, D., & Soskice, D. (2016). Growth models, varieties of capitalism, and macroeconomics. Politics and Society, 44(2), 209–226. Howard, C. (1997). The Hidden Welfare State: Tax Expenditures and Social Policy in the United States. Princeton University Press. Johnston, A., & Regan, A. (2017). Introduction: Is the European Union capable of integrating diverse models of capitalism? New Political Economy, 15, 115. Kato, J. (2003). Regressive Taxation and the Welfare State: Path Dependency and Policy Diffusion. Cambridge University Press. Kemmerling, A. (2010). Does Europeanization lead to policy convergence? The role of the Single Market in shaping national tax policies. Journal of European Public Policy, 17, 1058–1073. Kemmerling, A. (2017). Left without choice? Economic ideas, frames and the party politics of value-added taxation. Socio-Economic Review, 15, 777–796. Limberg, J. (2019). “Tax the rich?” The financial crisis, fiscal fairness, and progressive income taxation. European Political Science Review, 11(3), 319–336. Limberg, J. (2020). What’s fair? Preferences for tax progressivity in the wake of the financial crisis. Journal of Public Policy, 40(2), 171–193. Lindert, P. H. (2004). Growing Public: Social Spending and Economic Growth since the Eighteenth Century. Cambridge University Press. Mares, I., & Queralt, D. (2015). The non-democratic origins of income taxation. Comparative Political Studies, 48(14), 1974–2009. Mares, I., & Queralt, D. (2019). Fiscal innovation in nondemocratic regimes: Elites and the adoption of the prussian income taxes of the 1890s. Explorations in Economic History, 77, 101340. Martin, C. J. (1991). Shifting the Burden: The Struggle over Growth and Corporate Taxation. University of Chicago Press. Martin, C. J. (2015). Labour market coordination and the evolution of tax regimes. Socio-Economic Review, 13, 33–54. Meltzer, A. H., & Richard, S. F. (1981). A rational theory of the size of government. Journal of Political Economy, 89, 914–927. Piketty, T., Saez, E., & Stantcheva, S. (2014). Optimal taxation of top labor incomes: A tale of three elasticities. American Economic Journal: Economic Policy, 6(1), 230–271.

112  Handbook on the politics of taxation Prasad, M. (2012). The Land of Too Much: American Abundance and the Paradox of Poverty. Harvard University Press. Prasad, M., & Deng, Y. (2009). Taxation and the worlds of welfare. Socio-Economic Review, 7, 431–457. Scheve, K., & Stasavage, D. (2010). The conscription of wealth: Mass warfare and the demand for progressive taxation. International Organization, 64, 529–561. Scheve, K., & Stasavage, D. (2012). Democracy, war, and wealth: Lessons from two centuries of inheritance taxation. American Political Science Review, 106, 81–102. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States. Princeton University Press. Seelkopf, L., Lierse, H., & Schmitt, C. (2016). Trade liberalization and the global expansion of modern taxes. Review of International Political Economy, 23(2), 208–231. Steinmo, S. (1993). Taxation and Democracy: Swedish, British and American Approaches to Financing the Modern State. Yale University Press. Steinmo, S., & Tolbert, C. J. (1998). Do institutions really matter? Taxation in industrialized democracies. Comparative Political Studies, 31(2), 165–187. Swank, D. (2016). Taxing choices: International competition, domestic institutions and the transformation of corporate tax policy. Journal of European Public Policy, 23, 571–603. Swank, D., & Steinmo, S. (2002). The new political economy of taxation in advanced capitalist democracies. American Journal of Political Science, 46, 642–655. Thelen, K. (2014). Varieties of Liberalization and the New Politics of Social Solidarity. Cambridge University Press. Timmons, J. F. (2005). The fiscal contract: States, taxes, and public services. World Politics, 57, 530–567. Timmons, J. F. (2010). Taxation and credible commitment: Left, right, and partisan turnover. Comparative Politics, 42(2), 207–227. Truchlewski, Z. (2020). “Oh, what a tangled web we weave”: How tax linkages shape responsiveness in the United Kingdom and France. Party Politics, 26(3), 280–290. Wagschal, U. (2015). Families of Taxation: Convergence or Divergence. Paper presented at the ECPR Joint Sessions of Workshops in Warsaw.

8. Political regimes and taxation: do democratic rule and regime stability count? Christian von Haldenwang

1. INTRODUCTION Doing field research on the decentralization of the property tax in Indonesia in 2014 (see von Haldenwang et al., 2015), our research team was puzzled by the observation that the reform, which was affecting a large number of citizens, did not seem to play any role at all in the upcoming local elections. During the political campaign period in the weeks prior to the elections we expected property tax to be a topic of discussion and public discourse. However, in the seven cities that we visited as case studies we could not find any public reference to taxes, and our interview partners agreed that taxes in general were not an electoral issue. Does this prove that Indonesians at that time considered taxes above all a technical matter, separated from politics? Probably not. Rather, most interviewees found that property tax was politically quite sensitive at that moment and politicians were reluctant to raise the issue due to the political cost associated with it. In a few cities, public protests had been staged against higher property tax rates following decentralization, and politicians were apparently fearful of uncontrolled civic mobilization. In a still rather young, pluri-ethnic and pluri-religious democracy, which puts high value on political consensus, candidates seemed to agree that nobody was to gain from raising such a potentially divisive and clearly unpopular issue. This experience, though highly context-specific, contains a basic insight and invites us to ask a couple of relevant questions. The basic insight is that the institutional setting of politics – the political regime1 – shapes the freedom governments enjoy to tax citizens and businesses. Taxes, whether a matter of public debate or not, are politically sensitive. The relationship between ruler and ruled tends to change with taxes – at the local level as well as at the national level. Politicians are mindful of the impact taxation might have on political stability and rule. Among the questions raised by the case reported above, the following two seem to be particularly relevant. First, what does democracy do to taxation? Are electoral competition, free speech and freedom of association drivers of lower or higher taxation? In the Indonesian case, it appears that they were factors working against higher taxation, at least in the short term: political decision makers preferred to leave tax rates as they were in order to keep the subject out of public debate. A second question refers to the impact of taxation on political regime stability. Indonesia belongs to the group of countries with a rather low tax-to-gross domestic product (GDP) ratio. Would raising taxes in such a context help to consolidate the political regime or would the opposite be the case? Though decentralization of the property tax was certainly not a political game changer in Indonesia at that time, fear of political protests seems to have played a certain role here. Hence, in a nutshell this case contains many of the questions political science research explores when looking at the politics of taxation. This chapter reviews the academic literature on three types of relationships between taxation and political regimes by contrasting theoretical approaches with the available empirical 113

114  Handbook on the politics of taxation evidence from comparative – mostly statistical – research. A first line of research looks at the impact political regime type has on revenue collection and the composition of tax systems. Though it is difficult to relate specific traits of tax systems to specific properties of political regime types (Cheibub, 1998), it appears that both fully democratic as well as fully autocratic regimes are better at collecting taxes than those regimes located somewhere in the middle of the two extremes. As a second dimension, the chapter explores the impact of political regime stability or durability on taxation. Are ‘old’ political regimes better at collecting taxes than ‘new’ regimes? Since the willingness to pay taxes seems to be associated with what taxpayers expect from their political regimes (for instance, see von Schiller, 2018), regime stability is supposed to play a role, but the relationship is not yet fully understood. One of the reasons for this might lie in the difficulty to distinguish mere persistence in time from concepts such as regime stability, durability or consolidation, and the role access to material resources plays in this distinction. A third line of research the chapter sets out to discuss explores the inverted causality path: in which way does taxation affect political regime change? Is it a driver of democratization, as research on the emergence of the modern tax state suggests (Tilly, 1985)? We are certainly aware of moments in time where changes in taxation triggered major political events – the Boston Tea Party of 1773 is probably the best known of these events (Ross, 2004). Yet again, research is still far from providing conclusive evidence on this relationship, as many intervening factors seem to play a role.

2.

POLITICAL REGIME TYPE AND TAXATION

2.1 Theory In recent decades social science research has produced a limited yet steady flow of studies on the relation between governance or regime type and tax collection or tax structure, covering a broad range of theoretical approaches and methods.2 Most scholars assume that democracy and the ability to obtain revenue from taxes are positively associated, but the theoretical underpinnings of their arguments differ widely and empirical evidence is not conclusive. Broadly speaking, researchers identify three different factors that affect the relationship between regime type and taxation: economic growth, redistribution and legitimation. Contributions to the debate based on modernization theory build their case on a positive link between economic growth and higher tax collection due to growing taxable income. Under the premise of a positive relation between democratic rule and economic growth (Acemoglu et al., 2019), democratization should eventually lead to higher tax collection (Boix, 2003; Persson & Tabellini, 2009; Profeta & Scabrosetti, 2010; Przeworski et al., 2000). Empirical evidence is still inconclusive, however. The impact of democracy on growth is partly driven by indirect effects such as higher investments in human capital (Doucouliagos & Ulubasoglu, 2008). Since these effects are an outcome of increases in public spending, financed (at least in part) through taxes, causality can go either way. A second approach identifies distribution as the key causal mechanism. The median voter theorem (Downs, 1957; Meltzer & Richard, 1981; Milanovic, 2000; Romer, 1975) attributes more and better public services and higher levels of redistribution to democracies as a result of the expansion of suffrage and the growing relevance of organized interest groups. This points

Political regimes and taxation  115 to higher tax collection, as bigger governments need to raise more revenue: ‘[A]fter a transition to democracy shifts the position of the median voter toward the lower side of the income distribution, the level of taxes and public spending should increase’ (Boix, 2003, p. 171). Further, Olson’s concept of encompassing rule (Olson, 2000) claims that governing elites may engage in redistribution out of pure self-interest if the constituency they represent is large enough. The argument has an additional twist: since the majority earn part of their income from the market and thus perceive an income loss from taxes, democratic rulers will be more sensible raising taxes compared to autocrats, with the latter being less restricted by distributive concerns. If more citizens have a say in government decisions as a result of democratic competition, incumbents seeking re-election have an incentive to limit coercion and, hence, taxation (see Gould & Baker, 2002; Kenny & Winer, 2006; Ross, 2004). This incentive could be additionally affected by the electoral cycle. Not only does public expenditure tend to grow prior to elections, but it has also been shown that tax expenditure (i.e., the use of tax incentives such as exemptions, lower tax rates, etc.) grows during campaign times (Therkildsen & Bak, 2019), thus reducing the revenue intake of governments.3 In contrast, autocratic regimes are presumably less reluctant than democracies to use coercion in tax collection (Olson, 1993). As autocratic rule is typically accompanied by a stronger concentration of power in the executive branch, higher tax collection should be the outcome according to Olson. This hypothesis is based on the assertion that paying taxes is never a totally voluntary act and requires at least some degree of coercion (Martin et al., 2009). A regime with more freedom to coerce should therefore be in a better position to extract taxes from its citizens. Also, the costs of repression and higher expenditures on the military (see Mulligan et al., 2004) may force autocratic regimes to step up revenue collection. At the same time, however, authoritarian leaders may be more reluctant to tax the economic powerful through direct taxes on corporate and household income, thus forgoing a part of their potential tax revenue. The argument is supported by Gerry and Mickiewicz (2008), who analyse 27 transition economies. According to them, authoritarian regimes find it significantly harder to raise taxes in cases with high levels of income inequality. A third line of academic research emphasizes the importance of legitimacy and credibility in bargaining processes and tax compliance. It explores how bargaining between citizens and governments over tax collection can provide a foundation for the development of responsive and accountable government (Campbell, 1993; Prichard, 2019; Rakner, 2017). At the core of this perspective is the assumption that citizens who pay taxes are more likely to demand that governments are responsive to their needs (Beach, 2018). Viewed from this perspective, democracy should lead to higher tax collection, as taxpayers can be more confident that taxes are spent for the common good, that the distribution of the tax burden is fair and that the risk of radical policy changes in the future is low. Participatory governance may thus enhance the capability of governments to raise taxes (for instance, see Touchton et al., 2019). This strand of research is also closely connected to the literature on fiscal sociology, which from a macro perspective links the state’s legitimacy to its public service portfolio and revenue mobilization (Hettich & Winer, 1988; Levi et al., 2009; Steinmo, 1993; Timmons, 2005). The argument is based on a fiscal contract model of ‘quasi-voluntary’ tax payments in exchange for public services (Levi, 1988). It is further corroborated by Kenny and Winer (2006, p. 205) who discover that ‘consent to taxation plays an important role in determining the structure of taxation’. In turn, autocratic regimes may often find it difficult to generate trust, due to lower levels of transparency or even blatant violations of the principles of fairness and equity. Accordingly,

116  Handbook on the politics of taxation there should be less ‘quasi-voluntary’ compliance. Still, legitimacy is not necessarily confined to democratic rule (for instance, see von Haldenwang, 2017), and authoritarian leaders firmly entrenched in power may be quite credible in making non-compliance a risky undertaking. 2.2

Empirical Evidence

Several studies aspire to provide statistical evidence on this topic, but they are confronted with problems of sample selection and endogeneity (including omitted variable bias), leading to mixed results when more sophisticated econometric models are introduced. For instance, Boix (2003) presents empirical support for the median-voter argument of higher taxes and spending as an outcome of democratic rule and higher electoral turnout, except for countries with very low levels of per capita income. His analysis is based on a sample of 65 countries, covering the period 1950–1990. In contrast, Mulligan et al. (2004) find evidence for higher tax revenue of non-democracies, based on a sample of 142 countries between 1973 and 1990. With a sample of 86 developing countries covering the years 1980–1989, Fauvelle-Aymar (1999) arrives at a similar conclusion (higher tax take of autocratic regimes). However, none of the three studies provides information on sample selection (for instance, with regard to country income groups), nor do they address endogeneity or reverse causality concerns. This makes it difficult to assess the quality of the empirical findings (Houle, 2009). Cheibub (1998) analyses the impact of regime type on tax collection with data for 108 countries between 1970 and 1990. Initial regressions indicate better performance of democracies compared to dictatorships: ‘[E]ven after controlling for other factors that also affect taxation, such as per capita income, the relative size of the agricultural and mining sectors, the country’s openness to foreign trade, and the occurrence of elections, we find that taxes tend to be higher in democracies’ (Cheibub, 1998, p. 365). However, accounting for sample selection bias, Cheibub finds no robust evidence regarding a differential impact of regime type on taxation. ‘Thus, the reason we observe a large difference in taxation in favour of democratic regimes has to do not with any inherent characteristics of this type of regime, but with the factors that make us observe countries as democracies or as dictatorships’ (Cheibub, 1998, p. 372). In a similar fashion, Ross’ (2004) analysis of 115 countries with an observation period from 1971 to 1997 does not produce any significant association between tax ratio and regime. Profeta and Scabrosetti (2010) report results from a study of 39 Asian, Latin American and new European Union member countries over the period 1995 to 2004. They find initial evidence ‘that more democratic countries generally show a higher level of tax revenue, even when a certain number of control variables are included and robustness checks are performed’ (Profeta & Scabrosetti, 2010, pp. 2–3). However, in another study with the same sample and a slightly different observation period (1990–2005), Profeta et al. (2013) find no robust evidence of a positive correlation between the democratic structure of the polity and taxation (tax revenue and tax structure) when controlling for country fixed effects, with the exception of an inverted U-shaped relationship between the strength of democratic institutions and the level of indirect taxes and a positive correlation of democracy and trade taxes. Timmons (2010) explores the relationship of representation and taxation by analysing panel data from 106 countries between 1970 and 1999 as well as cross-sectional data from 75 democracies (1990–1998). He finds weak evidence indicating that democratic rule and voter turnout increase tax revenue, but results do not support the fiscal contractualism argument pointing from higher legitimacy to a broader reliance on direct (income) taxation: ‘[T]here was

Political regimes and taxation  117 no general tendency for democratization or voter turnout to increase revenue from progressive taxes’ (Timmons, 2010, p. 192). In contrast, Mahdavi (2008) arrives at the opposite result by analysing 43 developing countries between 1973 and 2002 and taking Freedom House data on political rights and civil liberties as indicators for democracy and corruption. Even though the net effects of both variables on total tax revenue are not significant, the author finds that ‘in more democratic countries … the level of income, profits, and capital gains taxes … tends to be higher’ (Mahdavi, 2008, p. 615). Ehrhart (2012, p. 558) studies the influence of political regime on domestic tax revenue (i.e., total tax revenue minus trade taxes) with panel data from 66 developing countries between 1990 and 2005. Her paper produces ‘strong evidence that the political regime in a country does influence the extent to which domestic tax reforms are implemented and higher domestic tax revenues achieved’. Similarly, Yogo and Ngo Njib (2018) explore the impact of political competition on taxation in 89 developing countries over the period 1988 to 2010. They find a positive, though small, effect with regard to direct as well as indirect taxes and a negative effect on trade taxes. Finally, full-fledged democracies or autocracies are presumably more successful in stabilizing expectations than regimes situated in-between. This would imply a U-shaped curve, with higher tax collection at both margins of the spectrum. Kenny and Winer (2006) present evidence of a non-linear relationship between the level of repression and the tax structure (reliance on income tax and non-tax revenue), with higher effects related to the ‘initial loss’ of rights and liberties compared to established democracies. Based on a panel dataset of 131 countries and covering the period 1990–2008, Garcia and von Haldenwang (2016) show that in fact full democracies as well as full autocracies obtain a higher tax-to-GDP ratio than ‘hybrid’ or ‘anocratic’ regimes located in the middle of the spectrum. As can be seen from this review, both autocracies and democracies may be associated with higher or lower tax collection. In general terms, however, theoretical reasoning together with the existing empirical evidence seem to suggest that under democratic rule governments should have a higher extractive capacity resulting from increased legitimacy and better governance. At the same time and following most of the literature on the subject, the revenue interest of the ruling elite should be rather high, as governments face pressure for redistribution. Hence, a democratic polity should be considered more amenable to higher tax collection. Under autocratic rule, the government’s extractive capacity might be negatively affected by lower levels of legitimacy, but positively affected by higher levels of coercion. The governing elite could still be interested in higher tax revenue, but more often than not this regime type depends on a rather small group of supporters with a marked interest in avoiding higher tax payments. Consequently, autocratic rule should lead to lower tax collection, on average. Apart from the relationship between political regime type and tax revenue collection, academic research has studied other tax indicators that vary with political regime type, including tax compliance (Guerra and Harrington, this volume) and tax introductions. Based on historical evidence on the introduction of tax types in 131 countries, Seelkopf and Lierse (2020) observe, for instance, that more democratic governments are more likely to introduce progressive taxes on personal income and inheritance. This corroborates earlier findings that democracies rely more on progressive personal income tax than non-democracies (Kenny & Winer, 2006). The following section discusses how political regime durability affects tax systems through two main channels: the incentives governments have to tax, and their capability to do so.

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3.

REGIME DURABILITY AND TAXATION

Tax collectors know that ‘old taxes are good taxes’. The adage, coined by French economist Nicolas-François Canard more than two centuries ago (see Ganghof, 2005, p. 18), is often cited to highlight the fact that taxpayers grow accustomed to taxes. By and by, they accept the justifiability of specific taxes – or, at least, stop questioning their legitimacy. Tax administrations also adjust to existing tax regimes and acquire the capabilities necessary to manage these taxes (Thies, 2010). With both sides knowing what to do and what to expect from each other, compliance costs are supposed to fall and compliance rates to rise, leading to higher revenue levels. Does the same hold true for political regimes? Are ‘old regimes’ at the same time ‘good tax collectors’? The above-mentioned references to stable expectations and state capacity seem to suggest that this is indeed the case: regime change is often linked to serious disruptions in political decision making and public management. We would expect tax collection to be negatively affected by such a setting, given that stable expectations, a reliable polity and a capable public administration are commonly acknowledged to be important factors of economic growth and a well-functioning tax system (Cheibub, 1998; Persson & Tabellini, 2009). In other words, regime stability should have a positive effect on tax collection, independently of regime type. This assumption appears to be corroborated by the findings of a U-shaped relationship between regime type and tax-to-GDP ratio reported in the previous section (Garcia & von Haldenwang, 2016). But what exactly is the role of regime stability with regard to revenue mobilization? While the theoretical literature provides several alternative explanations pointing towards diverging outcomes, empirical evidence remains rather scant. Lack of comparable data and problems of endogeneity may play, again, a role in explaining this picture, but in addition to that it appears that researchers prefer to explore the link between political change and taxation, rather than studying the effects of political stability. A large body of literature addresses the issue of taxation against a background of regime change and democratic transitions, as will be discussed in more detail below. Obviously, political stability is not the same as regime longevity or persistence over time. Otherwise, any political regime would be at its stability apex just prior to its transition or collapse. Still, some studies use stability as a simple antonym to regime change, such as transitions to, or reversions from, democratic rule (Haggard & Kaufman, 2012). From this perspective, political stability is reduced to a residual category, epitomized, for instance, in the notion of (authoritarian) ‘regime survival’ (Ahmed, 2012; Boix, 2003). In contrast, Gerschewski (2015) identifies three pillars of autocratic regime stability: legitimation, repression and co-optation. Stabilization is then understood as a reinforcement process within and between these pillars, in which access to material resources plays an important role. This approach seems to be better suited to capture the many facets of regime stability, but it means at the same time that any attempt to generate robust evidence on the effect of regime stability on taxation will have to deal with endogeneity issues. Political regime stability has varied effects on a government’s incentives to raise revenues, and its capacities to do so. Studies highlight the detrimental (short-run) effects of regime transitions on state capacity, and the positive effects of stable expectations. However, not many authors focus their attention on the impact of regime stability (independent variable) on

Political regimes and taxation  119 tax collection (dependent variable) (Aizenman & Jinjarak, 2008; Burnside & Dollar, 2000; Mutascu et al., 2011). 3.1

Incentives to Raise Revenue

In terms of the incentives to raise revenue, it is possible to build several different, if not contradictory cases. As a first approach, it seems reasonable to assume that governmental financing requirements should be lower in times of political stability, thus easing the pressure on governments to collect taxes. Several factors account for this. Political instability is typically associated with higher expenditure related to repression and distribution or co-optation. Also, since regime change normally leads to a new ‘winning coalition’ (Bueno de Mesquita et al., 2003), the outgoing elite (or elite fraction) has often no incentive to pursue responsible fiscal policies. Incoming authorities are consequently faced with the pressing need to collect taxes from citizens and enterprises in order to cover the fiscal gaps inherited from their predecessors. This would be an argument in favour of higher tax collection as a consequence of regime instability, at least to the extent that new regimes cannot simply cut spending. The theoretical underpinnings of political stability leading to lower tax collection are formulated by Levi (1988). Levi bases her argument on the notion of the political discount rate, whereby rulers will be more inclined to maximize revenue through taxation if they operate with a short-term rather than a long-term political time horizon (see also Azzimonti, 2011). There is some supportive evidence for this argument: ‘Taxes in both dictatorships and democracies are higher when governments feel relatively insecure in office, lending support to the idea that governments tend to plunder when the rate at which they discount the future is relatively high’ (Cheibub, 1998, p. 369). In contrast, once governments operate with a lower discount rate (i.e., in a more stable political environment), excessive tax collection becomes less probable. A basic conditioning factor underlying these arguments refers to the tension between the provision of public goods (the ‘common interest’ approach) and the realization of private gains by rulers (the ‘predatory state’ approach) in the tradition of Tilly (1985) as ultimate goals of revenue extraction. As shown by public choice theory (Olson, 1993, 2000), rulers representing a broader sector of society are typically more interested in providing public goods. Broad representation in combination with political stability should improve conditions to invest in public goods, creating incentives to raise the tax burden of citizens and companies. In contrast, rulers representing a small sector of society are likely to behave in a diametrically opposed manner, just as explained in the preceding paragraph. 3.2

State Capacity

Regarding the capacity of states to collect taxes, many authors agree on the detrimental short-term effects of regime change on state capacity in general. For instance, Thies (2010) presents evidence that instability ‘reduces all measures of state capacity’, including revenue collection. More specifically, Cukierman et al. (1992) find empirical support for the argument that political instability and polarization may cause governments to rely less on tax revenue and more on seigniorage, the latter being a less efficient but easier-to-manage revenue source (see also Fauvelle-Aymar, 1999, pp. 394–395). Cukierman et al. (1992) present results from a cross-sectional analysis with a sample of 79 countries, taking averages for 1971–1982.

120  Handbook on the politics of taxation Countries are selected on the basis of data availability. However, data availability is likely to be closely related to political stability. This raises the issue of sample selection bias – a rather common problem in comparative (large-N) studies on issues related to political stability. Likewise, Aizenman and Jinjarak (2008) observe that political durability increases value-added tax (VAT) collection efficiency (i.e., VAT revenue over the aggregate consumption divided by the standard VAT rate) in a sample of 44 countries covering the period 1970–1999. However, a major methodological problem arises from the scarcity of data on statutory VAT rates. Having only information on the standard VAT rate in 2003, the authors are forced to assume that VAT rates do not change over time. This appears to be rather far-fetched. To give an example, Colombia (which provides 25 out of 454 observations in the analysis) changed the standard VAT rate four times during the observation period. In addition, eight different VAT rates were applied by 2006, ranging from 1.6 per cent to 35 per cent (Clavijo, 2007). According to Cheibub (1998, pp. 362–363), government bargaining power diminishes in times of regime change, leading to lower levels of tax collection. This observation corroborates the fiscal contractualist argument according to which the capacity to tax depends fundamentally on the credibility of governments. It is important to note, however, that credibility does not necessarily refer to common-interest orientation. A credible commitment to coercion and tax enforcement may enable governments to maintain high levels of tax collection even in a context of limited distribution and deficient public goods provision (Garcia & von Haldenwang, 2016). Several studies in this field distinguish short-term negotiations on the distribution of the tax burden from long-term political settlements that are largely responsible for the path dependency of tax systems (Hassan & Prichard, 2016; Khan, 2010). The concept of political settlements links the domestic revenue mobilization capacity of the state to stable formal and informal institutions shaping the power relations between contending elite sections. A core assumption is that for political settlements to persist over time the distributional capacity of the state has to be in line with the distribution of power that shapes the bargaining capacity of societal groups (Khan, 2010, p. 25). Cheibub (1998, p. 369) also observes that transitions to democracy lead to higher tax collection, indicating that young democracies may be better suited to overcome the pitfalls of regime change. This is consistent with Persson and Tabellini (2009, p. 122), who find that ‘becoming a democracy, on average, leads to an improvement in growth’, which, in turn, favours tax collection (Burgess & Stern, 1993, p. 774). Democratic stability, in particular, contributes to physical capital accumulation, setting off a virtuous circle of stability, growth and tax collection. D’Arcy and Nistotskaya (2018) provide evidence on the long-term impact of fiscal capacity acquired by European states during the early modern period (1450–1800). They show that the quality of cadastral records is an important predictor of contemporary tax outcomes. The long-term tendencies in the evolution of fiscal contracts are also researched by Andersson (2017), who studies the impact of urbanization on tax structures from as far back as 1800. Seelkopf and Lierse (2017) analyse the rise of progressive taxation in Western democracies since the mid-nineteenth century. Finally, some authors look at long-term impacts from colonial rule, often comparing the French and the British colonial heritage (Ali et al., 2018; Mkandawire, 2010). Strikingly, almost all former colonies kept taxes introduced under

Political regimes and taxation  121 colonial rule also after independence, suggesting that tax systems may be more durable than regimes. To sum up, theoretical reasoning together with the existing empirical evidence seem to suggest that regime stability should be connected to more revenue collection because of the absence of institutional disruptions. The effect could be partly offset, however, by lower political discount rates and lower financing needs. In turn, political instability with the concomitant shortening of political time horizons could encourage leaders to engage in plundering, causing tax collection to rise. At the same time, government credibility as well as administrative capacity are likely to suffer in times of instability, bringing tax collection down. Some of these contrasting (yet not necessarily mutually exclusive) effects are documented in empirical studies, as shown above, but the available empirical evidence is mixed at best.

4.

DO TAX SYSTEMS AFFECT REGIME CHANGE?

States that have been able to regularly collect revenue from broad tax bases have generally also been able to govern effectively, while the inability of a state to generate significant revenue through taxation has often been a precursor to state failure, or even collapse (La Porta et al., 1999; Tilly, 1990). Following this argument, we would expect political regime instability and regime change to be furthered by low revenue collection capacity, due to citizen dissatisfaction and the associated distributional conflicts (Acemoglu & Robinson, 2006). States that fail to deliver public services as a result of lacking fiscal space should run into trouble sooner or later. Yet, states do not always depend on tax revenues to cover their financial needs. In fact, the stabilizing effect of non-tax revenue on political regimes has been extensively studied with regard to revenue from non-renewables, particularly oil (Brooks & Kurtz, 2016; Ross, 2001; Wright et al., 2015). Morrison (2009) finds an increase in non-tax revenue to be associated with less taxation of elites in democracies, more social spending in dictatorships and more stability for both regime types. His sample covers 104 countries between 1973 and 2001. The inverse relation, higher levels of taxation leading to regime change – democratization in particular – is based on a theoretical argument that has already been outlined above: fiscal contract theory teaches us that paying taxes makes citizens demand more participation in politics, a request usually associated with democratic rule (Freeman & Quinn, 2012). As a consequence, governments seeking to extract more revenue from their constituencies are forced to make concessions with regard to political representation and access to decision making (Balamatsias, 2018). Direct taxes have been identified as drivers of democratization (Mahon, 2005). Bates and Lien (1985) reason that taxing mobile assets in particular is a factor leading to more representative government. Ross (2004) explores two underlying arguments. First, citizens resent paying a higher share of their income as taxes in non-democratic settings, and democratization would then be a way to arrive at a lower tax burden (the ‘anti-tax’ model). Second, high taxes would not produce greater demands for representative government if the taxes were offset by greater government benefits (the ‘cost–benefit’ model). Both models are tested with a sample of 113 countries covering the period 1971–1997. Findings do not support the anti-tax model, but are consistent with the cost–benefit model. Based on an instrumental variable approach, Gur (2014) finds corroborative evidence that higher taxation leads to democratization. Based on a sample of 31

122  Handbook on the politics of taxation countries from Sub-Saharan Africa, Baskaran and Bigsten (2013) find that higher capacity to tax has led to more democratic and less corrupt governments in that region. Slater et al. (2014) study a specific case of regime change, the breakdown of democratic regimes following military coups in postcolonial settings. Their sample comprises 139 countries between 1972 and 2007. They find no evidence for the hypothesis that democratic breakdown would be the result of redistributive taxation, measured as reliance on direct taxes on income, profits and capital gains. Rather, their findings from quantitative and qualitative analysis indicate ‘that authoritarian takeovers have neither been inspired by successful redistributive policies nor followed by their reversal’ (Slater et al., 2014, p. 354). A third dimension refers to the role of taxation in state building. Does taxation have an impact on how states develop following political regime change? This relationship has been explored more extensively (Bräutigam et al., 2008; Di John, 2009; Everest-Phillips, 2009), though, again, empirical evidence is rather thin. Based on a sample of 117 countries covering the years 1984–2006, Altunbas and Thornton (2011) observe that higher tax-to-GDP ratio is associated with higher quality of governance measured in terms of bureaucratic quality, corruption and rule of law. The effect is stronger for those taxes that affect citizens directly, such as personal income tax and social security contributions.

5. CONCLUSION The chapter has shown that taxes are intimately linked to the performance, emergence and persistence of political regimes. It has also become evident, however, that this relationship is highly complex and that theoretical assumptions regarding specific aspects of this relationship are hardly ever backed by conclusive empirical evidence. Since the extraction of taxes and the specific properties of political rule are closely connected to each other, research on the varied linkages between both is plagued by pervasive endogeneity problems. With regard to the impact of political regime type on taxation, a number of empirical studies lend support to the widespread notion that democratic regimes fare better in extracting taxes from their citizens than non-democratic or, more specifically, autocratic regimes. This notion is based on three different causality assumptions, linking political regime types to economic growth, redistribution and legitimacy. First, democracy is supposed to be good for economic growth (Acemoglu et al., 2019). Since a growing economy tends to generate more taxes due to an increase in taxable income, democracies should find it easier to collect revenue, compared to non-democracies. Second, democratic rule is often associated with higher needs for redistribution, with the median voter theorem probably being the most prominent theoretical expression of this rationale (Meltzer & Richard, 1981). This means that democracies experience more pressure to tax, in order to meet their constituency’s requirements for more public services. Third, democratic regimes are considered more likely to enjoy high levels of legitimacy and trust, compared to their autocratic counterparts. Following this line of thinking, taxpayers should be more willing ‘to pay taxes to a state that they perceive to be legitimate and to a tax authority that they regard as a competent agent of a legitimate state’ (Everest-Phillips, 2010, p. 77).4 However, the academic literature is far from producing conclusive evidence on any of these causality assumptions. If anything, it appears that full democracies as well as full autocracies collect more taxes than the ‘hybrid’ or ‘anocratic’ or ‘defective’ political regime types located

Political regimes and taxation  123 in-between both extremes. This could be due to the stabilization of expectations associated with both types. Though based on different mechanisms, both full democracies and full autocracies are better suited to produce a climate of tax certainty and compliance than the political regimes in the middle of the spectrum. With regard to tax structure, there are indications that democracies might rely more on direct taxation than autocracies, but, again, empirical evidence is rather weak. The stabilization of taxpayers’ expectations is also relevant with regard to the second dimension treated in this chapter: the impact of political regime stability on taxation. Keeping in mind that regime change is often associated with economic crises, violent conflicts and serious disruptions in public administration, it seems fair to assume that stable regimes are better tax collectors, independently of their specific regime type. Still, in discussing this issue it is important to distinguish a regime’s incentives to tax from its capacity to tax. Rulers’ incentives to collect taxes from citizens and businesses are shaped, among other factors, by the political discount rate that captures their individual time horizons and their perceived security of rule (Levi, 1988). A high discount rate creates pressure to maximize revenue in the short run. There is a wealth of anecdotal evidence showing how weak political collectives combined with insecurity in office lead to this type of behaviour. In contrast, lower discount rates should in principle lead to lower tax collection. There are not many causal links we can be sure of in the context of this chapter, but the negative impact of political instability on state capacity appears to be one of them. This refers to the bargaining power governments enjoy vis-à-vis their taxpayers, to the negative short-term consequences of regime change on public service delivery and public sector performance, but also to the long-term acquisition of fiscal capacity as a consequence of stable rule. Looking at the interaction of incentives and capacity, the impact of political regime stability on taxation seems to be driven by two diametrically opposed factors, one – incentives – operating in favour of lower and the other – capacity – in favour of higher tax collection. The question as to which factors would prevail under which circumstances is difficult to address – not least due to a serious data constraint: periods of political regime change are typically characterized by limited access to data. As a result, empirical evidence on this topic is scarce and the available studies are often faced with endogeneity and sample selection problems. Finally, looking at the impact of taxation on regime change, it has been argued that the needs of rulers to levy taxes in order to finance wars have been a key driver of representative rule and democratization (Tilly, 1990). This argument has been extended to present-day episodes of democratization. Another line of reasoning links widespread dissatisfaction with public services as a result of low revenue collection to regime change. In general terms, however, isolating the impact of taxation levels or tax structure from other factors influencing regime change has proven to be a difficult task. The picture is different with regard to non-tax revenue: it is a well-established fact by now that rents from oil tend to stabilize autocracies and hinder democratization (Ross, 2001). With political science becoming more and more aware of the critical relevance of taxation – the present handbook being proof of this tendency – it can be expected that academic research will shed more light on these relationships in the future.

124  Handbook on the politics of taxation

NOTES 1.

Cheibub (1998, p. 351) defines political regimes as ‘the broad institutional framework within which decisions concerning the production and allocation of public resources are made’. Many studies that explore the varied relationships of political regimes and taxation part from a binomial typology of democratic versus non-democratic regimes, such as the one developed by Przeworski et al. (2000) or Boix et al. (2013). Other studies use continuous measures based on datasets such as the Polity IV project (Garcia & von Haldenwang, 2016; Seelkopf & Lierse, 2020), or more fine-grained distinctions of political regime type (for instance, see Kenny & Winer, 2006). 2. This section draws on theoretical debates and empirical insights presented in Garcia and von Haldenwang (2016). For an historical overview, see Andersson’s chapter on political institutions and taxation in this volume. 3. On the topic of tax expenditures, please refer to von Haldenwang et al. in this volume. 4. On individual preferences over tax policy, see the chapter by Berens and Gelepithis in this volume.

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126  Handbook on the politics of taxation Levi, M., Sacks, A., & Tyler, T. (2009). Conceptualizing legitimacy, measuring legitimating beliefs. American Behavioral Scientist, 53(3), 354–375. Mahdavi, S. (2008). The level and composition of tax revenue in developing countries: Evidence from unbalanced panel data. International Review of Economics and Finance, 17(4), 607–617. Mahon, J. E. (2005). Liberal States and Fiscal Contracts: Aspects of the Political Economy of Public Finance. Annual Meeting of the American Political Science Association, 1–4 September, Washington, DC. Martin, I. W., Mehrotra, A. K., & Prasad, M. (2009). The thunder of history: The origins and development of the new fiscal sociology. In I. W. Martin, A. K. Mehrotra, & M. Prasad (eds), The New Fiscal Sociology: Taxation in Comparative and Historical Perspective, 1–27. Cambridge University Press. Meltzer, A. H., & Richard, S. F. (1981). A rational theory of the size of government. Journal of Political Economy, 89(5), 914–927. Milanovic, B. (2000). The median-voter hypothesis, income inequality, and income redistribution: An empirical test with the required data. European Journal of Political Economy, 16, 367–410. Mkandawire, T. (2010). On tax efforts and colonial heritage in Africa. Journal of Development Studies, 46(10), 1647–1669. Morrison, K. M. (2009). Oil, nontax revenue, and the redistributional foundations of regime stability. International Organization, 63(1), 107–138. Mulligan, C. B., Gil, R., & Sala-i-Martin, X. (2004). Do democracies have different public policies than nondemocracies. Journal of Economic Perspectives, 18(1), 51–74. Mutascu, M., Tiwari, A., & Estrada, F. (2011). Taxation and political stability. MPRA Paper No. 32283. Munich Personal RePEc Archive. Olson, M. (1993). Dictatorship, democracy, and development. American Political Science Review, 87(3), 567–576. Olson, M. (2000). Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships. Basic Books. Persson, T., & Tabellini, G. (2009). Democratic capital: The nexus of political and economic change. American Economic Journal: Macroeconomics, 1(2), 88–126. Prichard, W. (2019). Tax, Politics, and the Social Contract in Africa. Oxford University Press. Profeta, P., Puglisi, R., & Scabrosetti, S. (2013). Does democracy affect taxation and government spending? Evidence from developing countries. Journal of Comparative Politics, 41(3), 684–718. Profeta, P., & Scabrosetti, S. (2010). The Political Economy of Taxation: Lessons from Developing Countries. Edward Elgar Publishing. Przeworski, A., Alvarez, M. E., Cheibub, J. A., & Limongi, F. (2000). Democracy and Development: Political Institutions and Well-Being in the World, 1950–1990. Cambridge University Press. Rakner, L. (2017). Tax bargains in unlikely places: The politics of Zambian mining taxes. The Extractive Industries and Society, 4(3), 525–538. Romer, T. (1975). Individual welfare, majority voting, and the properties of a linear income tax. Journal of Public Economics, 4(2), 163–185. Ross, M. L. (2001). Does oil hinder democracy? World Politics, 53(3), 325–361. Ross, M. L. (2004). Does taxation lead to representation? British Journal of Political Science, 34(2), 229–249. Seelkopf, L., & Lierse, H. (2017). Taxation and redistribution in autocratic and democratic regimes over the long-run of history. EUI Working Paper MWP 2017/11. European Union Institute. Seelkopf, L., & Lierse, H. (2020). Democracy and the global spread of progressive taxes. Global Social Policy. https://​doi​.org/​10​.1177/​1468018120911567 Slater, D., Smith, B., & Nair, G. (2014). Economic origins of democratic breakdown? The redistributive model and the postcolonial state. Perspectives on Politics, 12(2), 353–374. Steinmo, S. (1993). Taxation and Democracy: Swedish, British and American Approaches to Financing the Modern State. Yale University Press. Therkildsen, O., & Bak, A. K. (2019). Democratisation in Tanzania: No elections without tax exemptions. ICTD Working Paper 98. Institute of Development Studies. Thies, C. G. (2010). Of rulers, rebels, and revenue: State capacity, civil war onset, and primary commodities. Journal of Peace Research, 47(3), 321–332.

Political regimes and taxation  127 Tilly, C. (1985). War making and state making as organized crime. In P. B. Evans, D. Rueschemeyer, & T. Skocpol (eds), Bringing the State Back In, 169–191. Cambridge University Press. Tilly, C. (1990). Coercion, Capital and European States: AD 990–1992. Blackwell. Timmons, J. F. (2005). The fiscal contract: States, taxes and public services. World Politics, 57(4), 530–567. Timmons, J. F. (2010). Taxation and representation in recent history. Journal of Politics, 72(1), 191–208. Touchton, M., Wampler, B., & Peixoto, T. (2019). Of governance and revenue: Participatory institutions and tax compliance in Brazil. Policy Research Working Paper No. 8797. World Bank. von Haldenwang, C. (2017). The relevance of legitimation: A new framework for analysis. Contemporary Politics, 23(3), 269–286. von Haldenwang, C., Elfert, A., Engelmann, T., Germain, S., Sahler, G., & Stanzel Ferreia, A. (2015). The Devolution of the Land and Building Tax in Indonesia. DIE. www​.die​-gdi​.de/​uploads/​media/​ Studies​_89​.pdf (accessed 15 May 2021). von Schiller, A. (2018). Party system institutionalization and reliance on personal income taxation in developing countries. Journal of International Development, 30(2), 274–301. Wright, J., Frantz, E., & Geddes, B. (2015). Oil and autocratic regime survival. British Journal of Political Science, 45(2), 287–306. Yogo, U. T., & Ngo Njib, M. M. (2018). Political competition and tax revenues in developing countries. Journal of International Development, 30(2), 302–322.

9. The politics of tax expenditures Christian von Haldenwang, Achim Kemmerling, Agustin Redonda and Zbigniew Truchlewski

1. INTRODUCTION All over the planet, governments are desperate for funds to finance social policies, public infrastructure and development projects. Yet, the very same governments routinely forego huge amounts of tax revenues by granting tax incentives to investors, setting lower value-added tax (VAT) rates for the consumption of specific goods or services, exempting specific groups of taxpayers from paying energy taxes, and so on. These mechanisms are called ‘tax expenditures’, i.e. departures from the normal tax structure or benchmark, designed to favour a particular activity, or group of taxpayers. Tax expenditures are sometimes widely communicated as a state’s reaction to exogenous shocks. For instance, at the time of writing this chapter many governments are announcing additional tax relief as a crisis containment measure under the COVID-19 pandemic. Typically, however, tax expenditures represent the hidden side of the fiscal contract (Howard, 1997, 2008; Mettler, 2011). They are used by governments as a less visible, yet powerful tool to pursue their political agenda. Once installed, tax expenditures become quickly locked in, thus undermining the fiscal space of governments in the long term. Unlike budget items, they rarely have to be negotiated in parliament year after year and the real fiscal impact of the measures is often unknown. An assessment of the 46 G20 and Organisation for Economic Co-operation and Development (OECD) countries shows that two of them have not reported any tax expenditures over the last ten years and only 30 countries publish regular and comprehensive reports (Redonda et al. 2021a). The picture is even bleaker in Africa, the region with the highest number of low- and lower middle-income countries. Out of 54 African countries recently reviewed by the Global Tax Expenditures Database (GTED) team (Redonda et al., 2021b), only 28 have released public reports at least once between 1990 and 2020. The remaining 26 countries did not publish any reports during this period. This is not a minor issue. In the United States (US) alone, the federal government is estimated to have forgone more than 1.4 trillion US dollars in 2019. This equals roughly a third of its direct federal spending and above 6.8 per cent of the country’s gross domestic product (GDP), according to the latest figures provided by the US Department of the Treasury (2020). Recent estimates show that tax expenditures range from 1.3 per cent to 6.9 per cent of GDP in Latin America and from 0.6 per cent to 8.0 per cent of GDP in Africa (Redonda et al., 2021a). Governments claim that they use tax expenditures to pursue strategic policy goals such as the promotion of economic growth, social equality and environmental sustainability. With regard to growth, preferential tax treatments are used to attract investment capital, develop a priority sector or activity, or promote efficiency. Relating to equality, lower consumption tax rates are supposed to increase access to and demand for basic goods and services, and 128

The politics of tax expenditures  129 tax cuts are used to support specific subgroups of the population. Concerning environmental sustainability, specific provisions are put in place to channel investments to sustainable sectors or technologies and to promote access to environmentally friendly goods and services. However, tax expenditures are also prone to abuse. Pressure groups and economic elites often lobby heavily to influence their governance and design in order to capture specific benefits (IMF et al., 2015). In addition, even those provisions that are set up with the best intention to serve the common good might end up being ineffective or even damaging. The strikingly high redundancy ratios of tax incentives in developing countries (i.e. the share of investors claiming that they would have invested even without those incentives in place) underscore this point (James, 2013). Perhaps even more importantly, however: in many, if not most, cases, we simply do not know whether or not specific provisions are effective. Tax expenditures are often completely opaque. The picture drawn here leads to the following key questions: Why do governments insist in using costly fiscal policy mechanisms without any proof of effectiveness? What is to be gained from this specific mode of tax governance, which bypasses ordinary tax and spending politics? This chapter shows that different rationales come together to explain the frequent and sustained use of tax expenditures. Ideological positions may play a role, for instance with regard to the private or public provision of common goods such as social security or health insurance. External factors (tax competition) and institutional lock-ins can also be relevant to grant or keep certain tax incentives. Not least, these instruments are readily available to reward specific clientele groups or to obtain rents, while ring-fencing their economic and political impact. This makes them an important pillar of the politics of taxation and the political economy of tax bargaining (Prichard, 2019). Based on a distinction originally coined by Stepan (1985, pp. 320–340), tax expenditures can be analysed as ‘offensive’ and ‘defensive policies’. Offensive policies have a foundational character and may lead to new power and distributive constellations. ‘Offensive tax expenditures’ are employed as tools to gain political power – either internationally, as features of a country’s business model, or domestically, as key instruments for the distribution of resources. Defensive projects, in turn, are formulated in reaction to a perceived threat. They aim at preserving (or reconsolidating) a given structure. ‘Defensive tax expenditures’ are used by governments as a reaction to external constraints. They would not be used if such constraints did not exist. The following section introduces the concept and describes the phenomenon of tax expenditures. It shows that due to widespread underreporting, our knowledge of the actual relevance of tax expenditures is rather limited. Section 3 explores the factors that motivate governments to rely on tax expenditures even though they often ignore their real costs and benefits. Section 4 looks at the use of tax expenditures in three different areas: economic growth, social policy and environmental protection. The concluding Section 5 discusses the impact of tax expenditures on the politics of taxation.

2.

WHAT ARE TAX EXPENDITURES AND WHAT DO WE KNOW ABOUT THEM?

Tax expenditures – also known as tax subsidies, benefits, relief, holidays, incentives, allowances, breaks or simply spending through the tax system – are preferential tax treatments

130  Handbook on the politics of taxation for specific taxable activities or specific groups of taxpayers. They take different shapes and forms. The most relevant are reduced rates, exemptions, deductions, credits and deferrals. For instance, many governments reduce VAT rates for basic goods and services, or grant tax exemptions for religious or charitable activities. Deductions reduce the amount that is subject to taxes, i.e. the taxable income. Tax credits directly reduce the amount owed by the taxpayer (her tax liability). Tax deferrals allow taxpayers to postpone the payment of taxes for a given period. These mechanisms all have in common that they discriminate some taxpayers positively against the rest. Tax expenditures are useful to pursue different policy goals such as attracting investment, creating employment, supporting home ownership, boosting pension savings or reducing inequality and poverty. They cover the entire fiscal system. For instance, in most industrialized countries tax incentives for research and development (R&D) lower corporate income tax liability. Governments grant tax relief for energy-intensive firms and trade-exposed sectors in order to boost competitiveness and mitigate leakage effects in the context of energy taxation. Deductions for pension savings, commuting expenses, mortgage interest payments, etc. reduce personal income tax. Lower (or zero) VAT rates aim to increase access to basic goods and services as a measure to fight poverty. In some ways, the impact of tax expenditures is similar to direct spending – both from the perspective of governments and of affected taxpayers. A direct spending programme that grants 100 euro to cover childcare expenses should have a similar effect (both for the beneficiaries and the government’s budget) to the effect of a tax expenditure that reduces a taxpayer’s liability by the same amount. Yet, there are some important differences when it comes to coverage, measurement and estimation. Regarding coverage, distributive policies that rely on income tax expenditures (such as the example given above) are more limited in scope compared to direct expenditures because they only reach those who actually pay taxes. This is particularly relevant for poorer countries where large parts of the population are not liable to direct taxation, e.g. due to large shares of informality. At the same time, implementing reduced VAT rates to basic goods and services benefits all consumers, even those with high incomes – hence, its coverage is broader than desired from a purely anti-poverty perspective. Regarding measurement and estimation, determining the fiscal cost of a direct spending programme is straightforward. In contrast, the estimation of the revenue forgone through tax expenditures can be a time- and resource-consuming task that requires, for instance, large databases and sophisticated micro-simulation models. Existing estimations are almost entirely based on the so-called ‘revenue forgone approach’, which estimates the amount by which taxpayers have their tax liabilities reduced based on their actual economic behaviour. While this method may be less demanding than others, the fact that it does not internalize behavioural changes is one of its major weaknesses.1 Another feature that distinguishes tax expenditures from direct spending regards benchmarking. Tax expenditures are deviations from a country-specific benchmark tax system, which is defined by the domestic tax law, but also, to some degree, subject to politicization. In VAT systems, for instance, it is common to have various tax rates (reduced, standard or rates for ‘luxury’ goods). With a given level of complexity, it is unclear which of these rates serves as the benchmark (Prasad, 2011). The benchmark is also crucial when it comes to international comparability. Differences in national tax structures lead to certain tax provisions being considered as tax expenditures

The politics of tax expenditures  131 in one country, and not in another. For instance, when a carbon tax is in place, a government may grant reduced rates and even exemptions for energy-intensive sectors in order to avoid competitive disadvantages compared to countries where carbon dioxide (CO2) emissions are not taxed. In this case, the country with a carbon tax would register higher tax expenditures in this sector compared to the other country, simply because the latter country does not tax CO2 emissions at all. Similarly, when comparing reduced VAT rates, one should take into account differences between standard VAT rates in the first place. 2.1

What Do We Know about the Magnitude of Tax Expenditures?

Since June 2021, the GTED provides an encompassing worldwide overview of the number of provisions, the range of beneficiaries, the types of tax bases affected and the fiscal costs of tax expenditures implemented. Out of 218 jurisdictions, 97 provide at least some data on tax expenditures (Redonda et al., 2021a). Prior to the GTED, several international organizations and non-governmental organizations sought to build databases, using governmental and non-governmental data, but coverage and comparability were limited and in most cases focused on specific regions or activities.2 The fiscal costs of tax expenditures are sizeable. Some examples from Europe may illustrate this point. The United Kingdom (UK) tax system had 575 tax reliefs in place in 2018–2019, with a forecast cost of 166 billion pounds (UK National Audit Office, 2020). In Ireland, total revenue forgone under tax expenditures accounted for more than 69 per cent of total tax revenue in 2018. According to a report by the French Cour des Comptes (2018) (the supreme body for auditing the use of public funds in France), the country forgoes around 100 billion euro every year through the implementation of tax subsidies. The 513 provisions listed in Italy’s 2019 tax expenditure report amounted to 61 billion euro, with provisions related to personal income taxes accounting for 65 per cent of the total (OECD, 2019). Given the striking lack of transparency in the tax expenditure field, figures should be taken cautiously. With few exceptions, such as Australia, Canada, the Netherlands and South Korea, tax expenditure reporting needs to be significantly improved worldwide. Even some of the richest countries do not report on tax expenditures at all. Switzerland is a case in point. The last comprehensive federal report on tax expenditures dates back to 2011 and the revenue forgone estimates are based to a significant extent on 2005 figures from one single canton (Bern), extrapolated to the rest of the country (Moes, 2011). Common features of deficient reporting include providing aggregate figures by tax base or type of tax expenditure rather than disaggregated data at the provision level, omitting information on the policy goal or beneficiaries of the different provisions (only nine out of the 46 G20 and OECD economies provide this type of information) or giving no description of tax expenditures implemented, which is crucial to interpret the spirit of the provision without the need to dig deep into the tax law (see von Haldenwang et al., 2021). Underreporting is another feature that significantly hinders transparency. Most countries that issue reports provide revenue forgone estimates for only a limited number of provisions. The share of listed provisions for which no revenue foregone estimate is reported can be as high as 75 per cent or more (for instance, Greece and New Zealand). Even reports providing the fiscal cost of all listed provisions (such as Mexico, South Africa, US) cannot be fully trusted, since it is rather likely that not all existing tax expenditures are actually listed.

132  Handbook on the politics of taxation The picture becomes even more worrisome as we move away from the group of rich countries. As mentioned before, only 28 African countries published tax expenditure figures at least once between 1990 and 2020, with the levels of detail varying significantly from case to case. Although cross-country data are not yet available, the lack of transparency in Asia seems to be in line with (or even worse than) what is observed in Africa. Apart from some OECD or G20 member countries (India, Indonesia and South Korea), only a few additional countries in the East Asia and Pacific region report on tax expenditures (e.g. Philippines and Papua New Guinea). Interestingly enough, however, reporting is quite widespread in Latin America. The latest information provided by the GTED shows that 19 Latin American countries publish tax expenditure figures. Possible motivations to publish – or not to publish – such reports will be discussed in the following section.

3.

WHY DO GOVERNMENTS USE TAX EXPENDITURES?

This section addresses three distinctive though interrelated questions. First and most importantly, which factors drive the widespread granting of tax expenditures? Second, which (additional) factors make governments keep tax expenditures even in cases where they are clearly damaging? Third, what prevents so many governments from reporting their tax expenditures on an encompassing and regular basis? When we look at the existing literature on the politics of taxation, tax expenditures still play a minor role. Apart from the blatant lack of visibility highlighted in the previous section, one reason for this widespread neglect might be that several basic political economy approaches, such as for instance political ideology (left versus right) arguments, do not seem to have much explanatory power in the context of tax expenditures, at least at first sight. To give an example, a radical pro-market ideology would imply that politicians were against most major forms of taxation and against discriminatory, distortionary tax expenditures in particular. However, tax expenditures might be a useful second-best option for pro-market forces, if lowering tax rates beyond certain limits is out of the question (see below).3 Other, perhaps more suitable approaches explore rent seeking and interest group politics. It is obvious that many types of tax expenditures serve specific (organized) interests or economic sectors. Numerous country studies have shown how lobbying creates special tax ‘incentives’. For the US, for instance, Alexander et al. (2009) observe that for each dollar spent on lobbying the return could be as high as 220 dollars in reduced corporate income taxation (see also Richter et al., 2009). The German VAT tax code with its exemptions also owes much of its existence to interventions from different economic sectors (Kemmerling, 2017). In a study on tax expenditures for investments in the Dominican Republic, Daude et al. (2017) provide evidence on the political influence of business elites in maintaining inefficient incentive mechanisms. Lobbying may matter differently in different political settings and regime types. Steinmo (1993), for instance, argues that the committee system of the US Congress is more suitable for pork barrelling (i.e. the exchange of particular benefits for political votes and allegiance) than the UK Parliament (see also Kemmerling & Truchlewski, this volume). The type of federalism also clearly matters, since some forms of competitive federalism and fiscal decentralization induce lower-tier jurisdictions to attract capital through tax incentive schemes (for instance, see Galletta & Redonda, 2017; Li, 2016; Garmendia Madariaga, this volume).4 This may lead

The politics of tax expenditures  133 to a ruinous race to the bottom among subnational units (see da Costa Campos et al., 2015 with reference to Brazil). Above all, however, conditions for successful lobbying of tax expenditures in favour of specific groups are greatly enhanced by non-democratic rule – at least to the degree that such a rule is based on executive dominance, weak checks and balances and repression of free speech and public debate (see chapters by Andersson and von Haldenwang, this volume). Another powerful source of tax expenditures is global tax competition.5 However, again, not all types of contexts are conducive to using tax expenditures. For instance, while small countries can compete on both across-the-board rate reductions or special tax incentive schemes, larger countries tend to rely more on tax incentives, as the fiscal costs of general rate reductions grow with the size of domestic markets (Kemmerling & Seils, 2009). Moreover, tax competition is not the only international factor that might play a role in the creation or abolition of tax expenditures. For instance, in corporate income taxation, international organizations and large OECD member countries used their power to induce a process called rate cuts-cum-base broadening (Swank, 2006) which exerted some downward pressure on the number and size of tax expenditures in income taxation prior to the world economic crisis (Kemmerling, 2010). Most of these explanations draw a picture of rather ‘reactive’ or ‘defensive’ politics, similar to the literature on the hidden nature of the welfare state (Howard, 1997). The hidden aspect relates to the idea that politicians hide away expenditure programmes in the tax code, in part because of the political costs and resistance associated with taxation and ‘excessive’ spending. Howard mainly used the term against the US background in which federal spending programmes tend to be unpopular with public opinion. However similar lines of public reasoning are visible in many other countries (Kemmerling, 2009). And yet, governments sometimes do the opposite of hiding tax expenditures – at least with regard to specific instruments. For instance, the UK government under Blair openly embraced and expanded a tax credit for working families in the late 1990s and early 2000s. There are many other instances in which tax expenditures do not emanate from the hidden, secretive world of lobbying and competition. Our reference to ‘offensive’ and ‘defensive’ policies mentioned above alludes to the observation that the political rationale underlying the use of tax expenditures appears to vary considerably. In some cases, mechanisms are used offensively to reshape a political economy, like some trade liberalization programmes and shock therapies did in Latin America, Africa, Asia and Central-Eastern Europe in the 1980s and 1990s (Bates, 1981; Przeworski, 1991; van de Walle, 2001). In such a context, tax expenditures are part of a political narrative that emphasizes transformative change and uses these mechanisms to legitimize executive power. In these cases they transcend the world of special interest groups and address larger segments of society. In other cases, tax expenditures are mainly used defensively to preserve a given power structure, stabilize a political system under stress or protect economies from competition and exogenous shocks. They are still primarily executive power tools, but run mainly ‘below the surface’ of political communication – unless they are part of a short-term crisis response package. The factors that drive the introduction of tax expenditures are similar but might sometimes differ from those that determine their persistence over time. How come governments are often so unwilling or find it so hard to get rid of individual provisions even if they prove to be ineffective or harmful? Empirical evidence shows that institutional and power lock-ins evolve around specific tax expenditures, making it politically costly to dismantle them. Universal

134  Handbook on the politics of taxation sunset clauses could be used to overcome such stalemates, but few countries have introduced them as a general policy. Domestic resistance against the dismantling of individual provisions can be quite strong. Public protests are widely documented in the literature, particularly with regard to fossil fuel subsidies, which often have a large impact on the costs of mobility, food production, heating and lighting of poorer urban households (Chelminski, 2018; McCulloch, 2017; Rentschler, 2016). These studies also show that protests are often fuelled by a general lack of trust in government, as citizens are reluctant to trade present benefits for a promise of uncertain future compensations. Another factor adding to the persistence of tax expenditures is lobbying by powerful economic groups or large companies for the extension of sector-specific or individual tax breaks. Threats of disinvestment and reference to the benefits offered by competing economies may be used to influence policy-making. Diffusion at an international scale and pressure from international actors (multinational enterprises, governments of capital-exporting countries) make departure from general practice additionally difficult (Christians, 2016; Hearson, 2018). Not least, politicians themselves may lobby for keeping certain territorial tax expenditure schemes, such as for instance special economic zones (SEZs), that favour their electoral districts or local constituencies (for instance, see Daude et al., 2017). With regard to public reporting of tax expenditures, it has been observed that a lack of transparency leads to problems of salience and misperception regarding the range of potential addressees and the distributional relevance of the provisions (Goldin & Listokin, 2013). However, research on the factors driving public (non-)reporting by governments is still rather scarce. Obviously, governments that use tax expenditures as an element of secrecy in international tax competition do not have strong incentives to disclose this information to the public. This might explain the above-mentioned reluctance of Switzerland to generate such reforms. For the group of low- and lower middle-income countries as well as the group of fragile and conflict-ridden countries, state capacity is probably another limiting factor, though recent years have witnessed growing technical assistance in this matter (for instance, see IMF, 2019). Tax expenditure reporting may also reflect a general disposition of governments to basic principles of political legitimacy and democratic rule, such as open political debate, freedom of speech and accountability. While the available data do not yet provide conclusive proof of such a relationship, there is some initial evidence that this might in fact be the case. The 15 African countries listed in the GTED that have produced itemized tax expenditure reports obtain a median score of 51 on the 2020 Freedom in the World Index. In contrast, the 17 African countries that do not provide any information at all register a median score of 29.6

4.

WHAT DO GOVERNMENTS USE TAX EXPENDITURES FOR?

It has been said above that tax expenditures are sometimes part of short-term crisis response packages, such as for instance in the current COVID-19 pandemic. However, governments typically justify the use of tax expenditures with reference to overarching goals. The following subsections discuss the use of tax expenditures from a perspective of three such governmental goals: economic growth, social distribution, and environmental protection and mitigation of carbon emissions.

The politics of tax expenditures  135 4.1

Economic Growth

A major part of tax expenditures in place worldwide are incentives to stimulate investment and growth. Some are general across-the-board tools, but others have a specific purpose. For instance, many incentive schemes are devised to lure companies into specific sectors or to promote desirable activities such as R&D. The impact of these incentives can be analysed from a perspective of effectiveness or efficiency (see IMF et al., 2015): tax expenditures are effective to the degree that they reach their stated objectives. They are efficient to the degree that the ratio between the benefits they generate and the social costs (above all government revenue losses) they imply is high. Most contributions to the debate conclude that the effectiveness of investment incentives depends on a series of factors, including the economic sector targeted by the provision, the degree of market regulation and exposure to competition from other economies. Regarding the efficiency of measures, evidence is rather scarce, partly due to the lack of reliable data mentioned already. It is fair to say, however, that most contributions to the debate put a question mark on the use of tax incentives to promote growth, particularly in developing countries (Caiumi, 2011; Morisset & Pirnia, 2000; OECD, 2014). Why is this the case? To start, many provisions have a negligible impact on investment because they are poorly designed. If anything, they are granted defensively to counter international tax competition, thus further eroding the tax bases of the economies involved. Hence, they are likely to end up being a redundant policy instrument that mostly generates windfall gains for businesses. This implies that governments either lack strategic capacity or foresight to fully capture the consequences of such schemes, or that they fall prey to rent-seeking behaviour and treaty shopping (Weyzig, 2013). According to a survey run by the World Bank, redundancy ratios can be as high as 98 per cent in some countries, meaning that almost all investments would have taken place even if no tax incentive was implemented (James, 2013). Patent boxes are a case in point. First introduced in Ireland in the 1970s, patent boxes provide special tax reliefs for profits generated by certain forms of intellectual property. Whereas these provisions may have a considerable impact on attracting intellectual property, their effect on real activity is often minimal as they create incentives for multinational enterprises to shift the location of their patents rather than modifying their real investment decisions (Alstadsæter et al., 2018). The extraction of non-renewable natural resources also provides plenty of opportunities for (dubious) tax incentives to attract investment. The sector is highly capital- and technology-intensive, and multinational firms with access to both may obtain very beneficial treatments at the onset of the project. Consequently, provisions in the mining sector are often ineffective in the long run (Barma et al., 2012). According to a survey run by the Intergovernmental Forum of Mining, Minerals, Metals and Sustainable Development and the OECD, roughly two thirds of the countries give corporate income tax benefits to mining investors either in the law or in mining contracts (or both). Even more strikingly, around half grant complete tax-free periods (‘tax holidays’) for between three and 12 years (Redhead, 2018). Countries such as Ecuador, Madagascar, Niger and the Philippines provide statutory corporate income tax holidays that are likely to open the door to abuse, for instance by incentivizing investors to speed up the rate of extraction so that as much income as possible is generated within the tax-free period. This speaks very much to the rent-seeking and interest group models mentioned above.

136  Handbook on the politics of taxation SEZs provide another example. Despite a few success stories – mainly in Asian economies such as China, South Korea and Taiwan – empirical evidence shows a significant lack of effectiveness as SEZs often have a negligible impact on economic growth, employment creation, exports and attraction of foreign direct investment (FDI). For instance, using micro data to evaluate export-free zones in Costa Rica, El Salvador and Dominican Republic, Artana (2015) finds that tax incentives can be redundant, create incentives to artificially readjust projects to keep receiving those benefits and favour tax avoidance through strategic tax planning taking advantage of subsidiaries located in eligible zones. Likewise, a 2017 study by the World Bank that uses firm-level data for the Dominican Republic finds a positive effect of SEZs on employment creation that, nonetheless, comes at the expense of a huge fiscal cost (Reyes et al., 2016). As a result, the government’s capacity to finance other investment and social services is severely diminished. This is further evidence of the pivotal role of tax expenditures in asymmetric forms of tax competition (Abbas & Klemm, 2013; Holzinger, 2005; Keen & Konrad, 2013; Kemmerling & Seils, 2009). All in all, tax incentives to attract (foreign direct) investments are mainly driven by defensive considerations, especially if they are implemented in reaction to similar measures enacted by competitors. Developing countries in particular feel obliged to offer generous tax breaks to attract FDI, as they are less able to compete on other locational factors, such as market size or high-quality public services (Andersen et al., 2018). However, governments may also use incentive schemes in a more offensive sense, to signal that they are business-friendly, technologically ambitious economies. Some provisions to stimulate R&D, for instance, seem to follow this logic. 4.2

Social Distribution

In addition to stimulating investment and growth, governments use tax expenditures in social and welfare policies. This begs three important questions. First, why would governments prefer tax expenditures in this policy area over other welfare state instruments that have proven to be effective? Second, are tax expenditures effective in tackling inequality and poverty? Third, what are the political consequences of tax expenditures? Are tax expenditures politically neutral and do they have an impact on the institutional setting of the welfare state? First, there are several reasons why governments prefer tax expenditures over other tools of the welfare state. To begin, tax expenditures are a much more malleable instrument than traditional spending: in most countries they do not have to be introduced in a single, potentially contested bill, as expenditure-based social policies typically are. Rather, they simply need to be included in the annual budget bill – if at all. Given this premise, two key factors contribute to the use of tax expenditures: austerity and polarization. Austerity can make it unpopular to raise spending and taxes. Polarization, on the other hand, means that political parties cannot agree on a way to redistribute through the budget. As a result, each of them has an incentive to use tax expenditures instead of the cumbersome budget approval to target its own constituency. The US example illustrates this political logic of tax expenditures in times of austerity and polarization. Their widespread use for distributive policy goals inspired Howard (1997) to coin the phrase ‘the hidden welfare state’ developed in the context of a constraining political environment (Faricy, 2016). Because middle-class Americans are reluctant to redistribute to what they perceive as the ‘undeserving’ poor (who would live off welfare) as well as the rich (who have benefited from the rise in inequality since the 1980s), majoritarian coalitions

The politics of tax expenditures  137 are hard to cobble together.7 For a Democrat, it is politically risky to support big spending programmes for the poor. Consequently, tax expenditures (called tax credits for the working poor) can be seen as an obfuscation strategy to reach the target group while avoiding being tagged as the tax and spending party or the party of growing federal government. Democrats employed tax expenditures in the context of a political strategy called ‘triangulation’ (used by both the Clinton and Obama administrations) between a democratic base, which they wanted to satisfy, and Republicans in Congress, whose support they needed to pass critical legislation. Republicans, in turn, could hardly oppose the measures since tax cuts are a Republican trademark. Similarly, for Republicans, tax expenditures (in this case, tax exemptions) for the wealthier constituents helped to build and sustain their reputation of promoting small government. Hence, policies that could not be passed through ordinary tax-and-spending channels were implemented through complex amendments to the tax code. Tax expenditures thus maximized redistribution while minimizing political risks, given their ambiguity. Second, does social redistribution through tax expenditures work? Evidence from OECD member countries is rather mixed in this regard, according to Crawford et al. (2012). One key influencing factor is the tax base: if tax expenditures target capital gains or pension savings, they tend to benefit the rich disproportionally. In contrast, if they are designed as income tax credits, poorer people benefit more. Pension savings are a case in point: wealthier households save more and thus benefit more from tax expenditures targeting pension savings, while poorer households save, and benefit, less. More importantly, do tax incentives work for the poor? Several recent studies in the economic and sociological literature help to shed light on this question. On the one hand, evidence from the US suggests that the Earned Income Tax Credit increased economic mobility above all via single-mother labour (because the tax credit is linked to employment): for children from most disadvantaged backgrounds, it raised academic (graduation of high school and college) as well as labour market (employment and earnings) performance (Bastian & Michelmore, 2018). On the other hand, however, evidence from other countries is less positive. Research using micro simulations shows that tax expenditures, even when used with higher tax allowances, are often more beneficial to middle and upper-middle classes (Avram, 2018). One possible mechanism is that if the income tax schedule is more progressive, wealthier taxpayers benefit more from deductions. Given the complexity of tax systems, the result is that policymakers have much less control over the amounts and target groups of redistribution than with traditional spending programmes, unless they use refundable tax credits. Third, what are the political consequences of tax expenditures? A first wave of studies pointed to the fact that these mechanisms may alter the functioning of the welfare state (Greve, 1994). Above all, tax expenditures in social policy can undermine traditional collective and public redistributive mechanisms by creating markets for private service providers. For some scholars in the literature, tax expenditures can be seen as a way to shift risk from the collective polity to individual citizens through market creation (Hacker, 2008) and to shift partisan politics from the budgetary field to other policy fields such as the labour market where tax breaks target constituents (Gingrich, 2011, p. 34). Pensions are a case in point (Naczyk, 2013): tax expenditures can be used as ‘nudges’ to spur private retirement savings which complement or, in some instances, replace public insurance schemes for old age. The accompanying redistributive impact on different constituencies may affect support for the welfare state itself and further strengthen (neo-)liberal perspectives on the role of the state. As a recent study shows,

138  Handbook on the politics of taxation the availability of private sector insurance schemes lowers the support of upper and middle classes for public collective insurance (Busemeyer & Iversen, 2020). As a result, tax expenditures shape not only the relationship between state and society, but also between different social groups. Further, they shape the relationship between the executive and legislative branches of government (usually by tilting it in favour of the executive). Rigidities of budget and tax policy may lure governments to use tax expenditures rather than engage in cumbersome bargaining with parliament. 4.3

Environmental Protection and Mitigation of Carbon Emissions

Tax expenditures have a wide range of environmental implications. Fossil fuel subsidies are probably the most evident case in point. Roughly 60 per cent of the measures listed in the ‘Inventory of Support Measures for Fossil Fuels’ published by the OECD (2015) are tax expenditures, including for instance reduced excise rates on aviation fuel in Australia, a special tax regime for inputs used in the exploration and production of fossil fuels in Brazil and an energy tax refund for diesel used in agriculture and forestry in Germany. The myriad of tax expenditures granted in the context of CO2 taxation in order to mitigate the so-called competitiveness and leakage effects provide further examples. Despite this inventory being the most comprehensive source of cross-country information on the support for fossil fuels, the lack of transparency is – once again – a crucial problem (Dom & McCulloch, 2019). As stated in the 2015 report, ‘a limiting factor in respect of tax expenditures relating to fossil fuels is the extent to which countries release such estimates already’. Strikingly though, concrete measures to phase out fossil fuel subsidies are rare, and progress remains slow. Moreover, tax incentives linked to the consumption and production of fossil fuels are not only harmful to the environment. Tax benefits incentivizing an unsustainable use of natural resources – including deforestation – trigger undesired effects on resource allocation, growth and social development (McFarland et al., 2015). As becomes obvious the motives for such expenditures are mixed. The reduced excise rates on aviation fuels clearly illustrate a collective action problem and show how much countries compete for airline traffic. However, with other fuel tax reductions the picture is less clear. Governments may simply fear the economic transition costs of higher fuel taxes, or the political costs of public protests associated with the dismantling of such schemes, exemplified by the French Gilet Jaunes movement in 2019, for instance. Many tax expenditures have negative effects on the environment that are less straightforward while still being non-negligible, and should thus be also internalized. The mortgage interest deduction (MID), which allows mortgage interest payments to be deducted from personal taxable income to foster home ownership, provides a concrete example. MID schemes are implemented in several countries including the Netherlands and Switzerland. In the US the associated fiscal costs were estimated to amount to 63.6 billion US dollars in 2017, making it one of the largest federal tax expenditures in the country (US Congress Joint Committee on Taxation, 2017). Despite empirical evidence showing that the MID is highly regressive and ineffective in promoting home ownership (see Hilber & Turner, 2014), some authors have observed that it creates incentives to acquire larger and more expensive houses, which in turn raises concerns regarding its environmental impact. The tax treatment of company cars and commuting expenses provides another example. As stated by the OECD, most member countries treat only 50 per cent of the personal benefit

The politics of tax expenditures  139 to employees from company cars as taxable, which often creates incentives for employees to use company cars for personal use, and to drive longer distances than they might do otherwise. This triggers a negative impact on the environment and climate change. Using data for Germany, Heuermann et al. (2017) show that the preferential tax treatment of commuting expenses is both regressive and has a negative effect on the environment. Similar to the previous case, the story here seems to be that subsidies have been granted to either particularly large or particularly influential parts of the electorate. This creates legacy effects as abolishing such tax expenditures may turn out to be politically too costly (also see Schaffer’s contribution to this volume). Finally, tax expenditures can also serve pro-environment causes if they incentivize the use of low-carbon technologies.8 For instance, several OECD member countries (and a few other countries) have enacted legislation that grants tax exemptions or tax deferrals for household investments in renewable energy production. In some cases (Germany being one of them), such provisions have been used with the explicit goal of promoting technological innovation and industry development in this sector. Further, tax expenditures related to fossil fuels have been moving up on the climate change agenda in recent years (see Schaffer in this volume). The Sustainable Development Goals include an indicator measuring fossil fuel subsidies (12.c.1 – Amount of fossil fuel subsidies per unit of GDP (production and consumption)). Seeking to achieve a balance between lowering household emissions of CO2 and harming industrial production can be a difficult undertaking for governments, especially since CO2 taxation is not coordinated globally.

5.

CONCLUSION: THE LONG PATH TO TAX TRANSPARENCY

This chapter has conveyed a simple message: any analysis of taxation and tax systems will be necessarily incomplete if it does not account for tax expenditures. It is an important observation that the academic as well as the public interest in this topic seems to be growing. Still, this chapter has also shown the many challenges associated with the operationalization, measurement and political debate of tax expenditures. This calls for research strategies that combine inductive inference based on in-depth case studies with comparative statistical analysis that makes use of new data-gathering initiatives such as the above-mentioned Global Tax Expenditures Database project. From a micro perspective, each tax expenditure has its own logic, such as attracting FDI, protecting markets and improving the welfare state. It is certainly necessary to analyse – and justify – each policy from such a perspective. However, viewed from the macro level it has become clear that tax expenditures reshape the linkages between state and society. Above all, they affect the margins between collective revenue mobilization for common goods, on the one hand, and individual or group-based access to specific benefits, on the other, discriminating certain groups or activities against others. At present, it is a key feature of tax expenditures that they tend to hide these impacts from academic scrutiny and public debate. This is what we have called the ambiguity of tax expenditures. It has been argued that because of their ambiguity tax expenditures can be a key element of ‘fiscal illusion’, i.e. a misperception of the real fiscal burden associated with the delivery of public services, which may significantly distort fiscal and electoral choices (Dziemianowicz et al., 2017; Oates, 1988; Wagner, 1976). Related to this line of reasoning, tax expenditures

140  Handbook on the politics of taxation could play an important role in political business cycles as part of the fiscal policy packages politicians employ to increase their chances for re-election (Mosley & Chiripanhura, 2016; Nordhaus, 1975; Rogoff, 1990). To give an example, Therkildsen and Bak (2019) explore how electoral cycles affect the use of tax exemptions in Tanzania. We would expect comparative research to produce more insights on these issues once better and more detailed data are available. At present, however, any comparative statement on the use of tax expenditures in specific political contexts or regime types would be highly speculative. We have seen that tax expenditure policies can be heuristically framed as ‘offensive’ or ‘defensive’ projects, following Stepan’s (1985) distinction. They are offensive to the degree that they are embedded in broader projects of political change and transformation, based on ideological positions that favour market-based over state-based solutions, and are used to gain political power. They are defensive to the degree that they are formulated in reaction to a perceived threat or shock, driven by pragmatism rather than ideology, and used to preserve rather than gain political power. As offensive projects, tax expenditures are often openly communicated, while they are mainly kept below the surface of political communication if they are used defensively – though there are also cases where the opposite holds true. As academics and citizens, we strongly prefer timely and encompassing public reporting on tax expenditures. However, we can also imagine situations where this may lead to increased rent seeking, for instance in cases where transparency on benefits granted to specific groups fuels lobbyism and generates political pressure for an expansion of such provisions to other groups or sectors. Finally, at the time of writing this chapter, the global COVID-19 pandemic has caused havoc in social and economic life all over the planet. Most governments use tax expenditures as one of several approaches to confront the crisis. It is still far too early to say how economic reactivation and subsequent fiscal consolidation measures are going to look in each country. However, as in other policy areas, we see opportunities along with risks. Those governments that are able to maintain (or quickly revert to) orderly fiscal and budgetary processes will probably be in a better position to resist lobbying for excessive tax exemptions by powerful economic groups. In addition, fiscal needs may be an important driver for a concerted effort to get rid of inefficient and ineffective tax expenditures. On the other hand, previous crises have shown that even the most capable governments may implement ineffective and fiscally damaging measures when operating under pressure. Not least, there is a real risk that governments of capital-importing developing countries will grant ever more generous tax expenditures in a desperate quest for FDI, unless international tax cooperation prepares the ground for joint and concerted action.

NOTES 1. The other two methods are the ‘revenue gain approach’, which estimates the additional revenue that would be collected if a tax expenditure was removed by accounting for behavioural changes resulting from this removal, and the ‘outlay equivalent approach’, which estimates the government cash outlay required for an alternative direct spending programme replacing the tax expenditure that would have the same benefit for the taxpayers – again, assuming no behavioural change. For more details on the different methods, see Myles et al. (2014). 2. For instance, the non-governmental organization International Budget Partnership and the Inter-American Center for Tax Administrations have collected detailed information on tax expenditures in Latin America (de Renzio, 2019; Peláez Longinotti, 2019). The European Commission as

The politics of tax expenditures  141 well as the OECD have put together information on tax incentives for research and development (see Appelt et al., 2019; European Commission, 2014). Further, there is a broad body of research on tax incentives for investments (see Andersen et al., 2018; Klemm & Van Parys, 2012; Li, 2006; Redonda et al., 2019), and consultancy firms such as PricewaterhouseCoopers publish detailed legal information on a country-by-country basis (see PwC, 2018). 3. Also see the chapter on domestic determinants of tax mixes by Kemmerling and Truchlewski in this volume. 4. On fiscal decentralization, see Garmendia Madariaga’s chapter in this volume. 5. See Lierse’s chapter on the politics of international tax competition in this volume. 6. See Redonda et al. (2021b) for information on tax expenditure reporting in Africa. The Freedom in the World Report is published annually by Freedom House and covers 210 countries and territories. For the sample of countries discussed here, scores range from 2 (lowest) to 92 (highest). For the latest scores, see https://​freedomhouse​.org/​countries/​freedom​-world/​scores (accessed 6 May 2020). We use the median in order to control for extreme values in country scores. 7. See Alesina and Glaeser (2004); Gilens (2009); McCall (2013). A recent study by Tuxhorn et al. (2019) shows, however, that the ideological gap between conservatives and liberals over budget size and taxation tends to vanish if trust in government is high. 8. See Schaffer’s chapter on environmental taxation in this volume.

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10. Fiscal decentralization Amuitz Garmendia Madariaga

1. INTRODUCTION Fiscal decentralization refers to the political initiative to push decision-making authority regarding revenues downwards, that is, from central to regional and/or local levels of government. As such, it can take different institutional forms; from an increase of (conditional and unconditional) transfers from the central government to subcentral governments (SCGs), to the creation of new subcentral taxes, to the devolution to local or regional governments of a tax autonomy that was previously central. Moreover, it responds to the expansion that, in the name of the principle of subsidiarity (and the idea of allocative efficiency), size, and diversity, SCGs’ expenditure responsibilities have experienced internationally in the last 50 years. Nowadays, SCGs are front-line service providers; indeed, many of these governments hold a preeminent position in the provision of critical welfare policies, such as education, health services, or other safety nets, such as unemployment benefits. Issues related to fiscal decentralization lie at the intersection of governmental organization, institutional and policy design, public finance, and distributive politics. Consequently, since its inception, the study of its theory and practice has interestingly brought together a diverse group of scholars pertaining to different areas of knowledge, from economics, to public administration, and to political science. From a general perspective, fiscal decentralization presents one of the most genuine and rich examples of how an initially theory-guided normative approach to the study of a particular economic and political phenomenon transforms itself into an evidence-rich analytical research line due to the exceptional and real-time transformation of governmental institutions around the world. The chapter proceeds as follows. First, it presents a thorough overview of the state of the art on fiscal decentralization, from the initial emphasis on the normative expectations of the ‘public finance’ and ‘public choice’ approaches, to the later focus on the political processes and institutional design of a second generation of ‘political economy’ scholars that reviews previous assumptions based on empirical evidence. In line with this, the chapter presents some of the most relevant topics regarding the politics of subcentral taxation and fiscal organization, emphasizing the comparative nature of this phenomenon: a trend with clear institutional consequences that has reshaped governmental organization in all world latitudes in very heterogeneous ways. The chapter deepens into issues such as tax assignment, fiscal equivalence, multilevel tax administration, and subcentral tax capacity, shedding light upon future research avenues.

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Fiscal decentralization  147

2.

THE INTELLECTUAL HISTORY

2.1

The Welfare Economics Approach

Commonly known as the First Generation of Fiscal Federalism (FGFF), the initial welfare economics approach to the study of fiscal decentralization took its name from Wallace Oates’ 1972 book Fiscal Federalism. The FGFF was soundly influenced by the view of public finance that prevailed in the 1950s and 1960s and by the work of its main contributors when defining the perspective of the public sector: mainly Richard Musgrave (1959) and Paul Samuelson (1954). As Oates (2005) later described, the implicit view of this perspective was that whenever the private market system ‘failed’ because of various sorts of public good provision problems, governments should step in and produce appropriate policy measures to correct these deficiencies. Governments would seek to maximize social welfare, either because of some kind of benevolence or, perhaps more realistically, as a way of anticipating electoral accountability in democracies. The FGFF was also largely influenced by the political theory tradition that emphasized the advantages of small jurisdictions over bigger ones when representing societal preferences (Rodden, 2007). Madison (1961 [1787]) saw federalism as a way to provide collective goods covering a large territory without sacrificing local accountability. And Tocqueville (1889) praised federal systems for combining the different advantages which result ‘from the magnitude and the littleness of nations’. Then, fiscal decentralization was thought to offer some potentially important opportunities in the hope that ‘state and local governments, being closer to the people, will be more responsive to the particular preferences of their constituencies and will be able to find new and better ways to provide these services’ (Oates, 1999, p. 1120). To do so, those who design a federal system had first to solve the so-called ‘tax assignment problem’ (Musgrave, 1959), that is, the idea of ‘who should tax, where, and what’ (Musgrave, 1983). Practically speaking, this meant solving the trade-off between the coordination challenges of having multiple levels of government against the informational efficiencies arising from having governmental units that could potentially match citizens’ local preferences (Gramlich, 1973). This prescription was a quite general one though. The FGFF did not offer a precise delineation of the specific goods and services to be provided at each level of government (Olson, 1969) and the presumption in favor of decentralized finance developed by Oates, in his 1972 ‘Decentralization Theorem’, was established by simply assuming that centralized provision will entail a uniform level of output across all jurisdictions. As the author subsequently acknowledged, in the presence of cost savings from the centralized provision of a good – as the existence of perfect information on the optimal-level provision of a particular public good in a particular country – and from the existence of interjurisdictional externalities, ‘it would obviously be possible for a benevolent central planner to prescribe the set of differentiated local outputs that maximizes overall social welfare’ (1999, p. 1123). 2.2

The Public Choice View

The mobility of economic factors played an important role when motivating the alleged benefits of fiscal federalism. Indeed, Tiebout’s (1956) model has been the centerpiece of the FGFF for many decades. Built as a response to Samuelson’s claim that decentralized choice could

148  Handbook on the politics of taxation not result in an efficient provision of public goods, Tiebout proved that, by ‘voting with their feet’, property owners could sort themselves into communities that offer them a desired mix of tax and ‘local public goods’, choosing Pareto efficient outcomes (Gramlich & Rubinfeld, 1982; Ostrom, 1983). This link between decentralization and improved efficiency through competition brought the ‘public choice’ literature into the study of fiscal decentralization. While for welfare economists the mobility of citizens and capital was mainly a mechanism of preference revelation for incumbents, ideally laying the groundwork for the optimal provision of public goods by jurisdiction, scholars of ‘competitive federalism’ saw in production factors’ ability to exit a way to constrain governments’ (Leviathan’s) economic voracity. ‘Public choice’ theorists, unlike welfare economists, believed that governments had a natural tendency towards excess (Mueller, 2003). Accordingly, the Leviathan theory (Brennan & Buchanan, 1980; Hayek, 1939; Friedman, 1977) portrayed the government as a creature with the monopoly over taxation and the willingness to extract as much revenue as feasible. By dividing decision-making authority among multiple layers of government, federal constitutions provided scholars with a possible solution (De Figueiredo & Weingast, 2005). Under decentralized decision making, incumbents should compete with one another for mobile assets, decreasing the opportunities for overtaxing and inefficient spending, and thus resulting in a small jurisdiction competition-based fiscal policy delivery (Rose-Ackerman, 1983). Following this same logic, the literature on market-preserving federalism (Buchanan, 1950; Montinola et al., 1995; Qian & Weingast, 1997; Rodden & Rose-Ackerman, 1997; Weingast, 1993) presented federalism as market-friendly because of its tendency to limit the aforementioned expansive nature of the public sector through citizens’ ability to punish incumbents either with their ballot or ‘with their feet’. This approach has been revisited in subsequent efforts by authors like Weingast (1995) or Persson and Tabellini (2000), who have identified capital mobility under federalism as a way for SCGs to commit not to overtax capital or overregulate the economy. 2.3

From Consensus to Skepticism: The Empirical Evidence

The virtual consensus on the potential benefits of decentralization contributed to a trend towards decentralization that reshaped governmental organization in the world in the last decades of the past century (Grossman & Lewis, 2014). Efforts in this direction had many origins: from central governments themselves, in democratic and autocratic polities, to international organizations, and development agencies, which at times conditioned their economic assistance on developing countries’ commitment to undertake decentralization programs (Treisman, 2007). Yet, the performance-based early evidence on the effects of fiscal decentralization soon demonstrated that the purported outcomes were at best mixed. Oates (1985) himself became one of the first to prove that there was little empirical support for the proposition that fiscal decentralization provided an effective constraint on the growth of government. Even if some United States (US), Canadian, and Swiss localities showed lower government spending (Feld et al., 2003; Marlow, 1988; Zax, 1989), comparative studies were unable to confirm the effect hypothesized by scholars of ‘competitive federalism’ (Rodden, 2003). Moreover, an increasing number of pieces started to link decentralized government to local fiscal failure (Baldassare, 1998) and, more generally, to macroeconomic distress (Prud’ Homme, 1995; Treisman, 2000b; Wibbels, 2000). Rather than as welfare-maximizing benevolent despots,

Fiscal decentralization  149 studies started to portray a much less benign image of governments and their representatives in federations, which were perceived to be on average more corrupt (Treisman, 2000a) and significantly connected to suboptimal economic behavior and outcomes, such as subcentral fiscal opportunism and irresponsibility (Remmer & Wibbels, 2000; Rodden, 2002; Rodden & Wibbels, 2002). A lot of it has to do with the fact that, rather than showing a clean division of responsibilities across levels of government to respond to the initial ‘assignment problem’ described by welfare economists, most of the federal constitutions in the world show a division of authority over taxation, expenditures, borrowing, and policy decisions that is inherently diverse, convoluted, contested, and frequently politically renegotiated. According to Rodden (2006, p. 43), in practice, the ‘dual sovereignty’ perspective of the classical view of federalism could only be approximated under extremely narrow conditions as the ones explained above. Instead, the ‘incomplete contracting’ (Tommasi & Saiegh, 2000) perspective refers to a more realistic alternative view according to which divisions of authority over time tend to transform into ‘complex vertical overlaps between two and usually three levels of government (central, regional and local) … as a response to court decisions, power struggles, and opportunistic attempts to shift credit and blame’ (Rodden, 2006, p. 43, see also Filippov et al., 2003). As Beramendi (2007a, p. 765) neatly describes: financial self-reliance of subnational units needs necessarily to combine fiscal autonomy and fiscal accountability. Fiscal accountability refers to the extent to which subnational units internalize the consequences of their economic behavior. As such, it presupposes high levels of fiscal autonomy, i.e. that subnational governments rely more on their own revenues and less on transfers from the federal government. Yet, the reverse is not necessarily true. Fiscal autonomy does not always imply high levels of fiscal accountability.

This ‘challenge of fiscal discipline’ (Rodden et al., 2003) of SCGs around the world has been relevantly connected to a specific type of ‘common pool problem’ known as ‘soft budget constraints’ (Kornai et al., 2003; Rodden, 2003). These are situations in which the center is importantly responsible for the financing of SCGs’ expenditures and thus cannot commit not to bail them out in the event of bankruptcy, which under regular conditions creates perverse incentives for the fiscal discipline of SCGs ex ante. Intertwined systems of authority distribution also transform the envisioned role of citizens in normative fiscal models. According to the latter theories, as taxing and spending are decentralized to SCGs, responsibilities should also be clearer, and mobile citizens and firms (or voters) might be able to consider future tax increases when making location decisions (or deciding their vote choice). However, when subcentral revenue capacities are limited and depend to a large extent on vertical transfers, citizens might be incapable of holding their governments accountable for their economic outcomes. Indeed, the finding that economic voting is weakest in countries where decentralized government is prominent (Anderson, 2006, 2009) has recently put federal institutions under the spotlight of the clarity of responsibilities side of the economic voting literature (Arceneaux, 2006; Cutler, 2004; Garmendia Madariaga, 2021; Hobolt et al., 2013; León, 2011; Tuschhoff, 1999; Wlezien & Soroka, 2010). Undoubtedly though, one of the most studied findings of fiscal decentralization is the one associated with its possible role on the existence of lower levels of redistribution and higher levels of inequality (Cremer et al., 1996; Epple & Romer, 1991),1 especially as the heterogeneity of a population increases. Early contributions to the theory of tax competition emphasized

150  Handbook on the politics of taxation the possibility that competition for capital leads to a second ‘common pool problem’ characterized by inefficiently low tax rates and public expenditure levels, a so-called race to the bottom (Wilson, 1986; Zodrow & Mieszkowski, 1986; see also Lierse’s chapter, this volume). Welfare economists’ view on this subject was that redistributive policies should be centralized given that SCGs could experience a sort of adverse selection: redistribution creates locational incentives that attract those who benefit from these policies (the poor) and repel contributors (taxpayers). Yet, for many ‘public choice’ scholars this approach welcomed a third type of ‘common pool problem’ associated with the centralized provision of local public goods. As a consequence, since then, a wide range of scholars have devoted relevant efforts to reflect upon the trade-off between centralized and decentralized taxation and the provision of local public goods (Besley & Coate, 2003; Bolton & Roland, 1997; Wildasin, 1991) by focusing on issues such as spillovers, interjurisdictional variation in tastes for public spending, different structures of market integration, etc. Actually, the existence of constraints on redistribution have not only been linked to fiscal decentralization, but also to political decentralization: fragmented political structures are known to open the door to a process of preference concentration that favors second dimensions (such as identity, territory, or race) and represents electoral-based pressures, limiting the feasibility of large redistributive coalitions (Iversen & Soskice, 2006; Volden, 1997). 2.4

Endogenous Fiscal Structures

The theoretical and empirical approximations to the study of fiscal decentralization up until the late 1990s were based on the premise that constitutions and laws influence political outcomes (see Andersson’s chapter). But, the evident mismatch between normative expectations and fiscal outputs made a new generation of scholars (Alesina & Spolaore, 2003; Bolton & Roland, 1997; Diaz-Cayeros, 2006; O’Neill, 2005; Persson & Tabellini, 1996a, 1996b; Rodden, 2006; Wibbels, 2005a) focus on the origin of formal fiscal institutions motivated by the idea that they ‘are no more than rules and rules are themselves the product of social decisions’ (Riker, 1980, pp. 444–445). Unlike the public finance side of the FGFF, which largely assumed that public officials seek the common good, the Second Generation of Fiscal Federalism (SGFF) scholars depart from the assumption that both voters and officials have their own objective functions that they seek to maximize. Specifically, this new political economy literature draws more directly on political science by assuming that public officials are motivated by electoral goals, and presents fiscal decisions as distributive bargaining outcomes that depend on self-interested, reelection-seeking politicians working under the political incentive structures of parties, legislative organization, and electoral rules (Amat & Falcó-Gimeno, 2014; Cox & McCubbins, 1986; Dixit & Londregan, 1996; Gibson et al., 2004; Inman & Rubinfeld, 1997; Jones et al., 2000; Larcinese et al., 2006; Samuels & Snyder, 2001). Then, the SGFF takes more seriously the role of preference aggregation through voting and lobbying and, ultimately, instances of institutional design and change. For instance, taking Bolton and Roland’s (1997) and Persson and Tabellini’s (1996a, 1996b) seminal pieces as a starting point, a number of contributions have emphasized how preexisting economic territorial conditions are a key determinant of the decision to integrate politically and make specific constitutional choices in federations. Two economic realms are usually taken into account in this regard. On the one hand, the size of the tax base, which leads to a first intuitive prediction:

Fiscal decentralization  151 rich regions prefer decentralization whereas poorer ones always prefer a centralized fiscal regime. On the other hand, the distribution of income across and within regions, which leads to a second intuitive prediction: the chances to adopt a centralized fiscal regime decline as distributive tensions vary across regions. Relevantly, Wibbels (2005b) demonstrates that – at least for the cases of Argentina, India, and the US – the relative multilevel fiscal authority in federal constitutions depends on the interregional distribution of factor endowments and inequality. Similarly, Beramendi (2007b) shows that fiscal structures are also largely driven by differences in the demand for social insurance associated with the incidence of labor market risks in 14 Organisation for Economic Co-operation and Development (OECD) countries. On the consequences of the existence of a second dimension for the design of fiscal structures, a recent research line has worked on the formation and effects of constitutionally enshrined fiscal asymmetries. Asymmetric autonomy is commonly defined as a status quo constraint that a central government, looking for territorial integrity, faces at the moment of designing a country’s territorial distribution of power; that is, the existence of relatively more prosperous (resource-rich) high-demand (usually with territorially concentrated and mobilized minorities) jurisdictions lobbying for a greater fiscal authority (Bird & Ebel, 2007; Congleton et al., 2003; Filippov & Shvetsova, 1999; Sambanis & Milanovic, 2014). Although it has been normatively described as an institutional solution for the appeasement of secessionist threats, empirical evidence demonstrates that fiscal asymmetries create a centrifugal competition among some of the units for alternative deals (Garmendia Madariaga, 2016), and that accordingly, challenges to the institutional status quo constitute a systematic feature of these types of federations (Kymlicka, 1998; Solnick, 1995; Zuber, 2010).2

3.

THE STRUCTURE OF SUBCENTRAL TAXATION

3.1

Tax Assignment

In a fiscally decentralized country, tax assignment refers to the process by which the following three characteristics of the system are defined: (1) the level of government that is granted legal powers to introduce new taxes or define their tax bases and rates; (2) the way in which revenues from different taxes are shared, or not, among the different levels of government; and (3) the level of government that is responsible for the administration and enforcement of the different taxes (Martinez-Vazquez & Timofeev, 2010, p. 601). Departing from this framework, this section proposes an approximation to the theory and practice of multilevel tax assignment and administration in a comparative perspective. To do so, though, it seems necessary to first understand those key aspects that shape the way in which multilevel finances are structured and, above all else, this requires focusing on subcentral expenditure responsibilities. SCGs’ expenditure responsibilities can range from the provision of a few minor services as agents of the central government in each jurisdiction to the delivery of important public services that require making important decisions to determine the appropriate revenue assignment. As can be observed in Figure 10.1, even if countries have experienced relevant expenditure decentralization processes in the last 30 years, there are still important between-country heterogeneities; for instance, OECD members seem to have higher levels of expenditure decentralization than the rest of the countries in the sample.3 This seems to be consistent with findings in the literature that demonstrate that expenditure decentraliza-

152  Handbook on the politics of taxation

Source: Government finance statistics of the International Monetary Fund.

Figure 10.1

Share of general government spending by level

tion correlates with country size, democracy, federal constitution, gross domestic product per capita, and ethno-linguistic diversity (Panizza, 1999; Garrett & Rodden, 2006). As Falleti (2005) seminally developed,4 the prevailing interests, timing, and mechanisms of (revenue and expenditure) reforms determine the particular sequence of decentralization that a given country undergoes. And the prevailing interests and bargaining power of political actors in the origin of this process depend heavily on the historical roots of a decentralized country. According to Stepan (1999), federal and quasi-federal systems can be of two types: ‘coming-together’ or ‘holding-together’. In the former, previously sovereign polities agree to give up part of their sovereignty in order to pool their resources together in a union to increase their collective security and to achieve other goals, including economic ones; whereas in the latter, to hold the borders of a centralized unitary country together in the event of secessionist threats, a centralized polity devolves power constitutionally to its constitutive units. Following Falleti’s logic, ideally, in the former, the tendency will be for strong SCGs to acquire fiscal responsibilities (taxing autonomy) before administrative ones (expenditure responsibilities), while in the latter the incentives of the strong central government will be exactly the opposite (2005, p. 332). According to Bird (2010, p. 6), in principle, a totally subcentral tax should be one that satisfies the following five conditions: SCGs should have the autonomy to decide (1) to levy the tax or not; (2) to define the tax base; (3) to determine the tax rate; (4) to administer it; and

Fiscal decentralization  153 (5) to keep for them all the revenues they collect. In reality, however, as the author comments, subcentral taxes show only a few of these conditions, what has led to intricated tax assignment systems. Indeed, empirically speaking, most of the existing data samples define subcentral own revenues broadly, including ‘own taxes’ plus revenue-sharing funds, tax sharing, and surcharges on the tax base of a higher level of government.5 Exceptionally, the OECD Fiscal Decentralization Database distinguishes between ‘own taxes’ and ‘tax-sharing arrangements’, specifying the multilevel authority upon particular characteristics, such as tax rates and bases (see Table 10.1 for an example). In general terms, tax assignment has been approached from a normative perspective in the literature. The FGFF envisioned a system in which SCGs were mere decentralized service providers, and as such, even if they had a broad control over expenditures, they were expected to levy few taxes. Justifications for limiting subcentral taxation were diverse: the maintenance of economic integration, the avoidance of ‘tax wars’, or the necessity to achieve redistributive equity (Musgrave, 1983), among others. Later on, performance-based outcomes motivated the SGFF call for an alternative paradigm, that is, a fiscal and political incentive-guided optimal system, grounded in two rules (Weingast, 2008): on the one hand, SCGs should control their own revenues to facilitate the effective management of their decentralized expenditure responsibilities; on the other hand, controlling taxes should imply that these governments have the authority to design and choose their taxes and respective rates to finance their own policy choices. Essentially, this was Olson’s (1969) intuition when developing the ‘Principle of Fiscal Equivalence’, that is, the desire to achieve higher levels of fiscal responsibility by linking expenditures with taxes. The empirical evidence has shown quite a different reality though. In a majority of decentralized countries, including federations, the decentralization of revenue and spending responsibilities have not gone hand in hand, resulting in what is commonly known as vertical fiscal imbalances (VFIs). The concept characterizes situations in which decentralized expenditures surpass decentralized revenues and SCGs have to rely on intergovernmental transfers (see Figure 10.2). The motivation behind this mismatch is usually connected to the search for macroeconomic stability. Since subcentral tax bases are smaller than central ones and interjurisdictional spillovers are common, subcentral tax mixes should be composed not only by autonomous tax revenues, but also by taxes shared with the central government and by transfers coming from other jurisdictions, in order to adjust for horizontal fiscal imbalances through equalization revenues. Anyhow, most empirical studies based on comparative samples find that large VFIs, caused by transfer dependency, generally deteriorate SCGs’ fiscal performance (Van Rompuy, 2016, p. 1250), or even overall fiscal balances (Baskaran, 2010) confirming the underlying logic motivating some of the aforementioned prescriptions. Using a panel study of developing and developed countries over the period 1986–1996, Rodden (2002) demonstrated that transfer dependency worsens fiscal performance, particularly when high VFIs are accompanied by a high subcentral borrowing capacity. Eyraud and Lusinyan (2013) confirmed that the former is true, at least for OECD countries between 1969 and 2007, showing also that when expenditure decentralization is financed through own revenues, overall fiscal performance is improved. Van Rompuy’s (2016) work demonstrates that the latter is true only when the revenue share of ‘own taxes’ exceeds a minimum of about 35 percent. Actually, his results indicate that vertical transfers can sustain fiscal discipline if distributed when tax autonomy is low and the central government still controls expenditure policies.

23.4

22.6

8.2

Regional

Local

19.7

14

Regional

Local

16.6

3.5

Regional

Local

7.6

Local

-

100

100

-

100

-

-

-

-

-

-

-

-

-

0.1

15.7

-

-

-

-

14.4

3.9

58.4

26.3

-

-

-

-

41.6

-

26.2

Reductiond

-

-

-

-

-

-

-

-

on reliefse

-

-

-

-

-

-

-

-

by SCG f

Revenue split

-

-

-

-

-

42.5

92.7

-

consentg

by CG

with SCG

57.9

-

-

-

-

-

-

-

h

Revenue split

Revenue split CGi

0.1

-

-

-

-

-

-

15.2

reliefs set by

-

-

-

100

-

1.4

3.4

-

Other

100

100

100

100

100

100

100

100

Total

Note: a The recipient SCG sets the tax rate and any tax reliefs without needing to consult a higher-level government. b The recipient SCG sets the rate and any reliefs after consulting a higher-level government. c The recipient SCG sets the tax rate, and a higher-level government does not set upper or lower limits (piggybacking). d The recipient SCG sets the tax rate, and a higher-level government sets upper and/or lower limits (piggybacking). e The recipient SCG sets tax reliefs. f There is a tax-sharing arrangement in which the SCGs determine the revenue split. g There is a tax-sharing arrangement in which the revenue split can be changed only with the consent of SCGs. h There is a tax-sharing arrangement in which the revenue split is determined in legislation, and where it may be changed unilaterally by a higher-level government. i Cases in which the central government sets the rate and base of the SCG tax revenue.

7.6

Chile

South America

20.1

Australia

Oceania

33.7

US

North America

30.8

Germany

Europe

23.4

Local

decentralization)

(revenue

revenue

-

and reliefs Reductionb Fullc Fulla

total

tax

Discretion on rates

Percentage of

Taxing power of subcentral government as share of subcentral tax revenues Discretion on rates Discretion Tax-sharing arrangements Rates and

Available information in the 2014 OECD Fiscal Decentralization Database on a selection of countries

Japan

Asia

Table 10.1

154  Handbook on the politics of taxation

Fiscal decentralization  155

Note: Source:

Vertical fiscal imbalance = 1 (subcentral own revenues/subcentral own expenditures). Government finance statistics of the International Monetary Fund.

Figure 10.2 3.2

Subcentral vertical fiscal imbalances in a selection of federations and quasi-federations

Potential Sources of Subcentral Tax Revenues

The definition of what or who should constitute the tax base of an efficient multilevel tax assignment system has been the subject of a particularly interesting research line in the ‘public finance’ literature (Bird, 1999, 2010; Courchene et al., 2000). The way in which normative goals (efficiency, equivalence, and accountability), technical nuance, and economic and political incentives mix together make this a particularly interesting subject from an institutional design perspective. Below, I list some of the so-called ‘desirable attributes’ of subcentral tax structures as defined in the mentioned research: ●● Tax bases should be relatively stationary in order to give authorities margin to change rates without losing part of these bases. ●● Taxes should avoid distorting the location of economic activity. ●● Tax revenues should be adequate to meet subcentral financing needs while at the same time being relatively stable and predictable over time. ●● Tax revenues that are closely related to public service expenditures or benefits should be levied by the level of government that incurs the cost.

156  Handbook on the politics of taxation

Source:

Government finance statistics of the International Monetary Fund.

Figure 10.3

Share of tax revenues to central, regional, and local levels by source

Following these suggestions, as subcentral taxation of potentially mobile tax bases could be economically distorting, the prevailing view in the former literature suggests that central governments should be in control of corporate income tax and personal income tax, impose a value-added tax, or tax the exploitation of natural resources as a source of macroeconomic stabilization; regional governments should depend on piggybacks or surcharges on centrally imposed taxes, and on excises too, which could contribute to finance services that are generated to deal with the costs of the taxed consumption (on alcohol and tobacco, for example, to the extent regional governments are in charge of health expenditures); as for local governments, they should be in control of immobile tax bases over land or property, as well as of user charges linked, as payments, to the use of specific services or resources. Obviously, these are mere normative recommendations that might not be aligned with the actual preferences, incentives, and bargaining power of the decision makers. Specifically, central, regional, and local governments frequently have very different objective functions, which makes them weight these policy choices in various ways. Actually, Figure 10.3 demonstrates that federations or quasi-federations, where the second-tier governments have significant political power, tend to be countries in which these governments have access to much broader shares of revenues. This is a relevant distinction that is not observable when comparing OECD and non-OECD countries. In any case, as the figure interestingly shows, the actual multilevel revenue distribution by source seems to follow, to a large extent, the prescrip-

Fiscal decentralization  157 tions in the first generation of normative literature. Countries continue to be quite centralized on the classical main tax revenue sources, with the exception of property, which has a highly decentralized tax base that represents the bulk of local revenues. Moreover, there seems to be a mismatch between the level of services provided by regional governments (Figure 10.1), the amount of decentralized revenues to finance them (Figure 10.2), and the source of these revenues (Figure 10.3). When tying subcentral finances to specific revenues, it seems important to identify the type of demand for public services (soft or hard) and the elasticity of the revenues involved in their funding. 3.3

Tax Administration

Tax decentralization and the decentralization of tax administration are two related but distinguishable choices for government officials. The latter refers specifically to the vertical organization of tax collection and tax enforcement. Paradoxically, in a literature as fruitful as the one on fiscal federalism, the study of multilevel tax administration is scarce and relatively recent. Broadly speaking, the literature on optimal tax administration presents the choice for organizational arrangements as a trade-off between cost efficiency and accountability (Martinez-Vazquez & Timofeev, 2010). An important argument in favor of tax administration centralization in the literature is the reduction of efficiency and compliance costs. With regard to the first ones, the underlying logic is that the ability to work under lower costs as a consequence of the economies of scale in production, staff specialization and cost-intensive but efficient capital inputs, particularly modern tax technology, put centralized tax administrations in a position of advantage with respect to the rest of alternative administrative organizations (Vehorn & Ahmad, 1997; Bird & Zolt, 2008). The evidence in this regard is mostly fragmented in case studies. Exceptionally, OECD Comparative Tax Administration Reports provide interesting hints regarding country-level differences in centralization. However, there are very few studies comparing directly centralized and decentralized examples, and thus, for instance, there is no empirical evidence about the relative performance of large subcentral jurisdictions compared to smaller unitary systems. With respect to the second type of costs, the idea here is tax administration centralization contributes to its reduction by making taxpayers submit fewer returns, interact with fewer offices, and deal with a more uniform and harmonized administrative structure (Bird, 2015). The empirical evidence is also fragmented but, in this case, the contrasting experiences of individual and corporate taxpayers in the case of the US (Slemrod & Blumenthal, 1996) and Canada (Plamondon & Zussman, 1998) have demonstrated that compliance costs are particularly high when the tax base of a particular tax is mobile or overlaps more than one jurisdiction. Therefore, decentralized tax administration seems to be costlier for businesses than for individuals given that, usually, the former are more likely to have tax responsibilities in more than one jurisdiction. The issue of accountability seems to be much more complicated and empirically uncertain. The fundamental question here is to understand the role of tax administration when assigning responsibilities. Authors like Mikesell (2007, p. 65) have strongly defended that ‘when administration of local taxes is separate, it is easier for taxpayers to see which government levies what taxes and to hold each accountable’. But the truth is that the classical fiscal federalism literature has mostly departed from the idea that the collection of decentralized taxes should be developed by a centralized tax administration (Bird, 2010, 2015), under the assumption that

158  Handbook on the politics of taxation what matters for accountability is not so much who administers the revenue but who bears the political responsibility to determine the tax rate (McLure, 2000). Accordingly, the normative advice in the literature is usually that the administration of shared taxes or subcentral piggybacks on central taxes should always be centralized. In any case, as Martinez-Vazquez and Timofeev (2010) argue, to the extent that Mikesell’s argument for separate tax administration is valid, it should be understood against a totally centralized or decentralized administrative model. From the perspective of the international practice though, tax administration organization seems to vary as much as cases of fiscal decentralization exist. The organization of tax administration in a fiscally decentralized country could be portrayed as if located in a continuum that characterizes how centralized or decentralized the system is. Martinez-Vazquez and Timofeev (2010, pp. 609–611, see also Mikesell, 2007) use this particular theoretical framework to classify the vertical organization of tax administration in the world. Particularly, the authors distinguish four main models, as well as several country cases – that I expand below – that fit or approximate these general categories: ●● Model 1 (single centralized tax authorities): This represents one end of the spectrum, where there is a central tax administration in charge of administering all taxes, both central and subcentral ones. In these contexts, tax administration staff members, no matter their location in the territory, are central government employees, and taxpayers’ registration, their tax returns procedures, and tax enforcement processes are unified. Examples of this model include Russia or fiscally decentralized unitary systems, such as the Scandinavian countries. ●● Model 2 (independent tax authorities at each level of government): Each level of government has its own tax administration which controls the bulk of taxes assigned to its tier. There is little need for cooperation across levels and the empirical examples represent large federal countries such as Australia, Brazil, or the US. ●● Model 3 (mixed models): This is considered to be a residual category with features of the rest of the models. Tax administration in these contexts is intertwined across levels and it can be found, among others, in Canada, Spain, and Switzerland. There are no effective divisions of revenue sources between different levels of government; for instance, there are no formal tax-sharing arrangements that divide revenues across levels. ●● Model 4 (fully decentralized tax authorities): This is the other end of the spectrum, where subcentral tax authorities collect all taxes for all levels of government. These cases are empirically exceptional. This is the case of Germany, where state tax administration offices are in charge of all the collection and enforcement, and the federal government pays the states for the costs related to administering their taxes. Bird (2015) mentions China as the country in which tax administration comes closest to the German model: there was no central tax administration before 1994 and after that a small central tax office was established, which nowadays sets both policy and administrative guidelines, although all taxes for all levels of government continue to be collected by a network of provincial and local tax offices. According to Mikesell (2007), there are two relevant lessons to derive from this. The first is that the tax revenues available to a level of government might be administered by a different level than the one that levies them. The second is that unlike what is established in the norma-

Fiscal decentralization  159 tive literature, the actual practice demonstrates that there are examples of effective decentralized tax administration. Drawing on the latter experience, a recent trend in the literature has started to focus on subcentral state capacity; especially, after O’Donnell’s (1999) attention call to the high degree of unevenness with which countries in Latin America appear to function throughout their territory.6 Departing from a broader conception of tax administration, Beramendi (2012) has explained the political economy of fiscal structures as a function of the location of income and risk: as these two components grow geographically apart, so do preferences for the design of multilevel integrated insurance systems, thereby nurturing the political demand for more fragmented fiscal structures. In a recent piece, Beramendi and Rogers (2018) demonstrate that the variation in subcentral geographic endowments, which translate into divergence in subcentral economic productivity, encourages territorial conflict over the size of the central fiscal state, and thus is empirically associated with smaller taxing central governments (Lee & Rogers, 2019). This is a counterintuitive result if we consider that central governments’ equalization grants should be necessary to allow all states to provide comparable levels of services with comparable levels of tax effort in those countries where horizontal fiscal disparities are significant. Moreover, taxation at the subcentral level seems to face many of the same challenges as at the central level (Harbers, 2015): effective tax collection is conditional upon the ability of public agencies to monitor compliance and enforcement, and at the subcentral level as well, voluntary compliance seems to be higher where governments succeed in providing services to citizens.

4. CONCLUSIONS The FGFF presented innovative insights about the optimal distribution of authority across levels of government that are still relevant for the design of tax assignment worldwide. Yet, it overlooked issues related to institutional design and political economy. The SGFF overcame these shortcomings by first identifying and then analyzing voters, politicians, and bureaucrats’ incentives under different institutional settings. Fifty years of fruitful research and highly heterogeneous empirical evidence has provided us with a clearer idea of the conditions under which fiscal decentralization might facilitate or undermine macroeconomic management, efficient service provision, and democratic accountability. Given now available evidence in performance outcomes, the overall approach in the literature has moved from normative and functional perspectives into a much more analytical one; that is, there is a decreasing focus on the specific effects of decentralization and, instead, a growing attention on the political incentives created by institutional design variation across countries, and even regions within a country. This chapter has also demonstrated that, as fiscal decentralization reforms have unfolded across different latitudes, all sorts of highly intricated tax assignment systems have been designed and put in place. These systems vary not only in the revenue share that each level of government manages, but also in the type of multilevel tax arrangements or the authority each of these levels has upon the definition of tax bases, rates, and administration. As recent public finance literature has demonstrated, every potential combination of characteristics has relevant consequences for the classical outcomes of interest in the literature, and yet, there are very few political economy studies out there tackling these issues with the necessary nuance. A lot of it

160  Handbook on the politics of taxation has to do with the existing data limitations. Data efforts in this regard represent a very attractive room for improvement for prospective research. Likewise, future investigators should consider making the transition from observational to experimental empirical research in order to better capture the effect that this panoply of institutional choices has on individual behavior.

NOTES 1. For more on taxation and inequality see Limberg’s chapter. 2. For more information, see OECD Regional Development Policy Committee’s 2018 report on the consequences of asymmetric decentralization for fiscal, political, and administrative autonomy (Allain-Dupré et al., 2020). 3. I employ the International Monetary Fund’s government finance statistics; particularly, the Fiscal Decentralization Database, which includes 75 countries. 4. For a normative approach on optimal sequencing of decentralization decisions see Bahl and Martínez-Vazquez (2006). 5. See, for instance, the International Monetary Fund’s government finance statistics. 6. Bastiaens’ chapter on cross-country tax capacity presents an interesting benchmark.

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162  Handbook on the politics of taxation Gramlich, E., & Rubinfeld, D. (1982). Micro estimates of public spending demand functions and tests of the Tiebout and median-voter hypotheses. Journal of Political Economy, 90(3), 536–560. Grossman, G., & Lewis, J. (2014). Administrative unit proliferation. American Political Science Review, 108(1), 196–217. Harbers, I. (2015). Taxation and the unequal reach of the state: Mapping state capacity in Ecuador. Governance, 28(3), 373–391. Hayek, F. von. (1939). The economic conditions of interstate federalism. New Commonwealth Quarterly, 5, 131–149. Hobolt, S. B., Tilley, J., & Banducci, S. (2013). Clarity of responsibility: How government cohesion conditions performance voting. European Journal of Political Research, 52(2), 164–187. Inman, R. P., & Rubinfeld, D. L. (1997). The political economy of federalism. In D. C. Mueller (ed.), Perspectives on Public Choice, 73–105. Cambridge University Press. Iversen, T., & Soskice, D. (2006). Electoral institutions and the politics of coalitions: Why some democracies redistribute more than others. American Political Science Review, 100(2), 165–181. Jones, M. P., Sanguinetti, P., & Tommasi, M. (2000). Politics, institutions, and fiscal performance in a federal system: An analysis of the Argentine provinces. Journal of Development Economics, 61(2), 305–333. Kornai, J., Maskin, E., & Roland, G. (2003). Understanding the soft budget constraint. Journal of Economic Literature, 41, 1095–1136. Kymlicka, W. (1998). Is federalism a viable alternative to secession? In P. B. Lehning (ed.), Theories of Secession, 111–150. Routledge. Larcinese, V., Rizzo, L., & Testa, C. (2006). Allocating the US federal budget to the states: The impact of the president. Journal of Politics, 68(2), 447–456. Lee, D. W., & Rogers, M. (2019). Inter-regional inequality and the dynamics of government spending. Journal of Politics, 81(2), 487–504. León, S. (2011). Who is responsible for what? Clarity of responsibilities in multilevel states: The case of Spain. European Journal of Political Research, 50(1), 80–109. Madison, J. (1961 [1787]). Federalist 10. In A. Hamilton, J. Jay, & J. Madison (eds), The Federalist: A Commentary on the Constitution of the United States, 53–61. Random House. Marlow, M. L. (1988). Fiscal decentralization and government size. Public Choice, 56(3), 259–269. Martinez-Vazquez, J., & Timofeev, A. (2010). Choosing between centralized and decentralized models of tax administration. International Journal of Public Administration, 33, 601–619. McLure, C. (2000). Tax assignment and subnational fiscal autonomy. Bulletin for International Fiscal Documentation, December, 626–635. Mikesell, J. (2007). Developing options for the administration of local taxes: An international review. Public Budgeting and Finance, 27(1), 41–68. Montinola, G., Qian, Y., & Weingast, B. (1995). Federalism, Chinese style: The political basis for economic success in China. World Politics, 48(1), 50–81. Mueller, D. C. (2003). Public Choice III. Cambridge University Press. Musgrave, R. A. (1959). The Theory of Public Finance. McGraw-Hill. Musgrave, R. A. (1983). Who should tax, where and what. In C. E. McLure, Jr. (ed.), Tax Assignment in Federal Countries, 2–19. Centre for Research on Federal Financial Relations, Australian National University. O’Donnell, G. (1999). Counterpoints: Selected Essays on Authoritarianism and Democratization. University of Notre Dame Press. O’Neill, K. (2005). Decentralizing the State. Cambridge University Press. Oates, W. E. (1972). Fiscal Federalism. Harcourt Brace Jovanovich. Oates, W. E. (1985). Searching for the Leviathan: An empirical study. American Economic Review, 75(4), 748–757. Oates, W. E. (1999). An essay on fiscal federalism. Journal of Economic Literature, 37, 1120–1149. Oates, W. E. (2005). Toward a second-generation theory of fiscal federalism. International Tax and Public Finance, 12(4), 349–373. Olson, M. (1969). The principle of ‘fiscal equivalence’: The division of responsibilities among different levels of government. American Economic Review, 59(2), 479–487.

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PART II COMPARATIVE TAX POLITICS B: CURRENT DEBATES

11. A race to the bottom? The politics of tax competition Hanna Lierse

1. INTRODUCTION Has the globalization of the economy, particularly of capital markets, brought about a race to the bottom? There is the widespread view that globalization has made it difficult to tax multinational corporations and wealthy households. And in fact, the opening of borders has increased the opportunities for tax avoidance particularly for large firms and rich individuals which tend to own large shares of financial capital (OECD, 2014). They can move abroad, shift their profits, or hide their financial assets in tax havens. Modern technology has made it even simpler to move funds to undeclared bank accounts offshore. Some estimations suggest that 40 percent of multinational profits are shifted to tax havens each year globally (Tørsløv et al., 2020). The political science literature on tax competition deals with the influence of globalization on the national tax state (Basinger & Hallerberg, 2004; Genschel, 2002; Genschel & Schwarz, 2011; Lierse & Seelkopf, 2016; Swank, 2002). It theorizes about and empirically questions to what extent the internationalization of the economy restricts governments’ ability and willingness to tax capital. The main idea is that during times of closed economies, governments levy taxes according to the wishes and demands of their domestic electorate. Empirically, this is often compared to the post-war period until the 1980s even though national governments were integrated in an international order of free trade and investments. Yet, governments controlled capital markets to avoid speculative flows (Ruggie, 1982). This allowed them to pursue progressive and redistributive tax policies while engaging in a global and liberalized system of international trade. However, since the collapse of the Bretton Woods system, the world economy is characterized not only by decreasing trade barriers but also by a reduction of capital controls (Kose et al., 2009). The liberalization of capital markets fueled the old debate about the effect of globalization on the autonomy of the tax state. In the context of economic openness including financial openness, financial assets can be moved and hidden in low-tax regions. The economic baseline model of tax competition suggests that capital openness brings about a downward pressure on taxes, particularly on direct taxes (Zodrow & Mieszkowski, 1986). If neighboring governments offer more beneficial tax conditions, capital is likely to be moved to these low-tax regions as investments become more profitable. Then governments start undercutting each other’s taxes on high incomes and capital in the hope to attract financial capital for investments and growth. Engaging in such a competitive tax game can undermine the fiscal autonomy of national governments as they adjust taxes according to international capital requirements rather than to the preferences of the domestic voters. Figure 11.1 provides an overview of the co-evaluation of capital market openness and tax competition measured in terms of the average top corporate income tax rate. The top corporate 166

A race to the bottom?  167

Source:

Own illustration based on Chinn and Ito (2008) and Tax Foundation (2019).

Figure 11.1

Financial globalization and global average corporate tax rates for up to 251 sovereign states and dependent territories, 1980–2019

tax rate is commonly used as an indicator for tax competition as it sets an important signal for the tax burden placed on capital owners. Figure 11.1 shows that corporate tax rates were cut by about half from an average of over 40 percent in the 1980s to a little over 20 percent nowadays. Although this is a considerable cut, it is far from the predicted zero tax on capital. Moreover, capital tax cuts are far from homogenous between countries. Some countries such as the United Arab Emirates have maintained high tax rates of 55 percent, while others such as Switzerland apply a rate of less than 10 percent and again others such as the Bahamas and Cayman Islands do not tax corporations at all. Political science contributions started to focus on the conditions, which constrain the initially predicted race to the bottom. They adopted a more nuanced focus and investigated to what extent factors such as party politics, institutions, and the size of countries mitigate the pressures stemming from capital market liberalization (e.g. Basinger & Hallerberg, 2004; Genschel et al., 2016; Hays, 2009; Quinn & Shapiro, 1991). It is the goal of this chapter to give an overview of the main analytical perspectives on tax competition in the comparative political science literature and to provide empirical insights. Although tax competition can occur at different levels, i.e. between regions, states or within states, the main focus of this chapter is on national tax responses to international capital markets. Moreover, it does not deal with international cooperation and harmonization initiatives, which could offset the competitive game. This is done by Hearson and Rixen and Crasnic and Hakelberg in this volume. The following section summarizes the main analytical contributions before Section 3 provides some descriptive insights.

2.

ANALYTICAL PERSPECTIVES

How does globalization affect the autonomy of the domestic tax state? The literature on tax competition deals with this question, which is mostly centered on the advanced democratic

168  Handbook on the politics of taxation societies of the Organisation for Economic Co-operation and Development (OECD) (Garrett & Mitchell, 2001; Genschel, 2002; Genschel & Schwarz, 2011; Swank & Steinmo, 2002; Wilson, 1991). The early models of tax competition are in line with the economic baseline model (Zodrow & Mieszkowski, 1986). They suggested that an increasingly integrated global economy brings about tax competition and undermines governments’ ability to maintain high progressive taxes, particularly on capital. Others instead argued that governments are able to maintain or even increase (redistributive) taxes under conditions of liberalized capital markets. Later studies take on a middle way and focus on how a number of political and economic variables mitigate the competitive downward constraint. In this section, different arguments and mechanisms of causality are introduced and discussed before the next section provides empirical evidence. 2.1

The Early Debate on Tax Competition

Traditionally, the literature on tax competition originates from a structural power argument. That is, governments conduct policies in the financial interest of capital owners not because these groups lobby for such reforms but because states depend on the private sector to invest and to generate growth, employment, and prosperity. Firms and capital owners respond to government policies by changing their investment decisions to be most profit maximizing, which can have aggregate economic consequences (for an overview see Genschel & Schwarz, 2011; Wilson, 1991). If governments anticipate that a reform reduces investment, they are likely to withdraw from such decisions to avert those undesirable consequences. This structural power of capital increases with capital market openness. Now investors can freely choose the most profitable country and easily exit a jurisdiction that implements unfavorable e.g. high tax policies. Following such a structural account, scholars initially predicted that globalization would lead to a competitive race to the bottom leading to the zero taxation of capital (Zodrow & Mieszkowski, 1986). When investors can freely choose whether to invest in country A or B, they choose the one with the lower tax rate to capitalize on higher returns on investment. Consequently, governments have the incentive to undercut each other’s tax rates to attract capital from abroad. After all, by offering lower taxes than competing countries, they can lure international investments in the hope that this brings about economic prosperity. This strategy of undercutting each other ultimately leads to a race to the bottom, where businesses and capital will be taxed zero. Hence the early debate on tax competition was heavily centered on the idea that the openness of capital markets would lead to a competitive race to the bottom, in which governments stop taxing capital and businesses. As such tax competition would restrict the ability of national governments to apply redistributive policies in the light of global capital markets (Andrews, 1994; Cerny, 1994; Frieden, 1991; Rodrik, 1997). Global capital markets serve as an undisputed international constraint on the policy choices of governments. While the baseline model of tax competition is based on a structural account of power, more recently, scholars have also highlighted the political or instrumental power of economic elites, i.e. business groups and wealthy individuals (Bartels, 2008; Emmenegger & Marx, 2019; Fairfield, 2015; Gilens, 2012; Hacker & Pierson, 2010; Klitgaard & Paster, 2019). While these accounts do not contradict each other, the latter place more attention to the agency of capital owners, who push for and actively lobby for such policies (Fairfield, 2015). This is analytically distinct from the traditional account of tax competition, which highlights the structural

A race to the bottom?  169 constraints and takes governmental responses as predetermined without investigating the strategies and arguments of capital owners and business groups. The economic baseline model of tax competition has been heavily criticized, above all, because there was not enough empirical evidence to support the race to the bottom (see also Figure 11.1). In fact, supporters of the compensation school even argued that national governments were able to compensate losers from globalization. They had observed that particularly small and open economies tended to have larger governments in terms of public revenue (Garrett, 1995; Hallerberg & Basinger, 1998; Hays, 2009; Quinn & Shapiro, 1991). From this, they concluded that globalization does not pose a threat to the domestic tax state but that globalization can only go forward if the majority of voters benefit from the changes associated with more open economies. Thus, governments are likely to increase or adjust their public policies to compensate those who lose from globalization. This line of thought does not predict that globalization leads to a race to the bottom, but rather that domestic tax responses address the newly arising societal challenges that come with globalization. A different answer to the observed cross-national variation was that the incentives to compete vary with country size (Keen & Konrad, 2012; Wilson, 1991). Small states can gain from tax competition. They can offset the revenue losses stemming from tax cuts by poaching larger amounts of foreign tax revenue from the larger states. As such, engaging in tax competition can be welfare enhancing for the small states. Large states, by contrast, lose in welfare terms. They cannot sufficiently offset the revenue losses from a tax cut by luring more foreign capital from smaller states to their jurisdiction. According to this logic, we should expect small countries to engage in aggressive tax competition but not large ones. Indeed, tax havens are generally small. But not all small countries adopt low-tax strategies. And not all large countries keep high capital taxes even though economic theory predicts low international competitive pressure (Genschel et al., 2016). In sum, the early debate on tax competition was very much divided into two viewpoints: either an inevitable race to the bottom would take place, particularly for small states, or governments were able to fully compensate the newly emerging structural constraints emanating from capital market liberalization. Succeeding studies were more nuanced arguing for a middle way and trying to account for different mitigating factors. 2.2

Successors: A More Nuanced Middle Way

Following the first very deterministic wave of political science literature on tax competition, political scientists started to adopt more contextual approaches. While broadly accepting that capital market openness enhances the structural pressure for competitive tax cuts, they also highlighted a number of mitigating factors such as the political, institutional, and socio-economic variables that prevented the zero taxation of capital. I will briefly summarize the main propositions and findings. As regards political factors that mitigate the race to the bottom, the ideology of the political party in power, the organizational power of trade unions, as well as upcoming elections have been highlighted (Basinger & Hallerberg, 2004; Hays, 2009; Plümper et al., 2009). Building on the main idea of the power resource theory (Esping-Andersen, 1990; Hibbs, 1977; Korpi, 1983), scholars suggested that incumbency of different parties matters also during times of capital market liberalization. Left-wing parties still conduct policies in the interest of their electorate, low- and middle-wage earners, who are the main beneficiaries of progressive taxes

170  Handbook on the politics of taxation (Lierse, 2012; Quinn & Shapiro, 1991). By contrast, liberal and conservative parties are less supportive of such taxes as their electorate is the main financial contributor to these. Similarly, strong trade unions and corporatist decision making is likely to counter-balance the power of capital owners. Also, different factors from a new institutional perspective have been highlighted as restricting tax competition. For instance, veto players and regime type have proven important (Basinger & Hallerberg, 2004; Genschel et al., 2016). First, a higher number of veto players or a higher ideational distance between veto players make policy change generally more difficult. Second, with regards to regime type, democratic governments are institutionally constrained to be sensitive to the welfare implications of their tax policies. Hence, they tend to cut taxes if their country is small enough to potentially profit from tax competition and they tend to keep rates up (or cut them by less) if their country is large. Autocratic governments, by contrast, have fewer incentives to adjust to their competitive environment because their governments are less concerned about the general welfare of their populations. Finally, a number of socio-economic indicators have been listed as having a mitigating effect on tax competition. The main idea is intuitive: the higher the public debt or deficit, the less likely are governments to cut taxes, as it would create a financial void. For instance, the reduction of tax revenue is not necessarily an option given high levels of spending and debt (Genschel, 2002). Also Swank and Steinmo (2002) find that higher public debt is significantly associated with higher corporate tax rates. Others show that the impact of the financial crisis led to the increase of several taxes (Lierse, 2012; Lierse & Seelkopf, 2015). However, direct taxes were less likely to be raised. Overall, a number of different factors have been highlighted that condition the impact of capital market openness. Besides political and institutional factors, also other socio-economic pressures such as high public debt and deficits can have a positive influence on capital taxes. In sum, political science scholars have extensively built on and contributed to the baseline model of tax competition. The majority of studies, with the exception of those following the compensation school, accept the assumption that financial liberalization has constrained the ability of governments to levy taxes on corporations and capital. However, this does not imply that it leads to a race to the bottom including the zero taxation of capital. In fact, most governments have actively compensated corporate tax rate cuts with base-broadening measures at least in the field of corporate taxation. Yet, tax rate cuts have also occurred for high personal incomes as well as for net wealth and inheritance, which have largely been neglected in the tax competition literature. However, as wealth is mostly of a financial nature in the top of the wealth distribution, these taxes are subject to similar or possibly even more extreme pressure from financial liberalization, as will be discussed in the following section.

3.

EMPIRICAL EVIDENCE

How can we gauge the extent to which tax competition has undermined the autonomy of the national tax state? This section does not systematically test the influence of capital market liberalization and the role of the previously discussed mitigating factors on corporate tax rates. Instead the objective is to provide some descriptive insights into the evolution of direct taxes, particularly those on high incomes, capital, and wealth, in contrast to indirect ones. If tax competition has constrained the national tax state, we should find a comparatively higher decline of taxes on capital and wealth in comparison to wage and consumption taxes. In con-

A race to the bottom?  171 trast to indirect taxes, direct taxes are not only a key instrument to redistribute from high- to low-income groups, but they also tend to be more highly mobile. As with corporate profits, wealth at the top of the wealth distribution tends to be of a financial nature and as such can be highly mobile and moved to low-tax jurisdictions (OECD, 2014). In a first step, this section provides a global overview of the evolution of corporate income taxes by gauging similarities and differences between continents over time. In a second step, the analysis is restricted to advanced industrialized democracies as more differentiated data exist for this region. This allows us to better understand how and to which extent direct taxes are constrained by economic globalization. Most scholars focus on the transformation of top marginal tax rates on corporate incomes to illustrate the effect of tax competition (e.g. Ganghof & Genschel, 2008; Genschel, 2002; Hallerberg & Basinger, 1998; Lierse & Seelkopf, 2016; Swank & Steinmo, 2002). The corporate income tax is a key component of modern tax systems and one of the primary ways of taxing capital. It tends to generate a rather high share of revenue (see Figure 11.4) while their tax bases are highly mobile as (financial) profits can easily be shifted across borders. Figure 11.2 illustrates the evolution of effective corporate income tax rates across the world since the 1980s. It shows that top tax rates have declined all over. Yet, in some areas, particularly in Europe, the decline has been particularly pronounced. Here the average rates were cut from about 40 to 18 percent. Similarly, drastic cuts occurred in Asia and North America, while average changes were less radical in Africa and South America. Regional differences can be due to a number of mitigating economic, political, and institutional factors, discussed in Section 2. Different than corporate income taxes, wealth taxes such as the net wealth and the inheritance taxes have received less attention from the tax competition literature. However, the steadily rising wealth gap between the rich and the poor has resparked the interest in wealth taxes (Emmenegger & Marx, 2019; Lierse, forthcoming; Scheve & Stasavage, 2012, 2017). Different than income taxes, they are not levied on the flow of money, but on the stock. However, they also form part of the direct tax category. Net wealth and inheritance can be moved to low-tax regions and thus be avoided while this exit option is largely unavailable to consumption and low incomes.

Source:

Own illustration based on OECD (2019) and Tax Foundation (2019).

Figure 11.2

Corporate income tax rate by continent, 1980–2019

172  Handbook on the politics of taxation Figure 11.3 illustrates the development of different marginal tax rates since the 1980s on OECD average. While (b) shows the tax rate trajectories on high incomes and capital, the focus of (a) is on low incomes and consumption taxes. It demonstrates that the top tax rates for high incomes, wealth, and capital were drastically lowered in all categories. For instance, the corporate income tax rate was almost halved from an OECD average of a little over 40 and the top personal income tax rate from 58 to about 40 percent. Similarly, the inheritance and the net wealth tax rates are about half the levels nowadays in comparison to the 1980s. In sum, Figure 11.3b suggests a drastic decline of the tax burden on high incomes and capital since the 1980s. In fact, several countries have not only cut direct taxes, but they have completely abolished their inheritance and net wealth taxes. In Europe, there are only three countries left with a net wealth tax (OECD, 2018). In Figure 11.3a, we can compare this development to the tax rates levied on low incomes and consumption, two taxes with immobile tax bases. Here the tax rates have risen as demonstrated by the value-added tax rate, or remained stable in the case of the tax rate on low incomes. In sum, Figure 11.3 suggests that direct taxes have experienced a considerable decline in comparison to taxes on low incomes and consumption.

Source:

Own illustrations based on OECD (2019).

Figure 11.3a Trajectories of tax rates on immobile factors, low income and consumption, OECD averages 1980–2019

Source:

Own illustrations based on OECD (2019).

Figure 11.3b Trajectories of tax rates on mobile factors, corporate and high incomes, OECD averages 1980–2019

A race to the bottom?  173 The focus on tax rates and their development over time certainly suggests that tax competition has taken place. While not leading to the predicted zero taxation on capital, the gradual opening of capital markets since the 1980s has brought about competitive tax cuts. Moreover, in the field of wealth taxes, we can in fact observe a trend towards zero taxation. Although net wealth taxes have never been widely spread, with the exception of three countries (Spain, Norway, and Switzerland), they have been completely abolished. Also, inheritance taxes have been repealed in several countries including Austria and Sweden. Yet, the literature has also pointed out that governments have compensated tax rate cuts by broadening the tax base (Genschel & Schwarz, 2011). For instance, it is possible to compensate a tax rate cut by including more and different forms of capital incomes into the calculation of the tax base or by allowing for fewer tax deductions and exemptions. In this manner, they can compensate revenue losses and still raise similar amounts of tax revenue from capital incomes. Figure 11.4 shows the evolution of tax revenue as a percentage of total taxes. It shows that direct tax revenue, including the personal and corporate income and property taxes, has increased from 45 to 50 percent, revenue from consumption taxes and social security contributions increased from 55 to 60 percent. Although this finding is in line with the main tax competition arguments, it also shows that while revenue from property and personal income slightly decreased, revenue from corporate income went up at the beginning of the 2000s. The latter can suggest that governments still raise substantial amounts of corporate taxes and even more so during the 1960s and 1970s. The revenue increase can be caused either because governments actively broadened the tax base or because there was simply more corporate income, which allowed the generation of more revenue despite lower taxes. Similarly, it is possible that revenue from social security increased not because people had to pay higher rates, but because more people started contributing. Overall, Figure 11.4 provides only mild support in favor of the race to the bottom prediction.

Source:

OECD Tax Database (2019).

Figure 11.4

Tax structure in the OECD, revenue by tax type as a percentage of total taxes

174  Handbook on the politics of taxation Overall, the descriptive evidence shows that governments have cut tax rates for wealthy individuals and international corporations since the 1980s. Yet, the revenue stemming from these sources has not declined to the same extent and variation in terms of national tax rates has remained high. An exception is wealth taxes. Here tax rates have not only been cut, but many advanced democracies have abolished them altogether without compensating this with tax base-broadening measures. While domestic factors, i.e. institutions, party politics, and the socio-economic context, condition the extent to which governments engage in competitive tax cuts, the overall evidence suggests that tax competition is a challenge for the national tax state. While the initially predicted race to the bottom has not taken place in income taxes, globalization is making it increasingly difficult for national governments to tax corporations and the rich.

4.

CONCLUDING REMARKS AND OUTLOOK

This contribution has discussed the political science literature on tax competition. Tax competition refers to the attempt of governments to undercut each other’s tax standards to lure investments and capital. The academic debate was resparked in the 1980s, when capital controls were largely removed between countries. It allowed for people and business to freely decide where and how to invest their capital. The early tax competition literature assumes that governments would react by offering ever lower tax rates to corporations and capital owners including its zero taxation. However, the predicted race to the bottom did not occur as had been hypothesized. Political scientists started to uncover different conditions, which mitigate the downward pressure. Besides country size, the role of government partisanship, and institutions, along with high deficit and debt levels tend to increase the pressure for higher taxes including capital and corporation taxes. Interestingly, the focus of the tax competition literature has been on income taxes, mostly on corporate income taxes. However, recently the decline of wealth taxes is also gaining scholarly attention. Different from the early tax competition literature, the analytical focus in this context is on the active lobbying and pushing for tax cuts by economic elites. Although they do not contradict one another, the assumptions about the causal mechanisms leading to the tax cuts differ. In the tax competition literature, the structural power of capital is taken for granted and governments react to the opening of capital markets with tax cuts without capital owners having to actively lobby for such. This is different in the newer literature, which is interested in the actual strategies and argument of business groups and wealthy individuals. This brings me to a few avenues for future research, which I conceive as important contributions that lie ahead. Future contributions should include, first, adjustments in the main dependent variables, that is, the kind of tax policy we look at and how we measure tax change and, second, further extensions in exploring the factors driving and mitigating tax competition. I will briefly discuss these outlooks. First, we need to better understand compensatory measures and linkages to other tax policies. The traditional focus on corporate income taxes is understandable as it is a major tax in terms of tax revenue stemming from corporations and capital. Yet, the restricted focus might also blur our understanding of tax competition. Governments are highly dependent on this source of revenue and hence need to compensate tax rate cuts with base-broadening measures. But do governments compensate tax rate cuts in other policy areas, and if so, how?

A race to the bottom?  175 For instance, in terms of personal income taxes, it is possible that a tax cut on high incomes is compensated either by restricting tax exemptions for this group or by increasing the tax burden for lower and middle classes (von Haldenwang et al., this volume). Similarly, it is unclear if and how compensatory measures take place for wealth taxes. Possibly governments have introduced new or increased other taxes such as the property tax on immoveable real estate or on capital gains. Such shifts will certainly also change the existing distribution of the tax burden in favor of certain groups. More research is however needed to uncover if and how compensatory measures are taking place. This can be done by including also financially less significant policies and by collecting data on exemptions and deductions. Second, it will become necessary to broaden the analytical focus in a few respects. This can be done by better understanding the key independent variables, particularly the linkage between the instrumental and the structural power by capital owners and multinational corporations. While there is a large literature on the role of economic elites, for the most part it is not connected to the tax competition literature. But do economic elites increase their lobbying activities in the context of financial market liberalization or does a general societal shift occur so that they do not have to actively push for policies in their interest? Moreover, most of the analytical arguments and the empirical evidence is tailored to advanced democratic societies, ignoring common and particular patterns and challenges faced by developing countries. Lastly, several interesting changes are taking place in the socio-economic context, which can enforce or mitigate competitive tax cuts. For instance, the digitization of the economy can facilitate monitoring and tax compliance for financial wealth and capital incomes. Alternatively, it can also provide new opportunities and means for multinational corporations and investors to shift profits and avoid taxes (see Christensen & Lips, this volume). As such, the tax competition literature, which is a relatively established field of research, keeps us moving and curious about new developments.

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176  Handbook on the politics of taxation Garrett, Geoffrey, & Mitchell, Deborah (2001). Globalization, government spending and taxation in the OECD. European Journal of Political Research, 39, 145–177. Genschel, Philipp (2002). Globalization, tax competition, and the welfare state. Politics and Society, 30(2), 245–275. Genschel, Philipp, Lierse, Hanna, & Seelkopf, Laura (2016). Dictators don’t compete: Autocracy, democracy, and tax competition. Review of International Political Economy, 23(2), 290–315. Genschel, Philipp, & Schwarz, Peter (2011). Tax competition: A literature review. Socio-Economic Review, 9(2), 339–370. Gilens, Martin (2012). Affluence and Influence: Economic Inequality and Political Power in America. Princeton University Press and Russell Sage Foundation. Hacker, Jacob S., & Pierson, Paul (2010). Winner-take-all politics: Public policy, political organization, and the precipitous rise of top incomes in the United States. Politics and Society, 38(2), 152–204. Hallerberg, M., & Basinger, S. J. (1998). Internationalization and changes in tax policy in OECD countries: The importance of domestic veto players. Comparative Political Studies, 31, 321–352. Hays, Jude C. (2009). Globalization and the New Politics of Embedded Liberalism. Oxford University Press. Hibbs, D. A. (1977). Political parties and macroeconomic policy. American Political Science Review, 71(4), 1467–1487. Keen, M., & Konrad, K. A. (2012). The theory of international tax competition and coordination. Working Paper July, 6. Klitgaard, Michael Baggesen, & Paster, Thomas (2019). How governments respond to business demands for tax cuts: An analysis of corporate and inheritance tax reforms in Austria and Sweden. Minda de Gunzburg Center for European Studies Harvard Open Forum Working Paper Series, 1–32. Korpi, Walter (1983). The Democratic Class Struggle. Routledge and Kegan Paul. Kose, M. Ayhan, Prasad, Eswar, Rogoff, Kenneth, & Wei, Shang-Jin (2009). Financial globalization: A reappraisal. IMF Staff Papers, 56(1), 8–62. Lierse, Hanna (2012). European taxation during the crisis: Does politics matter? Journal of Public Policy, 32(3), 207–230. Lierse, Hanna (forthcoming). Globalisation and the societal consensus of wealth tax cuts. Journal of European Public Policy. Lierse, Hanna, & Seelkopf, Laura (2015). Capital markets and tax policy making: A comparative analysis of European tax reforms since the crisis. Comparative European Politics, January 26. Lierse, Hanna, & Seelkopf, Laura (2016). Room to maneuver? International financial markets and the national tax state. New Political Economy, 21(1), 145–165. OECD (2014). How does the concentration of household wealth compare across countries? In In It Together: Why Less Inequality Benefits All, 239–290. OECD Publishing. OECD (2018). The Role and Design of Net Wealth Taxes in the OECD. OECD Publishing. OECD (2019). OECD tax database. www​.oecd​.org/​tax/​tax​-policy/​tax​-database/​ (accessed May 17, 2021). Plümper, Thomas, Troeger, Vera, & Winner, Hannes (2009). Why there is no race to the bottom in capital taxation. International Studies Quarterly, 53, 761–786. Quinn, Dennis P., & Shapiro, Robert Y. (1991). Economic growth strategies: The effects of ideological partisanship on interest rates and business taxation in the United States. American Journal of Political Science, 35(3), 656–685. Rodrik, Dani (1997). Has Globalization Gone Too Far? Institute for International Economics. Ruggie, John Gerard (1982). International regimes, transactions, and change: Embedded liberalism in the postwar economic order. International Organization, 36(2), 379–415. Scheve, Kenneth, & Stasavage, David (2012). Democracy, war, and wealth: Evidence from two centuries of inheritance taxation. American Political Science Review, 106(1), 82–102. Scheve, Kenneth, & Stasavage, David (2017). Wealth inequality and democracy. Annual Review of Political Science, 20(1), 451–468. Swank, Duane (2002). Global Capital, Political Institutions, and Policy Change in Developed Welfare States. Cambridge University Press. Swank, Duane, & Steinmo, Sven (2002). The new political economy of taxation in advanced capitalist democracies. American Journal of Political Science, 46(3), 642–655.

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12. Taxation and inequality Julian Limberg

1. INTRODUCTION Inequality is omnipresent. Already before Thomas Piketty’s bestselling book (Piketty, 2014), a fruitful academic debate about the causes and consequences of socio-economic inequality had emerged (Bartels, 2005; Hacker & Pierson, 2010; Lupia et al., 2007; Pontusson & Rueda, 2010). Inequality-reducing policies have even made their way back into political mainstream discussions (Casselman & Tankersley, 2019; Zeit, 2019). However, not all policy tools possess equal potential to limit inequality. Since income and wealth concentration lie at the heart of inequality dynamics nowadays, classical social policy measures only possess limited redistributive capacity. Instead, tax policies promise to be powerful political instruments to tackle soaring levels of inequality. Based on these considerations, I revisit the link between taxation and inequality. In particular, I focus on tax policies as national policy tools.1 In order to understand the complex relation between national tax policies and inequality, I first provide an overview on the redistributional impact of taxes. I differentiate between three dimensions of inequality: overall within-country inequality, income concentration at the top, and global interpersonal inequality. Furthermore, I discuss and present correlational evidence for how taxes can affect each of these three inequality dimensions: taxation can provide the funding base for redistributive welfare states, it can reduce income concentration at the very top, and it can foster international economic convergence by boosting global market integration. In the second part of the chapter, I investigate the drivers of tax policies (see also Kemmerling and Truchlewski, in this volume). More precisely, I examine the literature which deals with the impact of rising inequality on redistributive taxation. I start by sketching the highly influential median voter theory (MVT) (Meltzer & Richard, 1981). The fundamental point of MVT is that inequality induces redistribution. However, as I show afterwards, empirical support for this theoretical economic model is scarce. Only a few studies find evidence for thermostatic inequality dynamics. I corroborate these findings by looking at tax policy making for a global country sample over three decades. Neither do changes in inequality lead to subsequent hikes in top income tax rates, nor does overall revenue extraction (and thus the funding basis for the welfare state) increase. The limited explanatory power of MVT is the starting point for the third part of this chapter. Why does the easy, intuitive, and plausible assumption of the MVT fail to hold up to empirical scrutiny? I discuss three potential explanations that may account for the missing responsiveness of tax policies to inequality: unequal political representation, information asymmetries about inequality, and varying individual perceptions of socio-economic outcomes. These approaches are deeply rooted in the political science literature. Therefore, they highlight the importance of political science for the analysis of tax policy making. Finally, the last section concludes by discussing avenues for further research on the taxation–inequality nexus. 178

Taxation and inequality  179

2.

REDISTRIBUTIVE TAXATION

Can tax policies reduce inequality? In this section, I revisit the literature on the (re)distributional effects of taxation. To disentangle the impact of tax policies on inequality, it is crucial to differentiate between (1) dimensions of inequality and (2) the basic functions that taxes can fulfil. Based on these considerations, we can identify how tax functions can affect specific dimensions of inequality. 2.1

Dimensions of Inequality

Inequality is a multifaceted phenomenon. In this chapter, I focus on economic inequality as one of the most prominent forms. However, it is important to keep in mind that inequality is not solely limited to the economic dimension. For instance, environmental inequality, gender inequality, health inequality, and political inequality are other important forms which have also been subject to academic interest (Bartley, 2016; Lorber, 2011; Pellow, 2000). Whilst these types of inequality reflect different fundamental dimensions of socio-economic life, they are strongly connected to economic inequality. In particular, scholars argue that an unequal distribution of economic means is likely to translate into other forms of inequality (Gilens & Page, 2014; Pickett & Wilkinson, 2015). We can differentiate between several facets of economic inequality. First, and in its most straightforward form, economic inequality reflects the overall distributional shape of economic resources in a given country. Predominantly, the distribution is measured via Gini coefficients. These are calculated based on the overall dispersion of income (either disposable or market income). Gini coefficients range from 0 to 100 and show the percentage of income that needs to be redistributed in order to achieve a perfectly equal income distribution. Since these Gini coefficients are calculated for each country individually, they measure so-called within-country inequality. The top left panel in Figure 12.1 shows the development of inequality measured via the Gini coefficient of disposable market income in 192 states around the world from 1980 to 2010. On average, we can see that within-country inequality has increased in the last decades (Solt, 2016). Whilst the median Gini coefficient was 32 at the beginning of the 1980s, it stood at 40 in the 2000s. However, there are striking differences between countries. For example, inequality has increased remarkably in the United States (US). China and India have faced even stronger increases in Gini coefficients. To the contrary, Gini coefficients have stagnated or even decreased in some Latin American as well as in African countries (see e.g. Brazil and Kenya). Second, recent research has stressed the importance of top income shares for inequality (Atkinson & Piketty, 2010). In particular, skyrocketing top 1 per cent and top 0.1 per cent income shares have attracted much scholarly attention (Atkinson et al., 2011; Huber et al., 2017; Piketty & Zucman, 2014a; Volscho & Kelly, 2012). Some authors have argued that the extent to which income is concentrated at the very top is largely underestimated by conventional Gini coefficients (see e.g. Alvaredo, 2011). The reason for this is that most calculations of Gini coefficients rely on survey data. As these surveys often underreport top incomes, Gini coefficients are usually ‘more sensitive to transfers at the center of the distribution than at the tails’ (Alvaredo, 2011, p. 274). In contrast, top income shares are mainly based on tax return data. Hence, they provide useful additional insights into inequality dynamics within countries. One of the main findings is that the rise of top incomes reflects a fundamental shift in the

180  Handbook on the politics of taxation distribution of wealth. Scholars have pointed out that contemporary inequality dynamics are crucially driven by wealth concentration (Piketty, 2014; Piketty & Zucman, 2014a). As wealth becomes less dispersed, capital and income shares of the richest members of society increase (Atkinson, 2015; Atkinson et al., 2011). In other words, wealth inequality lies at the heart of (income) inequality nowadays. The top right panel in Figure 12.1 visualizes the trend in top income shares. The graph shows the development of income shares of the top 1 per cent for selected countries. Again, we can observe a general trend of rising inequality. China, India, and the US have experienced a strong increase in top income shares. In contrast, shares have been more stable in countries like Spain and Sweden.

Source: Data from Solt (2016), Alvaredo et al. (2018), and Darvas (2019).

Figure 12.1

Dimensions of inequality

Taxation and inequality  181 Finally, inequality can not only be measured within, but also across countries (Milanovic, 2016). Instead of calculating inequality measures – such as Gini coefficients – for each country alone, we can also measure so-called global interpersonal inequality. Here, all individual incomes are merged and a single Gini value for the overall distribution of income worldwide is calculated. Importantly, the development of global interpersonal inequality can differ from the development of within-country inequality. In fact, this is what we can observe empirically in the last decades (Figure 12.1, bottom panel). In contrast to rising within-country inequality, global interpersonal inequality has declined substantially (Darvas, 2019; Milanovic, 2016). Whilst in 1990, the global interpersonal Gini coefficient was around 67, it was only at 57 in 2015. This puzzling development is driven by catching-up dynamics of poorer countries (Sala-i-Martin, 1996). For instance, although inequality in China and India increased considerably, high levels of economic growth caused a rise in the general income levels in these countries.2 In other words, economic convergence has overcompensated dynamics of within-country inequality. As a consequence, overall interpersonal wage dispersion worldwide has decreased (Darvas, 2019). 2.2

How Taxation Affects Inequality

How might national tax policies affect these different dimensions of inequality? Again, let us start with overall within-country inequality measured via Gini coefficients. Two of the major redistributive tools are social security transfers and social insurance programmes (Esping-Andersen, 1990; Flora, 1983). In other words, generous welfare states are crucial for reducing inequality (see e.g. Korpi & Palme, 1998). Social policy programmes can induce both pre- and redistribution by smoothening the income distribution at the lower end as well as at the centre. However, welfare states are expensive. A sufficient funding base is an essential prerequisite for social policy programmes. This is where tax policy enters (Haffert, in this volume; Kemmerling & Truchlewski, in this volume). Modern taxation can help to expand the funding base of the welfare state whilst keeping the overall tax structure fairly efficient (Ganghof, 2006b; Helgason, 2017; Wilensky, 2002). Hence, the fiscal function of taxes may help to reduce inequality. The top left panel in Figure 12.2 exemplifies this by plotting public revenues as a percentage of gross domestic product (GDP) against Gini coefficients. On average, countries with a higher tax take have lower levels of inequality. Importantly, this is just correlational evidence. Nevertheless, it is in line with previous studies which have found that fiscal capacity can indeed reduce inequality (see e.g. Coady & Gupta, 2012). Second, progressive taxes can reduce inequality at the very top by putting a higher tax burden on top incomes. The top right panel in Figure 12.2 gives an example for this by plotting top personal income tax (PIT) rates against top 1 per cent income shares. The observable pattern is in line with previous research that has found a negative effect of top income tax rates on top income shares (Bargain et al., 2015; Huber et al., 2017; Scheve & Stasavage, 2019). However, progressive income taxation is not the only tax policy instrument that can influence income concentration. Recently, scholars have pointed out that contemporary inequality dynamics are driven by wealth concentration (Piketty, 2014; Piketty & Zucman, 2014a, 2014b). As wealth becomes less dispersed, capital and income shares of the richest members of society rocket (Atkinson, 2014; Piketty & Zucman, 2014a). In other words, wealth inequality lies at the heart of (income) inequality nowadays. Therefore, levying taxes that directly fall onto wealth (e.g.

182  Handbook on the politics of taxation

Source: Data from ICTD/UNU-WIDER (2019), Solt (2016), Alvaredo et al. (2018), Peter et al. (2010), Seelkopf et al. (2019), and Genschel and Seelkopf (2019).

Figure 12.2

Tax policy making and dimensions of inequality

net wealth taxes, inheritance taxes, and property taxes) is another approach to reduce income concentration. Finally, taxation can help to reduce global interpersonal inequality. Global market integration is one of the main determinants of economic catch-up processes (Villaverde & Maza, 2011; Williamson, 1996). Modern taxes can help to increase the degree to which a country is integrated into global market structures. Historically, the expansion of income taxation has enabled countries to slash tariffs and open up domestic markets (Seelkopf et al., 2016). In the last decades, the global diffusion of value-added tax (VAT) has helped to globalize economies

Taxation and inequality  183 further (James, 2015). For instance, Haffert and Schulz (2020) show that the introduction of VAT in the European Economic Community was driven by the idea to intensify the integration of the single market. In sum, taxation can help to reduce global inequality by fostering economic globalization. The bottom panel in Figure 12.2 underlines this by showing the level of economic integration for a global country sample in relation to the year in which a respective country introduced VAT. Prior to VAT uptake, general levels of economic globalization increased slowly, yet steadily. However, after VAT introduction, economic globalization paced up considerably.

3.

DOES INEQUALITY DRIVE TAX POLICY MAKING?

As the previous section has shown, tax policies can affect inequality in various ways. By and large, most authors agree that taxes can be powerful policy tools to tackle inequality. This provokes an inevitable follow-up question: do governments use tax policies when facing increasing inequality? Or, in other words, do inequality dynamics drive tax policy making? The effect of inequality on redistributive policies is a passionately debated topic. Much of the scientific interest is rooted in the puzzling limited explanatory power of MVT. MVT is the workhorse model for studying the politics of redistribution (Meltzer & Richard, 1981). Originally developed by economists, many political scientists have made MVT the theoretical focal point of their analysis (Bartels, 2008; Iversen & Soskice, 2006; Scheve & Stasavage, 2017). In its essence, it expects redistributive effort to increase when inequality rises. With regard to tax policies, MVT therefore posits that higher inequality expands redistribution via taxation. MVT’s starting point is that income distribution is right-skewed. Hence, the median income lies below the mean income. All else equal, democratic institutions would enable the person with the median income (the median voter) to support redistributive taxation until the median income equals the mean income. Thus, rising inequality should increase the median voter’s support for redistributive taxation. Although the model has been constructed to explain policy making in countries with democratic institutions, some authors have also used it to explain developments in autocracies – particularly in those that might fear democratization (Acemoglu & Robinson, 2006; Boix, 2003). However, MVT is empirically contested (Ansell & Samuels, 2014; Iversen & Soskice, 2006; Moene & Wallerstein, 2003). Many studies that analyse the impact of inequality on redistributive taxation focus on the micro level (Berens & Gelepithis, in this volume). Most empirical analyses do not find a connection between levels of inequality and demand for redistribution (Kenworthy & McCall, 2008). Looking at 26 countries in the Organisation for Economic Co-operation and Development (OECD), Lübker (2007) does not find support for MVT either, whereas Finseraas (2009) does identify a positive correlation between inequality and redistributive preferences. Instead of investigating general redistributive demand, some studies have focused on specific preferences for tax policies (Barnes, 2015). Berens and Gelepithis (2018) do not find a higher demand for progressive taxation in countries that are more unequal. Looking at preferences for tax progressivity after the financial crisis of 2009, Limberg (2020) does not find an effect of income inequality on the demand for progressive taxation either. Schmidt-Catran (2016) fails to find an effect of the inequality level on redistributive demand at first. However, when changing the analyses from looking at cross-sectional variation to a design that looks at changes in inequality within countries, his results show support for MVT. Luttig (2013)

184  Handbook on the politics of taxation analyses the public mood for economic policies in the US and does not find a positive effect of rising inequality on political appetite for redistribution. In sum, empirical results on the micro level are mixed. For example, most analyses fail to find general support for MVT. However, some studies demonstrate that rising inequality might lead to a higher political appetite for redistributive taxation under specific institutional and societal scope conditions (Pontusson & Rueda, 2010; Rueda & Stegmueller, 2016). In contrast to the numerous micro-level studies, macro-level work on the effect of inequality on actual tax policy changes is scarce. In general, most studies have failed to detect a positive effect of rising inequality on redistributive tax policies (Bonica et al., 2013; Scheve & Stasavage, 2017). For example, Scheve and Stasavage (2019) do not find a general effect of inequality on tax progressivity when looking at tax policy making in rich democracies from 1900 to 2010. Limberg (2019) looks at top PIT rates worldwide from 2006 to 2014 and does not find an effect of inequality on tax policies either. In order to revisit whether inequality affects tax policy making, I run time-series cross-sectional data analyses. I use a worldwide country sample consisting of up to 143 states and covering the years 1981 to 2005. Based on the discussion about the redistributive impact of taxation in Section 2.1, I operationalize taxation as my main dependent variable in two ways. First, as mentioned earlier, progressive taxation fulfils a direct redistributive function by placing a higher tax burden on richer individuals. One of the major facets of inequality is income differences (Atkinson et al., 2011). As a consequence, progressive income taxation has been a crucial policy tool for redistribution in the last 150 years (Scheve & Stasavage, 2016). To compare the progressivity of income tax systems cross-nationally as well as over time, most studies look at top marginal income tax rates (Ganghof, 2006a; Limberg, 2019; Scheve & Stasavage, 2010; Swank, 2016). In fact, top PIT rates are widely regarded as a suitable proxy for overall income tax progressivity (Scheve & Stasavage, 2016). Therefore, I use top marginal tax rates for personal income as one of my dependent variables. Data come from Peter et al. (2010). One of the advantages of top income tax rates is that they measure policy change directly. Whether a government decides to increase or decrease tax rates for top incomes is a highly visible indicator of redistributive policy making. However, this indicator also comes with some drawbacks. Most strikingly, countries might levy high tax rates on paper, but might lack the political will or the administrative capacity to collect them (Bastiaens, in this volume). In other words, we additionally need to look at a more comprehensive indicator for tax policies. Therefore, my second dependent variable is the overall tax take of a country as a percentage of GDP.3 This variable has the further advantage that it covers the capacity of states to tackle inequality via its fiscal function. The higher the overall tax take, the more possibilities states have to expand social security coverage and generosity. Data on revenue come from the Government Revenue Dataset (ICTD/UNU-WIDER, 2019). Since I am interested in whether inequality has an impact on tax policy change, I take the first difference of each dependent variable. This approach also reduces unobserved country heterogeneity. My main independent variable is the change in inequality. Here, I take the Gini coefficient for disposable income to measure inequality.4 I choose disposable rather than market income inequality because of its compatibility with MVT: in principle, citizens should be less concerned about hypothetical market inequality and instead make political decisions based on how much money ends up in their pockets. I lag the change in the Gini coefficient by one year to allow for a time lag in tax policy making and to reduce potential endogeneity

Taxation and inequality  185 bias. Furthermore, I use a year fixed effects approach to account for time trends and common shocks. I start by running minimal models to ensure that my findings are not driven by covariate choice. Then, I add the lagged level of the respective dependent variable to control for convergence dynamics. Finally, I add a battery of covariates. I control for democratic institutions by adding a dichotomous indicator for democracies (Boix et al., 2013). Furthermore, many studies have found that country size plays a crucial role for tax policy making (Bucovetsky, 1991; Ganghof, 2006a; Genschel et al., 2016). Therefore, I control for a country’s population (logged values). Moreover, I add variables that measure GDP per capita (logged values), real GDP growth, and the inflation rate. Data come from the World Bank (2018). Finally, globalization might affect tax policy making (Lierse, in this volume). Therefore, I control for a country’s integration into global market structures by including the KOF index for economic globalization as a covariate (Dreher, 2006; Dreher et al., 2008). Additionally, I use a jackknife approach to control for influential cases and I add country fixed effects. Table 12.1 shows the results. The findings are straightforward: previous changes in inequality do not have a significant effect on tax policies.5 Neither the overall tax take nor top PIT rates are affected by changes in inequality. This finding is robust to various model specifications. Furthermore, we cannot find an effect when running subset analyses for rich OECD democracies. Hence, these results underline the findings of previous macro-quantitative studies: inequality does not drive taxation. By differentiating between different tax functions, I have shown that neither overall extractive capacities, nor progressive income tax policies have been affected by changes in inequality.

4.

WHAT IS THE MATTER WITH MEDIAN VOTER THEORY?

As the previous empirical section has shown, MVT possesses only limited explanatory power. Yet, one could argue that the missing effect of inequality on redistributive tax policies comes as no surprise. During the time of rising within-country inequality since the 1970s, we can observe that progressive taxation has been on the demise. For example, more than a third of all countries worldwide that once had an inheritance tax have scrapped this highly progressive policy tool in the last 50 years. However, MVT has the crucial strength that it offers an easy, plausible, and intuitive theoretical framework. As a consequence, several researchers have been puzzled by its failure to produce empirically robust predictions about redistributive policies. We can differentiate between at least three different approaches that try to solve this puzzle: biased political decision making, information asymmetries, and perceptions of socio-economic outcomes. The first strand of literature argues that MVT does not hold empirically because political decision making is biased towards the rich (Schattschneider, 1960; Schlozman, 2010). Political scientists have been particularly vocal proponents of this claim. In particular, scholars have stressed the impact of unequal representation on policy making (Bartels, 2008). In democracies, low turnout might undermine fundamental assumptions of MVT (Bonica et al., 2013). Moreover, inequality might even depress turnout (Schäfer & Schwander, 2019). Since low income groups are more likely to abstain from voting, redistributive policies might not pay off at the ballot box. Furthermore, richer people have more means to affect policy making. Economic elites or specific interest groups can use their economic power to affect policies

P

X

Robust standard errors

Jackknife

1,552

X

P

P

0.045

X

P

P

0.067

1,449

P

P

P

0.067

1,449

–0.0060 (0.0060)

–0.0060 (0.0052)

0.0013 (0.0020)

0.0013 (0.0008)

0.0334 (0.0208)

0.0334

(0.0669)

(0.0609) (0.0199)

0.2472***

0.2472***

0.0093 (0.0279)

0.0093 (0.0261)

–0.0857 (0.1478)

–0.0857

(0.1018)

(0.1313)

(0.0972)

–0.1458

(0.0087)

–0.0362***

(4)

Note: Robust standard errors in parentheses; *** p < 0.001, ** p < 0.01, * p < 0.05.

P

Year fixed effects

1,552

0.029

R2

(0.0899)

(0.0963)

–0.1458

(0.0078)

(0.0042)

–0.0862

–0.0362***

(3)

Δ Public revenue

–0.0209***

(2)

–0.1487

(1)

(5)

X

P

X

0.272

1,449

(0.0178)

0.0472**

(0.0009)

0.0014

(0.0248)

0.0393

(0.4161)

0.5411

(1.9555)

0.4728

(0.3054)

0.2286

(0.1715)

–0.1574

(0.0442)

–0.3794***

Inequality and tax policy making worldwide, 1981–2005

Observations

Globalization

Inflation

GDP growth

GDP per capita (log)

Population (log)

Democracy

Δ Gini (t-1)

Top PIT rate (t-1)

Public revenue (t-1)

Table 12.1

X

P

P

0.038

2,180

(0.2877)

–0.2143

(6)

X

P

P

0.082

2,180

(0.2854)

X

P

P

0.096

1,968

(0.0080)

0.0016

(0.0005)

–0.0003

(0.0224)

–0.0058

(0.1008)

0.1829

(0.0518)

0.1310*

(0.1926)

–0.1453

(0.2945)

–0.3421

(0.0104)

–0.2692

–0.0724***

(0.0089)

(8)

Δ Top PIT rate

–0.0664***

(7)

P

P

P

0.096

1,968

(0.0085)

0.0016

(0.0008)

–0.0003

(0.0232)

–0.0058

(0.1058)

0.1829

(0.0563)

0.1310*

(0.2015)

–0.1453

(0.3144)

–0.3421

(0.0112)

–0.0724***

(9)

X

P

P

0.233

1,968

(0.0239)

–0.0191

(0.0007)

–0.0001

(0.0275)

–0.0273

(0.7650)

0.0200

(2.3408)

–1.0822

(0.5008)

–0.0404

(0.3534)

–0.1067

(0.0205)

–0.2636***

(10)

186  Handbook on the politics of taxation

Taxation and inequality  187 (Gilens & Page, 2014). For instance, they can attempt to influence decisions by offering expertise, they can threaten policy makers with economic exit options, or they simply donate money to convince political actors (Hacker & Pierson, 2010). Trying to influence public opinion is another option. For example, Emmenegger and Marx (2019) look at a Swiss referendum on introducing an inheritance tax. They show how business groups made use of their structural power to weaken public support for taxing the rich. Second, information asymmetries as well as individual ignorance can undermine MVT’s empirical validity (Bartels, 2005; Fernández-Albertos & Kuo, 2018; Kuziemko et al., 2015). This argument is widespread both in the economic and in the political science literature. MVT assumes that citizens are well informed of the level of inequality in their country. Furthermore, it assumes that individuals are perfectly aware of their position on the income and wealth distribution. Some studies have questioned these assumptions. Scholars have found out that especially poorer people often underestimate the overall level of inequality (Kuziemko et al., 2015). Furthermore, they tend to overestimate their relative income position (Fernández-Albertos & Kuo, 2018). Informing individuals about the actual level of inequality and their true relative income position can raise demand for redistributive taxation (Krupnikov et al., 2006). Finally, recent work has underlined the importance of how socio-economic outcomes are perceived (Fehr & Schmidt, 1999; Fong, 2001; Lü & Scheve, 2016). Again, both political scientists as well as economists have advanced this argument. Whereas MVT assumes inequality to drive redistribution per se, new approaches stress the role of inequality perceptions. If socio-economic outcomes are generally perceived as fair and deserved, demand to change the status quo will be low (Rowlingson & Connor, 2011). In particular, people could believe that the wealth is well deserved, e.g. due to hard work, merit, or because of taking bold economic decisions (Durante et al., 2014; Fong, 2001). Under these circumstances, there will only be little support for taxing the rich. In other words, other-regarding preferences matter (Dimick et al., 2018). But what factors can affect other-regarding preferences? State actions can be major driving factors here. When government policies are perceived as treating some people preferentially, they might be seen as unfair. As a consequence, governments may increase taxes on the rich to restore fairness perceptions and satisfy so-called compensatory demands (Haffert, 2018; Limberg, 2019; Scheve & Stasavage, 2016).

5. CONCLUSION This chapter has revisited the relation between taxation and inequality by proceeding in three steps. First, it has looked at the redistributive potential of taxation. By differentiating between three facets of economic inequality as well as between three fundamental functions that taxes can fulfil, the chapter has argued that taxation can indeed reduce inequality. Taxes can lower overall within-country inequality, decrease the income share of the rich, and reduce global interpersonal inequality by (1) providing the funding basis for redistributive spending programmes, (2) taxing the rich, and (3) speeding up economic convergence. Second, the chapter has investigated whether inequality itself affects tax policy making. In line with most empirical studies, it did not find a general effect of inequality on taxation. Finally, the chapter reviewed three different explanations for the lack of tax policy responsiveness to inequality. Biased political decision making, asymmetries in information about inequalities, and the way that

188  Handbook on the politics of taxation inequality is perceived by citizens are the most prominent explanations. All three approaches try to overcome the deterministic expectations of MVT by drawing on established theoretical models of power, political behaviour, and socio-economic perceptions from political science. Although the nexus between taxation and inequality has received much interest recently, several issues need further investigation. First, taxes may not always have equal effects on inequality. Tax policies that reduce inequality in advanced market economies might not work in poorer states. Factors that account for the varying redistributive effectiveness of taxation could yield powerful explanations for inequality dynamics worldwide. Second, the microand macro-level literature on taxation are to a certain extent detached from one another (see Bowler and Donovan (1995) as well as Monroe (1998) for notable exceptions). However, all major approaches on the connection between inequality and taxation are based on the impact of changing preference structures on policy making. Therefore, investigating whether policies follow voter preferences is a promising approach for further research. Finally, a closer differentiation between different tax types in times of rising inequality is needed. Does the perception of income taxes differ from taxes on wealth? Why do inheritance taxes seem to be fairly unpopular? And what drives taxes on real estate? Analysing the whole toolkit of progressive taxation is indispensable when evaluating policy responses to recent inequality dynamics.

NOTES 1. In this chapter, I focus on national tax policy tools. However, it is important to keep in mind that international taxes such as the proposed European Union financial transaction tax can affect inequality as well. 2. China and India are not chosen accidentally here. Both countries are prime examples for economic catching-up processes. In fact, Darvas (2019) shows that these two countries account for a large share of the overall decline in global interpersonal inequality. 3. This includes social security contributions. 4. Thus, the Gini coefficient post-tax and transfers. 5. Neither substantively nor statistically.

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190  Handbook on the politics of taxation Haffert, L. (2018). War mobilization or war destruction? The unequal rise of progressive taxation revisited. Review of International Organizations, 1–24. Haffert, L., & Schulz, D. F. (2020). Consumption taxation in the European Economic Community: Fostering the Common Market or financing the welfare state? JCMS: Journal of Common Market Studies, 58(2), 438–454. Helgason, A. F. (2017). Unleashing the ‘money machine’: The domestic political foundations of VAT adoption. Socio-Economic Review, 15(4), 797–813. Huber, E., Huo, J., & Stephens, J. D. (2017). Power, policy, and top income shares. Socio-Economic Review, 1–23. https://​doi​.org/​10​.1093/​ser/​mwx027 ICTD/UNU-WIDER. (2019). Government Revenue Dataset. Iversen, T., & Soskice, D. (2006). Electoral institutions and the politics of coalitions: Why some democracies redistribute more than others. American Political Science Review, 100(2), 165–181. James, K. (ed.) (2015). The Rise of the Value-Added Tax. Cambridge University Press. Kenworthy, L., & McCall, L. (2008). Inequality, public opinion and redistribution. Socio-Economic Review, 6(1), 35–68. Korpi, W., & Palme, J. (1998). The paradox of redistribution and strategies of equality: Welfare state institutions, inequality, and poverty in the Western countries. American Sociological Review, 63(5), 661–687. Krupnikov, Y., Levine, A. S., Lupia, A., & Prior, M. (2006). Public ignorance and estate tax repeal: The effect of partisan differences and survey incentives. National Tax Journal, 59(3), 425–437. Kuziemko, I., Norton, M. I., Saez, E., & Stantcheva, S. (2015). How elastic are preferences for redistribution? Evidence from randomized survey experiments. American Economic Review, 105(4), 1478–1508. Limberg, J. (2019). ‘Tax the rich’? The financial crisis, fiscal fairness, and progressive income taxation. European Political Science Review, 11(3), 319–336. Limberg, J. (2020). What’s fair? Preferences for tax progressivity in the wake of the financial crisis. Journal of Public Policy, 40(2), 171–193. Lorber, J. (2011). Gender Inequality: Feminist Theories and Politics, 5th ed. Oxford University Press. Lü, X., & Scheve, K. (2016). Self-centered inequity aversion and the mass politics of taxation. Comparative Political Studies, 49(14), 1965–1997. Lübker, M. (2007). Inequality and the demand for redistribution: Are the assumptions of the new growth theory valid? Socio-Economic Review, 5(1), 117–148. Lupia, A., Levine, A. S., Menning, J. O., & Sin, G. (2007). Were Bush tax cut supporters ‘simply ignorant’? A second look at conservatives and liberals in ‘Homer gets a tax cut’. Perspectives on Politics, 5(4), 773–784. Luttig, M. (2013). The structure of inequality and Americans’ attitudes toward redistribution. Public Opinion Quarterly, 77(3), 811–821. Meltzer, A. H., & Richard, S. F. (1981). A rational theory of the size of government. Journal of Political Economy, 89(5), 914–927. Milanovic, B. (2016). Global Inequality: A New Approach for the Age of Globalization. Harvard University Press. Moene, K. O., & Wallerstein, M. (2003). Earnings inequality and welfare spending: A disaggregated analysis. World Politics, 55(4), 485–516. Monroe, A. D. (1998). Public opinion and public policy, 1980–1993. The Public Opinion Quarterly, 62(1), 6–28. Pellow, D. N. (2000). Environmental inequality formation: Toward a theory of environmental injustice. American Behavioral Scientist, 43(4), 581–601. Peter, K. S., Buttrick, S., & Duncan, D. (2010). Global reform of personal income taxation, 1981–2005: Evidence from 189 countries. National Tax Journal, 63(3), 447–478. Pickett, K. E., & Wilkinson, R. G. (2015). Income inequality and health: A causal review. Social Science and Medicine, 128, 316–326. Piketty, T. (2014). Capital in the Twenty First Century. Harvard University Press. Piketty, T., & Zucman, G. (2014a). Capital is back: Wealth-income ratios in rich countries 1700–2010. Quarterly Journal of Economics, 129(3), 1255–1310.

Taxation and inequality  191 Piketty, T., & Zucman, G. (2014b). Wealth and Inheritance in the Long Run (SSRN Scholarly Paper ID 2501546). Social Science Research Network. http://​papers​.ssrn​.com/​abstract​=​2501546 Pontusson, J., & Rueda, D. (2010). The politics of inequality: Voter mobilization and left parties in advanced industrial states. Comparative Political Studies, 43(6), 675–705. Rowlingson, K., & Connor, S. (2011). The ‘deserving’ rich? Inequality, morality and social policy. Journal of Social Policy, 40(3), 437–452. Rueda, D., & Stegmueller, D. (2016). The externalities of inequality: Fear of crime and preferences for redistribution in Western Europe. American Journal of Political Science, 60(2), 472–489. Sala-i-Martin, X. X. (1996). Regional cohesion: Evidence and theories of regional growth and convergence. European Economic Review, 40(6), 1325–1352. Schäfer, A., & Schwander, H. (2019). ‘Don’t play if you can’t win’: Does economic inequality undermine political equality? European Political Science Review, 1–19. https://​doi​.org/​10​.1017/​ S1755773919000201 Schattschneider, E. E. (1960). The Semisovereign People: A Realist’s View of Democracy in America. Holt, Rinehart, Winston. Scheve, K., & Stasavage, D. (2010). The conscription of wealth: Mass warfare and the demand for progressive taxation. International Organization, 64(4), 529–561. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton University Press. Scheve, K., & Stasavage, D. (2017). Wealth inequality and democracy. Annual Review of Political Science, 20(1), 451–468. Scheve, K., & Stasavage, D. (2019). Equal treatment and the inelasticity of tax policy to rising inequality. Working Paper. Schlozman, K. L. (2010). Who sings in the heavenly chorus? The Oxford Handbook of American Political Parties and Interest Groups. https://​doi​.org/​10​.1093/​oxfordhb/​9780199542628​.003​.0022 Schmidt-Catran, A. W. (2016). Economic inequality and public demand for redistribution: Combining cross-sectional and longitudinal evidence. Socio-Economic Review, 14(1), 119–140. Seelkopf, L., Bubek, M., Eihmanis, E., Ganderson, J., Limberg, J., Mnaili, Y., Zuluaga, P., & Genschel, P. (2019). The rise of modern taxation: A new comprehensive dataset of tax introductions worldwide. Review of International Organizations. https://​doi​.org/​10​.1007/​s11558​-019​-09359​-9 Seelkopf, L., Lierse, H., & Schmitt, C. (2016). Trade liberalization and the global expansion of modern taxes. Review of International Political Economy, 23(2), 208–231. Solt, F. (2016). The Standardized World Income Inequality Database. Version 5.1, July. Swank, D. (2016). The new political economy of taxation in the developing world. Review of International Political Economy, 23(2), 185–207. Villaverde, J., & Maza, A. (2011). Globalisation, growth and convergence. The World Economy, 34(6), 952–971. Volscho, T. W., & Kelly, N. J. (2012). The rise of the super-rich power resources, taxes, financial markets, and the dynamics of the top 1 percent, 1949 to 2008. American Sociological Review, 77(5), 679–699. Wilensky, H. L. (2002). Rich Democracies: Political Economy, Public Policy, and Performance. University of California Press. Williamson, J. G. (1996). Globalization, convergence, and history. The Journal of Economic History, 56(2), 277–306. World Bank (2018). World Development Indicators (WDI). The World Bank. Zeit (2019). Steuerpolitik: OECD befürwortet Vermögensteuer in Deutschland. Die Zeit, 27 August. www​.zeit​.de/​wirtschaft/​2019​-08/​oecd​-steuerpolitik​-vermoegensteuer​-deutschland (accessed 18 May 2021).

13. Taxation and gender Laura Seelkopf

1. INTRODUCTION In 2004, Kenya was the first country to scrap sales taxes on female hygiene products (Jones, 2016). The cry to end the “tampon tax” was taken on by female rights activists around the world and other countries such as Australia, India, and Colombia followed suit and reduced their value-added tax (VAT) rates – thereby recognizing that female hygiene products belong to the group of basic needs items and therefore should be taxed at the same low or zero rates as other basic necessities. Yet, many countries continue, for instance, to tax Viagra at a lower rate than tampons – hence exempting “a medication to assist men in recreational sexual activity,” but not “products required by women’s reproductive systems” (Bennett, 2017, p. 194). We see gender-based1 discrimination in tax matters also when it comes to direct taxation. In many countries such as Germany, the husband is the first and main taxpayer on the income tax declaration by default, even if the wife earns more or is even the only one to declare an income. In Jersey, married women were not allowed to speak to the tax authorities without their husband’s permission. It took until 2020 to change this law from 1928 (Morris, 2020). While this might come as a shock for some, it might be less surprising if we think of taxation as a reflection of the social contract as a whole. All around the world the level and structure of tax revenue determines what a government can and cannot do, how many services it can deliver, how modestly or ambitiously it can define its goals, and how effectively it can constitute its authority domestically and internationally. Fiscal systems represent the societies in which they exist (Schumpeter, 1918). They show who is enfranchised and who is disenfranchised, who wins and who loses. Considering that even developed democracies severely restricted women’s political and economic power until well into the twentieth century, the continued effects into the tax system seem maybe less surprising. Think for instance of Switzerland, which only allowed women to vote in 1971, or Germany, where a husband could forbid his wife to work until 1976. The aim of this chapter is to give the interested reader an overview of the (implicit) effects tax policy has on different genders, thereby often (indirectly) discriminating against women. I start by defining different types of discrimination and will then summarize what we know from the literature so far. Yet, social science scholarship not only deals with discrimination in the tax code when it comes to gender issues. Recently, more and more research shows that women have different preferences and react distinctly from men to the same tax policy. I summarize the evidence we have on different gender preferences and the behavior of ordinary women as well as female politicians. In a next step I have a quick look at the gender of the scholars themselves to see potential biases inherent in the scholarship of taxation itself. The chapter ends with suggestions for avenues for future research into the politics of taxation and gender.

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Taxation and gender  193

2.

THE EFFECTS OF TAX POLICY ON WOMEN

2.1

What is Gender Discrimination in Taxation?

Before I summarize what we know about the gendered effects of tax policy, let me define and differentiate between different types of discrimination. Following Janet Stotsky (1996), we can mainly distinguish between explicit and implicit discrimination in the tax system. I discuss each in turn. Explicit discrimination Explicit discrimination refers to the different treatment of men and women in the tax code itself. Here the law directly lays down different rules for different genders. This applies for instance to income tax systems that allow only husbands to file tax declarations and allow no separate existence as taxpayers to their wives. This was for instance the case in France until 1983 and in Britain until 1990. As we have seen in the introduction, in some jurisdictions it has continued well into the twenty-first century. Other examples are tax deductions that only men can claim in their income tax declarations. In Morocco, for example, only the husband can receive tax deductions for children, unless the mother is able to prove that she supports her children financially (Grown & Valodia, 2010). And in the Netherlands, husbands were entitled to higher tax-free allowances than their wives until 1984 (Stotsky, 1996). While this outright discrimination by law is in many senses the hardest form of direct discrimination by the state, it is also the easiest to observe as researchers or activists simply need to examine the tax code. It is also clearly on the way out, especially in developed democracies as it violates gender parity clauses. Indirect discrimination What is much harder to tackle is indirect discrimination. Here the tax code is formally equal for men and women, but some laws have very different effects based on the sex of the taxpayer or the gender-based position in society. The tampon tax from the introduction is a clear example of indirect discrimination based on sex. Men and women pay the same consumption tax when buying female hygiene products, but of course men do not need them, whereas women do. Nevertheless, in most cases, implicit discrimination does not occur because of bodily sex differences, but because of different social and economic positions of men and women due to gendered cultural norms. As we will see in more detail in the next section, many income tax systems allow joint filing for married couples and set a higher tax rate for the lower income earner. This only implicitly discriminates women because they have traditionally been the second earners. Other examples include preferential tax treatments. In Ghana for instance, income derived from certain crops such as maize is taxed at a lower rate. And in Uganda, policy officers do not have to pay income taxes. In both cases, it is mostly men that grow these crops or serve in the police force (Grown & Valodia, 2010, cited by Woolley, 2011). Hence, while women have the de jure right to the same tax privileges, de facto they do not benefit. Substantive equality and gender impact assessment To overcome this implicit bias, some scholars and activists argue that we should focus on the equality of the tax system’s outcomes rather than on the formal equality of the tax code. This could even include different treatment of men and women in tax law (e.g. Grown & Valodia,

194  Handbook on the politics of taxation 2010, p. 7). Practically, some governments have started to assess their budgets in terms of gender equality. Australia for instance was a pioneer and released its first “Women’s Budget Statement” already in 1984 (Stewart, 2017, p. 328) to understand how different tax and spending policies affect men and women differently (but has since given up the practice). Scholars have done so similarly for the European Union (Gunnarsson & Spangenberg, 2019) and the United Kingdom (Himmelweit, 2002), for example. In general, the focus of both scholars and activists is very much on the expenditure side of the budget and often ignores the revenue side (Grown & Valodia, 2013; see Seguino, 2019 for an overview of feminist expenditure policy). If taxation is considered at all, it mostly comes at a very general level in terms of calls for more government spending (as women need more public goods due to their family obligations) and more progressive taxation (as men have higher incomes and wealth). If one wanted to design and argue for more gender-sensible tax policies, one needs to better understand the implicit discrimination in the tax system. The next part will try to do just that. 2.2

The Gendered Effects of Tax Policy

In this section, I summarize the literature on the gendered effects of tax policies. I am of course not the first to do so. Earlier reviews include Janet Stotsky’s (1996) report for the International Monetary Fund, Kathleen Barnett and Caren Grown’s (2004) report on developing countries and Edward McCaffery’s (2009) chapter on gender tax bias in developed democracies from a cultural sociology perspective. Generally, implicit discrimination can and does occur in any tax type (see Hakelberg & Seelkopf, this volume, for an overview of tax types). Yet, the majority of research focuses on personal income taxes, both because it has traditionally been the “queen of taxes” (Schratzenstaller & Wagener, 2009, p. 318) at least in the West and because as a direct tax one can clearly identify the gender of the taxpayer. Hence, I will first discuss the various findings on personal income taxes, before I discuss insights for other tax types.2 Personal income taxation When it comes to income taxation, scholars have mainly focused on two things: tax expenditures and taxation in married couples. In general, most income tax systems are built around male-breadwinner models, where the main taxpayer is heterosexual, male, and married (with kids). Wives do not work at all or constitute the second earner. Usually, states have progressive income tax systems, where the tax rate increases with income. Yet often not all gross income will be taxed as taxpayers can deduct various things from their income in their tax declarations (see Haldenwang et al., this volume, for an overview). Similar to spending policies, what can be deducted has very different consequences for male and female tax burdens. Countries also differ in their treatment of married couples. Traditionally, many take the household as the taxable unit. Hence, husbands and wives declare their income jointly and the state taxes them together. Other countries treat taxpayers as individuals independent of their family status. Depending on the differences in income both partners earn, this can lead to considerable differences in tax rates. As the next paragraphs will show, these different choices in tax expenditures and tax systems for married couples generate strong gendered effects on female tax rates, labor supply, and general vertical equity of tax systems.

Taxation and gender  195 Tax expenditures As we have seen above, tax deductions can be outright discriminatory. Think of Zimbabwe, where a married man is entitled to a tax credit, but a married woman is not. Or Jordan, where only the husband has access to certain deductions when a couple files separately (Stotsky, 1996). These instances are clearly discriminatory, but not the focus of most research. Rather, scholars try to estimate the effects of implicit bias in tax expenditures on women. Given that women earn on average much less than men and often stay at home or work part-time when they become mothers, they have a different socio-economic profile. Therefore, their income is affected differently by the size and type of deductions possible in any given tax system. First, because men earn more than women, they benefit more from tax expenditures in general, especially in progressive income tax systems. Their taxable income and effective tax rate shrink as the number of deductions increases. Hence, welfare states that work via tax expenditures rather than social spending, as is the case in the United States (Howard, 1999), benefit individuals earning higher wages more – and these are mostly male. Being able to deduct expenditures from a low income does not decrease the tax burden by much (Young, 2000). Second, it really matters what can be deducted. For instance, if private pension contributions are deductible, this allows men to deduct more as they earn more on average and hence can afford higher private pensions – extending their privileged income positions into retirement (Collins, 2020). Typically, in many tax systems male activities such as travel to work can be deducted, but child care for instance cannot. Given that the majority of single parents are mothers, this has potentially huge income effects. It also matters for the decision to work outside of home or not. As child care is still mostly provided by mothers, the possibility to deduct outside care costs allows women to work, thereby increasing the female labor supply (Ayala & Paniagua, 2019; Maloney, 1988; but see Spehar, 2015 for a feminist critique). Tax rates for married couples By far the most researched topic when it comes to gender and taxation is the way in which the taxation of married couples influences a woman’s choice to work. Politically, this is not only an issue of gender equality, but matters also for economic development in general – especially in the aging societies of the Global North. The issue was first highlighted by a memorandum of the European Commission in 1984. Traditionally, governments treat the household as the taxable unit, where husbands are the main if not sole provider of family income. This implies joint taxation of married couples, where it does not matter to the tax authorities who earns how much, but only what the couple earns together. Sweden was the first country to move away from this model in 1971 and now taxes individuals separately, independent of their marriage status. Other countries such as Germany or Switzerland continue to tax married couples jointly. How does joint or separate taxation lead to implicit bias? First of all, the decision to tax married (heterosexual) couples differently from other types of family units, which are already quite common and becoming more prevalent in the twenty-first century, discriminates in favor of traditional households. In Germany, for instance, cohabiting couples do not have the potential privileges of joint taxation, but the obligation to secure the partner’s income in case of unemployment (rather than apply for social assistance). When and how do married couples benefit from joint taxation? The biggest benefit usually exists when the discrepancy between the two incomes is highest. If the household is treated as the taxable unit, it does not matter whether both parties earn 30 000 € or one earns 60 000 € (usually the husband) and the other zero (usually the wife). The tax authority treats both couples the same

196  Handbook on the politics of taxation and applies the tax rate, deductions, etc. to the overall income divided by two, i.e. as if both would earn 30 000 €. If both partners were taxed independently, this would not change anything for the first couple, but increase the tax rate for the higher earner in the second couple. As most income tax systems are progressive, the husband’s tax rate would be higher and he could not use the deductions available to his wife. In countries with joint taxation, the financial losses for cohabiting couples with different incomes can be quite high. Hence, designing the tax system in this way does not only have an effect on the net income of couples, it even influences the decision to marry itself by providing a financial incentive (Barigozzi et al., 2019; Gayle & Shephard, 2019). Why would the state decide to treat married couples differently in the first place, given that this potentially reduces the tax take? Historically, this simply reflects the reality at the time most income tax systems were created. In the late eighteenth century to the early 1900s, marriage rates were high and husbands usually the sole earner. Second incomes simply did not exist. Today, the reality is different. Especially in high-income countries the labor share of women relative to men increased over the last century and is now close to 80 percent. Yet, women still work more part-time and in less well-paid sectors or even the informal economy (Ortiz-Ospina et al., 2018). This makes them the second earners in most couples and creates potential income tax revenue losses for governments that continue to apply joint taxation. The normative argument mostly conservative parties and voters raise in favor of this marriage tax privilege is that the government should adhere to the principle of subsidiarity and not interfere in the division of labor within families (see Kemmerling & Truchlewski, this volume; Berens & Gelepithis, this volume for a more general overview on party politics, partisan preferences, and tax policy). Interestingly, this is also how models of optimal tax theory used to model the household: as one unit with single earners and common preferences (Apps & Rees, 2011). Newer studies model couples as two separate individuals with different preferences for work and leisure, individually observed tax rates, and even as potentially non-cooperative units (Meier & Rainer, 2015). Given that joint taxation leads (compared to individual taxation) to lower tax rates for the high-income earner and higher rates for the second earner, most scholars focus on the labor supply of the second earner, usually the wife (see e.g. Fink et al., 2019; McMahon, 2015; Rosen, 1977). They show theoretically and demonstrate empirically that joint filing leads to an undersupply of second-earner labor (Boskin & Sheshinski, 1983), explaining the differences in labor supply among married men and women across different European countries (Bick & Fuchs-Schündeln, 2018). Individual country studies on tax reforms show the same picture. When Sweden abolished joint taxation in 1971 “employment grew considerably more among women married to high-income earners in the years following the announcement of the reform, especially among households with kids” (Selin, 2014, p. 894). The same could be observed for reforms towards more individualization in Spain in 1988 (Fuenmayor et al., 2018) and Ireland in 2000 (Doorley, 2018). Married women were more likely to take up paid work, increase the hours of paid work, and at the same time spend less time on unpaid child care. The effect is indeed symmetric. As the Czech Republic moved the other way and introduced joint filing in 2005, the employment rate of married women declined by 3 percent on average and twice as much for women with high-income husbands (Kalíšková, 2013). Hence, joint filing reduced the labor participation rate of the second earner. Given that these are predominantly women, it therefore indirectly discriminates against women, especially mothers and especially spouses of high-income earners. This also leads to less progressive taxation (and therefore more unequal

Taxation and gender  197 societies) in general, as it allows high-income men to lower their tax burdens (Apps & Rees, 2018). But the treatment of married couples does not only affect the labor supply of women. Depending on the tax system it also directly affects their disposable income. If social spending programs such as unemployment benefits or parental leave payments are based on net incomes, as is for instance the case in Germany, then joint taxation immediately leads to lower benefits. This effect is even enhanced by the socio-economic structure as women are more likely to be unemployed or take up parental leave. Indirectly, it also impacts the consumption decisions of women if they make spending decisions based on their own net income rather than on the household’s net income. In sum, the social forces that turn women into the predominant second earners are reinforced by income tax systems that treat married couples as one unit. This is why political actors call for separate filing as in Sweden (European Commission, 1984). Scholars even go a step further, suggesting that an optimal tax system would treat men and women differently. They call for gender-based taxation, where men (Alesina et al., 2011) or at least married men in heterosexual couples (Bastani, 2013; Gayle & Shephard, 2019) are taxed at higher rates than women (but see Komura et al., 2019 or Meier & Rainer, 2015 for models where women should be taxed more if they have a comparative advantage in home production3). In reality, gendered taxation is often seen as unfair, especially by men (Hundsdoerfer & Matthaei, 2020). Still, we see more and more countries moving away from joint filing and towards individual taxation, since the European Commission first called for less gender bias in taxation. Another – maybe less apparent – positive indicator is that the gender gap in tax offense convictions in the United States has been declining over time (Reese & Constantin, 2019). Other tax types As we have seen, there is a strong research focus on implicit gender discrimination in the personal income tax systems of high-income countries (Schratzenstaller & Dellinger, 2017). We know much less about gendered effects of other taxes. This section explains why this is the case and reviews the little we do know. Wealth taxes Probably due to their low revenue impact there is in general much less research on wealth taxes and therefore also on the gendered impact these taxes might have. Given that men typically are wealthier than women (Ruel & Hauser, 2013) and also more likely to own companies (Hiraga, 2018), progressive tax systems that rely strongly on wealth and personal and corporate income taxes are not only more equal in general, but also have a lower implicit gender bias. The same applies also to less common, but often called for taxes such as the financial transaction tax (Schaefer, 2016; see Metinsoy, this volume for a more general overview of this tax). Yet how big these effects are and if there are specific implicit biases other than via ownership remains to be seen. Consumption taxation We know relatively little about wealth taxes, probably because they are fiscally not so important. Indirect taxes are very relevant for the tax take, but also neglected in the tax policy discussion on the Global North (Schratzenstaller & Dellinger, 2017). They do come to the forefront, however, in discussions of gender discrimination in the Global South (see Joshi

198  Handbook on the politics of taxation et al., 2020; Lahey, 2018 for overviews). Given the relatively high levels of informality and low state capacity in less developed countries (see Bastiaens, this volume for an overview of taxation in developing countries), personal income taxes play only a minor role. Given that women have – if at all – on average less rights and income and are much more likely to work in the informal economy than men (van den Boogaard, 2018), the same gendered effects of direct taxation should also apply to income and wealth taxes in developing countries. Yet, other taxes matter much more in this context. When it comes to modern taxes, consumption taxes such as VAT are the main revenue instrument governments have. Given that indirect taxes are regressive – or at least less progressive than direct taxes – they put a higher tax burden on female households (Rossignolo, 2018 for Argentina). In systems with differentiated VAT rates, we see that low rates on necessities benefit female households (Casale, 2012 for South Africa), as suggested by the tampon tax discussion in the introduction. Informality: fees and presumed taxes Research into the gendered nature of tax systems in developing countries also brings other modes of taxation into the picture. Owing to the high level of informality, especially among women, governments need other ways to raise revenue and women are hit harder by these taxes. As governments try to include more individuals into the tax net, they often do so by raising taxes on self-employed small market sellers. As tax authorities often lack the capacity to assess the income earned, they presume how much sellers have earned. This discriminates against women, as they earn less than their male counterparts (Akpan & Sempere, 2019 for Nigeria; Ligomeka, 2019 for Zimbabwe). Tax administrators also matter in other ways. Male tax collectors in Nigeria, for instance, were found to ask for sexual favors from female, but not male market sellers (Akpan & Sempere, 2019). This alludes to another very serious hurdle women face when confronted with the male-dominated tax system. Another issue is not taxes, but fees for services that abound in developing countries as means to raise (local) government revenue. Across various studies in countries such as Tanzania, Zimbabwe, or Nigeria scholars have shown that fees disproportionally burden women (Akpan & Sempere, 2019; Ligomeka, 2019; Siebert & Mbise, 2018). Especially the very common toilet fees hit women much harder than men as female market sellers not only have to use toilets more often than men for biological reasons (Perez, 2019, ch. 2), but are also more at risk of violence or negative judgment if they don’t. Yet, not taxing women by leaving them to work and consume in the informal sector is not the solution. It leaves them victim to informal taxes and fees and potentially obstructs their political representation. In Sierra Leone, for instance, the tax law did not even allow women to be taxpayers until 2008. And even today local tax payments are linked to being able to vote or be voted in as chieftain (van den Boogaard, 2018). Not taxing women might thus be even worse than explicitly or implicitly discriminating against them in the tax system. In sum, most research on the effects of the tax system on women focuses on how governments in developed democracies tax married couples. These studies are mainly done by economists and show that joint income declarations raise income inequality and lead to less labor supply by women. Analyses of the Global South have shown that also consumption taxes and user fees implicitly bias women. Interestingly, most of the literature looks at the effects of certain taxes or tax reforms on women, not why policies are made in a gendered way. Here political scientists should and could certainly bring much to the interdisciplinary table.

Taxation and gender  199

3.

GENDERED BEHAVIORAL RESPONSES TOWARDS TAX POLICY

As we have seen in the previous section, much of the literature discusses how tax policy affects women and explicitly and implicitly discriminates against them. Yet more recently, there is also a growing literature that takes women as agents much more seriously and discusses how they might respond differently to the same policy than men and how they differ in their preferences when deciding on tax policy as voters or politicians. 3.1

Women as Taxpayers

From a more micro perspective, scholars started to ask whether male and female taxpayers have similar attitudes when it comes to paying their taxes (see Guerra & Harrington, this volume for a general overview on tax compliance). Tax compliance scholars showed relatively early that women were more compliant than men in lab experiments (Spicer & Becker, 1980). Despite this well-known early finding, half of the subsequent studies reviewed by Brockmann et al. (2016) ignored it and did not control for a gender dummy in their experiments. Those that do show that it is a very robust finding. Also, surveys across different countries bring further evidence that women are more opposed to tax evasion than men (McGee & Tyler, 2006; Torgler & Valev, 2010). Interestingly, this seems a stable relationship independent of the within- or across-country variation in gender equality (D’Attoma et al., 2017; Torgler & Valev, 2010). The question that has not been answered yet is why women behave differently than men when it comes to evading taxes. One set of answers looks for general behavioral differences across genders. Another set of answers looks at different tax policies to see whether men and women behave differently when facing the same treatment. I discuss each in turn. There is quite a consensus now in experimental economics that women behave differently than men and have distinct preferences (see Croson & Gneezy, 2009 for general differences in preferences). Most explanations are routed in either biological or psychological differences between sexes, but some also focus more on structural factors. Whether by nature or by nurture, women are more risk averse than men and hence less likely to engage in risky behavior such as evading taxes (Brockmann et al., 2016). They also value honesty more and care about the image they (and their firms) project towards stakeholders (Bauweraerts & Vandernoot, 2019). Men on the other hand are less obedient towards authorities and overconfident, thereby underestimating for instance the likelihood of being caught cheating on their taxes (see Bruner et al., 2017 for an overview). Other explanations focus more on macro factors, such as the combination of formal and informal rules in society or the sectors, in which men and women are predominantly employed (Gërxhani, 2007). Which of these factors matter (or in what combination) still remains an open question. Another mechanism might be that men and women do not differ in their general disposition, but in their reaction to different tax treatments. Despite calls for more subgroup tests (Neumayer & Plümper, 2017) and the clear evidence of gender differences in earlier experiments, 18 out of 23 reviewed studies did not test whether men and women reacted differently to the same treatment (Brockmann et al., 2016). Those that did all show that indeed they do. Women were more likely to comply with the tax code when the rules were positively framed (Hasseldine & Hite, 2003), they were exposed to friendly persuasion (Chung & Trivedi, 2003), or promised positive rewards for being honest such as a lottery ticket (Brockmann et al.,

200  Handbook on the politics of taxation 2016). Men instead evaded significantly less in negative, deterrent frames.4 This law and order interpretation for male behavior is also seen in a study of ethical behavior and exposure to tax knowledge. Whereas women are in general more ethical in business settings, their preferences do not change with more knowledge. Men instead become more ethical with increased exposure to the tax law (Fallan, 1999). Scholars also observe behavioral responses when it comes to labor supply. If faced with perceived unfair tax rates, such as gender-based tax rates, men react with less work. Women’s fairness perceptions are instead much more individualized and do not affect their labor supply (Hundsdoerfer & Matthaei, 2020). While this last finding speaks against gender-based taxation in the sense of the optimal tax literature from above, the literature clearly points towards behavioral differences across different genders. Hence, individualized taxation with differently worded forms (strict for men, more positive for women) might be the way forward towards more tax revenues, more labor supply, and less implicit discrimination of female taxpayers. 3.2

Women as Voters and Policy Makers

As we have seen, the majority of studies into gender and taxation are done by economists5 – although psychologists and political scientists have started to enter the field of tax compliance research. Therefore, it is not surprising that the focus is on the gendered economic effects of and on taxation. Of course, taxation is at the core of the state and its politics, and discrimination is deeply political. Yet, so far this has made it more of an issue for activists and politicians and not so much for political scientists or political economists. Luckily as women’s rights enter the political arena more and more and societies themselves become more equal, so grows the research on the gendered politics of taxation. There is still much to be done, as the example of a study on the effects of mayors on public finances in the German state of Bavaria shows. Across over 2000 municipalities and three decades there were so few women elected that the authors could not even test for gender effects (Freier & Thomasius, 2016). Nevertheless, this section gives a short overview of what we know on the different preferences of female and male voters and politicians. Similar to the gendered budget discussions, we know much more about distinctions on the spending side of the fiscal coin than we know about taxation. Women prefer different types of government expenditure than men. They are more likely to support welfare state or environmental spending and less likely to support military expenditures (Funk & Gathmann, 2015; Slegten et al., 2019). There is also evidence that women support more government spending (and therefore indirectly higher taxation) in general (Funk & Gathmann, 2015; Lott & Kenny, 1999). And they take these preferences with them to the voting booth. In a study of the extension of the franchise across the United States, Lott and Kenny (1999, p. 1163) found that suffrage “coincided with immediate increases in state government expenditures and revenue and more liberal voting patterns for federal representatives, and these effects continued growing over time as more women took advantage of the franchise.” Does this finding extend to female politicians, i.e. should we expect a change in fiscal policy when more women are elected (increase in descriptive representation6)? Again, we know much more about spending than taxation. From Belgium to Brazil, from India to Norway, scholars find that female politicians are more likely to spend more on “female” spending categories such as health care, education, or social assistance (Bratton & Ray, 2002; Chattopadhyay & Duflo, 2004; Funk & Philips, 2019; Slegten et al., 2019). This even holds true when comparing

Taxation and gender  201 men and women within political parties (Slegten & Heyndels, 2020). When it comes to the question of how to finance increased expenditures, a study of Flemish councilors found that women preferred progressive tax increases following the ability-to-pay principle, whereas men preferred user fees in line with the benefit principle (Slegten et al., 2019; see Hakelberg & Seelkopf, this volume for a general overview of tax principles). There still remains much to be studied when it comes to the behavior of female politicians and tax policy – both inside and outside the developed world and across tax policies. It would also be interesting to see whether women in office are more likely to insist on the adoption and application of gendered budgets. 3.3

Women as Tax Policy Researchers

The previous section has shown that there is still much to do when it comes to research on the politics of gender and taxation. Part of this might be due to the relative negligence of the field of taxation in political science in general (see Hakelberg & Seelkopf, this volume). Yet, this might also be due to the low descriptive representation of women when it comes to research on taxation in political science in general. Analyzing the top publications in political science on “tax” and “taxation,” less than 20 percent were (co-)authored by a woman, as Figure 13.1 shows. Out of 359 publications that have 20 or more citations, 270 or 75 percent were written by single male scholars or only-male teams. And only 9 percent were written by all-female authors. While women are still underrepresented in political science in general (Dionne, 2019), the field of taxation seems particularly bad. It shares this fate with tax consultants in financial services (Sorola et al., 2020) and tax administrators, although more equal teams improve organizational performance (Mwondha et al., 2018). As we have seen, more descriptive representation of women in politics leads to more substantive representation of female issues. Hence, more female academics working on the topic of taxation might also increase our knowledge of gender and tax politics.

4.

TAXATION AND GENDER: AVENUES FOR FUTURE RESEARCH

This chapter has shown that there are considerable differences between men and women when it comes to taxation. Tax systems all around the world treat women differently than men. This leads to explicit or implicit gender discrimination, leaving female citizens with less rights and less opportunities to engage in the formal economy. Indirectly, it might also hinder their political participation. When women engage with taxation either as taxpayers or as voters and politicians, they are more compliant and more in favor of higher taxation, especially when it pays for “female” issues such as social policies. So far, the literature has treated women mostly as a passive group which reacts to a given tax policy (especially to the way the income tax system treats married couples). We know much less about women as active participants that change the economic and political system. Especially when it comes to the gendered politics of taxation, there is still much to learn. I propose several avenues for future research.

202  Handbook on the politics of taxation

Figure 13.1

Tax research in political science by gender

4.1 Data Despite the growing political and scientific interest in gender and taxation, we still face a huge gender data gap. Similar to most other fields of life, men are taken as the norm and data separating men and women are simply not collected (Perez, 2019). Although many countries now have laws in place to consider the effects new laws have on women, there very often are no data to actually do it. Despite more than four decades of gender budgeting, government agencies such as tax authorities still simply do not collect information differentiated by gender (Gunnarsson & Spangenberg, 2019; Paus, 2020). Researchers and their representative organizations should continue to lobby governments for gender-disaggregated data as the norm. And they should certainly collect and record information on the gender of their participants in their

Taxation and gender  203 own studies. Even if this is not part of their own research, this might provide important insights for other scholars reusing their data. 4.2 Modeling As an applied researcher, looking for (theoretically implied) subgroup effects and testing whether treatment effects differ across groups is the norm. Given the growing evidence that women behave differently than men in general and certainly in the field of taxation, testing gender effects in any type of tax research should be the norm. From a political psychology perspective, it is of course important to understand why men and women behave differently. Is it nature, nurture, or structure or a particular combination of the three? These insights would also help theorists to expand their models and go beyond modeling individuals in households as (non-)cooperative separate entities with somehow fixed preferences or naturally given comparative advantages. 4.3 Topics Extending the findings of gender-specific tax politics to more than the two genders and also to other traditionally marginalized groups that deviate from the standard white male-breadwinner family model is another important avenue for future research. What are the effects of existing tax systems on non-traditional family models? Research should also look beyond personal income taxes. We know far too little about explicit and implicit gender bias in wealth and consumption taxation or user fees. As is the case with tax research in general (see Hakelberg & Seelkopf, this volume), we need to move beyond the in-depth analysis of a handful of countries in the Global North and start analyzing the gendered politics of taxation around the world. This will generate important insights into the relative importance of different tax types, the impact of tax administrations, and the relationship between taxation and representation. In sum, as scholars, we should work more on the gendered nature of the politics of taxation and not simply take it as yet another variable to control for. As teachers and mentors, we should encourage especially our female students and mentees to engage with the topic. Both gender and taxation are areas we know too little about in political science, yet they are important issues at the heart of the state and the fundamental rights of its citizens. As a discipline we can and should bring much to the table to understand their relationship better.

ACKNOWLEDGMENTS I would like to thank Lukas Hakelberg for very helpful comments and Anna Damerow, Stefan Hee, and Maksim Zubok for excellent research assistance, which was partly funded by the Deutsche Forschungsgemeinschaft (DFG, German Research Foundation) – Projektnummer 374666841 – SFB 1342.

204  Handbook on the politics of taxation

NOTES 1.

2. 3.

4. 5. 6.

I have thought a while whether I am actually writing on sex or gender differences. While the tampon tax example is of course due to the differences in biological sex, the discrimination in the tax code is due to the different gender roles men and women traditionally fill in society. I decided to go with gender – and here also distinguishing between male and female persons only. While the term gender is much more fluid nowadays, this has not entered the tax policy literature yet. Hence, unfortunately, discriminating between more than two categories does not help us learn more about the literature. Another way of looking at gendered effects of the tax system is to determine the overall tax burden for male and female households by income percentile (see e.g. Woolley, 2011). These assumptions are of course highly problematic as tax systems and societal structures as a whole do not only have an immediate effect on male and female labor supply, but also on gendered investments in education or preferences for or against unpaid care work. How steeply culturally embedded gender roles are shows in a study on Germany. In those cases, where wives had the higher income, couples were much less likely to allocate the lower tax rate to her – thereby even forgoing tax reductions associated with joint filing (Buettner et al., 2019). Although they seem to rebel, too; prior audits increased cheating by men (Kastlunger et al., 2010). As is tax research in general, see Hakelberg & Seelkopf, this volume. See Celis et al. (2008) for the difference between descriptive and substantive representation.

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Taxation and gender  205 Buettner, T., Erbe, K., & Grimm, V. (2019). Tax planning of married couples and intra-household income inequality. Journal of Public Economics, 179, 104048. Casale, D. M. (2012). Indirect taxation and gender equity: Evidence from South Africa. Feminist Economics, 18(3), 25–54. Celis, K., Childs, S., Kantola, J., & Krook, M. L. (2008). Rethinking women’s substantive representation. Representation, 44(2), 99–110. Chattopadhyay, R., & Duflo, E. (2004). Women as policy makers: Evidence from a randomized policy experiment in India. Econometrica, 72(5), 1409–1443. Chung, J., & Trivedi, V. U. (2003). The effect of friendly persuasion and gender on tax compliance behavior. Journal of Business Ethics, 47(2), 133–145. Collins, M. L. (2020). Private pensions and the gender distribution of fiscal welfare. Social Policy and Society, 19(3), 500–516. Croson, R., & Gneezy, U. (2009). Gender differences in preferences. Journal of Economic Literature, 47(2), 448–474. D’Attoma, J., Volintiru, C., & Steinmo, S. (2017). Willing to share? Tax compliance and gender in Europe and America. Research and Politics, 4(2), 1–10. Dionne, K. Y. (2019). Analysis: There’s a gender gap in political science. Our series examines the problem – and looks at some solutions. Washington Post, August 19. Doorley, K. (2018). Taxation, Work and Gender Equality in Ireland (SSRN Scholarly Paper ID 3177369). Social Science Research Network. European Commission (1984). Memorandum on income taxation and equal treatment for men and women. Information Memo P-94/84, December 1984. EU Commission, Press Notice. Fallan, L. (1999). Gender, exposure to tax knowledge, and attitudes towards taxation: An experimental approach. Journal of Business Ethics, 18(2), 173–184. Fink, M., Janová, J., Nerudová, D., Pavel, J., Schratzenstaller, M., Sindermann-Sinkiewicz, F., & Spielauer, M. (2019). (Gender-differentiated) effects of changes in personal income taxation. Intereconomics, 54(3), 146–154. Freier, R., & Thomasius, S. (2016). Voters prefer more qualified mayors, but does it matter for public finances? Evidence for Germany. International Tax and Public Finance, 23(5), 875–910. Fuenmayor, A., Granell, R., & Mediavilla, M. (2018). The effects of separate taxation on labor participation of married couples: An empirical analysis using propensity score. Review of Economics of the Household, 16(2), 541–561. Funk, K. D., & Philips, A. Q. (2019). Representative budgeting: Women mayors and the composition of spending in local governments. Political Research Quarterly, 72(1), 19–33. Funk, P., & Gathmann, C. (2015). Gender gaps in policy making: Evidence from direct democracy in Switzerland. Economic Policy, 30(81), 141–181. Gayle, G.-L., & Shephard, A. (2019). Optimal taxation, marriage, home production, and family labor supply. Econometrica, 87(1), 291–326. Gërxhani, K. (2007). Explaining gender differences in tax evasion: The case of Tirana, Albania. Feminist Economics, 13(2), 119–155. Grown, C., & Valodia, I. (2010). Taxation and Gender Equity: A Comparative Analysis of Direct and Indirect Taxes in Developing and Developed Countries. Routledge. Grown, C., & Valodia, I. (2013). Gender, poverty and taxation: An overview of a multi-country study of gender and taxation. In J. Leaman & A. Waris (eds), Tax Justice and the Political Economy of Global Capitalism, 1945 to the Present, 2008–2224. Berghahn Books. Gunnarsson, Å., & Spangenberg, U. (2019). Gender equality and taxation policies in the EU. Intereconomics, 54(3), 141–146. Hasseldine, J., & Hite, P. A. (2003). Framing, gender and tax compliance. Journal of Economic Psychology, 24, 517–533. Himmelweit, S. (2002). Making visible the hidden economy: The case for gender-impact analysis of economic policy. Feminist Economics, 8(1), 49–70. Hiraga, M. (2018). How many companies are run by women, and why does it matter? World Bank Data Blog. Howard, C. (1999). The Hidden Welfare State: Tax Expenditures and Social Policy in the United States. Princeton University Press.

206  Handbook on the politics of taxation Hundsdoerfer, J., & Matthaei, E. (2020). Gender Discriminatory Taxes, Fairness Perception, and Labor Supply. Discussion Paper 2020/6. Free University Berlin. Jones, A. (2016). The fight against period shaming is going mainstream. Newsweek, April 20. Joshi, A., Kangave, J., & van den Boogaard, V. (2020). Gender and Tax Policies in the Global South. IDS. Kalíšková, K. (2013). Family Taxation and the Female Labor Supply: Evidence from the Czech Republic (SSRN Scholarly Paper ID 2358474). Social Science Research Network. Kastlunger, B., Dressler, S. G., Kirchler, E., Mittone, L., & Voracek, M. (2010). Sex differences in tax compliance: Differentiating between demographic sex, gender-role orientation, and prenatal masculinization (2D:4D). Journal of Economic Psychology, 31, 542–552. Komura, M., Ogawa, H., & Ogawa, Y. (2019). Optimal income taxation when couples have endogenous bargaining power. Economic Modelling, 83, 384–393. Lahey, K. (2018). Gender Taxation and Equality in Developing Countries. UN Women. Ligomeka, W. (2019). Expensive to be a Female Trader: The Reality of Taxation of Flea Market Traders in Zimbabwe. International Centre for Tax and Development. Lott, Jr., John R., & Kenny, L. W. (1999). Did women’s suffrage change the size and scope of government? Journal of Political Economy, 107(6), 1163–1198. Maloney, M. A. (1988). An analysis of direct taxes in India: A feminist perspective. Journal of the Indian Law Institute, 30(4), 397–414. McCaffery, E. (2009). Where’s the sex in fiscal sociology? Taxation and gender in comparative perspective. In A. K. Mehrotra, I. W. Martin, & M. Prasad (eds), The New Fiscal Sociology: Taxation in Comparative and Historical Perspective, 216–236. Cambridge University Press. McGee, R. W., & Tyler, M. (2006). Tax evasion and ethics: A demographic study of 33 countries. Working Paper. Andreas School of Business, Barry University. McMahon, S. H. (2015). Gendering the Marriage Penalty (SSRN Scholarly Paper ID 2658451). Social Science Research Network. Meier, V., & Rainer, H. (2015). Pigou meets Ramsey: Gender-based taxation with non-cooperative couples. European Economic Review, 77, 28–46. Morris, S. (2020). Jersey scraps “only husbands talk tax” rule. The Guardian, February 4. Mwondha, M., Kaidu Barugahara, T., Nakku Mubiru, M., Wasagali Kanaabi, S., & Isingoma Nalukwago, M. (2018). Why African Tax Authorities Should Employ More Women: Evidence from the Uganda Revenue Authority. International Centre for Tax and Development. Neumayer, E., & Plümper, T. (2017). Robustness Tests for Quantitative Research. Cambridge University Press. Ortiz-Ospina, E., Tzvetkova, S., & Roser, M. (2018). Women’s employment. Our World in Data. Paus, L. (2020). Wie unser Steuersystem Frauen benachteiligt. EDITION F, November 9. Perez, C. C. (2019). Invisible Women: Exposing Data Bias in a World Designed for Men. Random House. Reese, B., & Constantin, K. (2019). Gender, status, and tax offenses over time. Deviant Behavior. Rosen, H. S. (1977). Is it time to abandon joint filing? National Tax Journal, 30(4), 423–428. Rossignolo, D. (2018). Gender equity in the Argentine tax system: An estimation of tax burdens by household type. CEPAL Review, 124, 177–202. Ruel, E., & Hauser, R. M. (2013). Explaining the gender wealth gap. Demography, 50(4), 1155–1176. Schaefer, D. (2016). Distributional Effects of Taxing Financial Transactions and the Low Interest Rate Environment (SSRN Scholarly Paper ID 2864303). Social Science Research Network. Schratzenstaller, M., & Dellinger, F. (2017). Genderdifferenzierte Lenkungswirkungen des Abgabensystems. WIFO Studies. Schratzenstaller, M., & Wagener, A. (2009). The Austrian income tax tariff, 1955–2006. Empirica, 36(3), 309–330. Schumpeter, J. (1918). Die Krise des Steuerstaats. Leuschner and Lubensky. Seguino, S. (2019). Macroeconomic policy tools to finance gender equality. Development Policy Review, 37(4), 504–525. Selin, H. (2014). The rise in female employment and the role of tax incentives: An empirical analysis of the Swedish individual tax reform of 1971. International Tax and Public Finance, 21(5), 894–922. Siebert, M., & Mbise, A. (2018). Toilets Not Taxes: Gender Inequity in Dar es Salaam’s City Markets. International Centre for Tax and Development.

Taxation and gender  207 Slegten, C., Geys, B., & Heyndels, B. (2019). Sex differences in budgetary preferences among Flemish local politicians. Acta Politica, 54(4), 540–563. Slegten, C., & Heyndels, B. (2020). Within-party sex gaps in expenditure preferences among Flemish local politicians. Politics and Gender, 16(3), 768–791. Sorola, M., Karavidas, D., & Laheen, M. (2020). Addressing gender issues through the management of tax talent. Journal of Tax Administration, 6(1), 51–73. Spehar, A. (2015). Gender equality for whom? A critical frame analysis of the 2007 Swedish domestic services tax reform. Critical Social Policy, 35(3), 350–368. Spicer, M. W., & Becker, L. A. (1980). Fiscal inequity and tax evasion: An experimental approach. National Tax Journal, 33(2), 171–175. Stewart, M. (2017). Tax, Social Policy and Gender. ANU Press. Stotsky, J. G. (1996). Gender Bias in Tax Systems. International Monetary Fund. Torgler, B., & Valev, N. T. (2010). Gender and public attitudes toward corruption and tax evasion. Contemporary Economic Policy, 28(4), 554–568. van den Boogaard, V. (2018). Gender and the Formal and Informal Systems of Local Public Finance in Sierra Leone. International Centre for Tax and Development. Woolley, F. (2011). Review of Taxation and Gender Equity: A Comparative Analysis of Direct and Indirect Taxes in Developing and Developed Countries, edited by C. Grown & I. Valodia. Feminist Economics, 17(2), 148–152. Young, C. (2000). Women, Tax and Social Programs: The Gendered Impact of Funding Social Programs through the Tax System (SSRN Scholarly Paper ID 1597446). Social Science Research Network.

14. The politics of green taxation Lena Maria Schaffer

1. INTRODUCTION Human activity, especially the industrial activity on which our economy is based, creates negative externalities for individuals and society at large. Production and transport pollute the local and global environments, imposing costs on everyone often without compensation (Tol, 2011). As pollution becomes a salient issue for affected citizens, policymakers especially in democracies need to react for electoral purposes (Congleton, 1992; Bernauer & Koubi, 2009). Environmental or green taxes are an important instrument in this regard. When markets do not take environmental harm into account, green taxes provide a price for pollution, thereby (partially) internalizing the social cost of the underlying economic activity. In essence, they shift the cost back from society towards those responsible for the damage and provide them with an economic incentive to reduce pollution (Pigou, 1920). Instead of strictly regulating a given amount of pollution, the set-up of an environmental tax is flexible to the point that those polluters who cannot easily cut back on detrimental behavior at least need to pay for it. While the implication that richer companies and individuals can buy themselves out is criticized by environmental groups or “deep greens” (Beder, 1996), the notion that green taxes are a flexible and cost-efficient solution to combatting externalities from environmental pollution remains widespread. Green taxes have been part of policymakers’ toolboxes for quite some time.1 While some countries’ ecological taxes date back to the 1920s, the environmental movements of the 1970s and 1980s were crucial to the wider diffusion of environmental taxes as instruments of environmental policy alongside other market-based solutions such as cap-and-trade. More recently, political pressure to decrease greenhouse gas (GHG) emissions in view of fighting climate change has mounted and carbon taxes (as a green tax on carbon emissions) have gained prominence for governments and scholars alike. Their general importance and recent application to carbon emissions give us a good reason to look at green taxes from a political science perspective. So far, the field is dominated by research from economists. For example, while a huge literature on the design of green taxes in economics provides policymakers with advice on how to design taxes that are economically efficient in reducing pollution, political scientists will be interested in which taxes are acceptable to the public and come at the lowest political cost (Daugbjerg & Svendsen, 2003; Fairbrother, 2017). Hence, the chapter argues that political science research on green taxes, while acknowledging and complementing existing literature in economics, may stress different research questions with respect to green taxes. First and most obviously, comparative political economy research into the conditions under which green taxes are adopted or discarded – i.e. which actors or institutions are pivotal – is still needed. While there is a fair amount of case studies on the comparative politics of green taxes (Andersen, 2019; Daugbjerg & Svendsen, 2003; Jordan et al., 2005; Harrison, 2010), systematic, large-N comparative inquiries remain rare (c.f. Best & Zhang, 2020; Castiglione 208

The politics of green taxation  209 et al., 2014; Skovgaard et al., 2019, Ward & Cao, 2012). More specifically, although carbon taxes are arguably the most potent instrument for fighting climate change, only 25 countries had implemented a nationwide carbon tax at the time of writing (see Section 4). This demands further political economy inquiries into the constraints that issues of public acceptance and interest group influence impose on policymakers. Second, there are still gaps with respect to what happens after the adoption of a policy. While the economics literature focuses heavily on effectiveness, political science research is concerned with political feedback effects. Do green taxes come at a (long-term) political cost for policymakers because of the resistance they entail (e.g. yellow vest movement)? Hence, this chapter’s purpose is not to survey – comprehensively or otherwise – the extant economic and political science literature on green taxation. It rather gives the reader an introduction to the topic of green taxes and their most important causes and consequences from a political economy perspective. As a special add-on, the chapter takes carbon taxes as a topical and prominent example of green taxation and discusses potential avenues and challenges for political science research in the context of climate change.

2.

ENVIRONMENTAL OR “GREEN” TAXATION

Taxation provides national governments with the most forceful means to steer citizens’ behavior. Besides the more well-known taxes on consumption, labor and capital, there are environmental taxes. The definition employed by Eurostat makes the link to the environment very clear: “A tax whose tax base is a physical unit (or a proxy of a physical unit) of something that has a proven, specific negative impact on the environment, and which is identified [in the European system of accounts] as a tax” (Eurostat, 2019). This definition puts emphasis on the effect of the tax, meaning that a tax becomes an environmental one because it increases the price of products harmful to the environment or makes pollutive activity more costly. Thus, the tax’s effect comes from its impact on relative prices and the level of activity. Alternatively, one may classify taxes whose revenue is earmarked for specific environmental purposes as environmental taxes. Earmarked taxes are indeed a subset of environmental taxes but not all environmental taxes according to our definition will necessarily be earmarked towards environmental purposes (Eurostat, 2013). Green taxes can help reduce a huge array of environmental problems, including air and water pollution, climate change and waste disposal, to name but a few. Moreover, they are economically efficient and generate revenue for the government. Rather than increased revenue, however, green taxes primarily aim at a behavioral change towards more environmentally friendly action and consumption. To unfold their full potential in this regard, environmental taxes need to be properly designed (Aldy & Stavins, 2012). Accordingly, the richest literature on green taxes is within environmental economics, discussing mostly the optimal shape of green taxes with respect to tax base, tax rate and the use of revenue. 2.1

Designing Green Taxes

For a green tax to be most effective, its tax base should be as close as possible to the source of pollution (Oates, 1995). Typically, the tax base refers either to a certain polluting substance (e.g. sulfur dioxide, nitrogen oxides) or to a proxy (e.g. fuel use). In order to get a better

210  Handbook on the politics of taxation Table 14.1

Environmental tax category used by Eurostat and example taxes on different bases in each category

Category (Eurostat)

Exemplary tax on base

Energy

Taxes on leaded petrol, diesel, fuel oil, etc.(energy products for transport purposes) Taxes on heavy or light fuel oil, natural gas, coal Taxes on electricity consumption Taxes on carbon content of fuels or greenhouse gas emissions

Transport

Registration and use of motor vehicles (e.g. yearly taxes) Road use taxes Taxes on flights and flight tickets

Pollution

Taxes on measured or estimated pollution from nitrogen or sulfur oxides (excluding carbon dioxide) Taxes on chlorofluorocarbon Taxes on water pollution from biological oxygen demand

Source: This is an excerpt, the full list can be retrieved from Eurostat (2020).

understanding of what environmental taxes (according to the definition used here) entail, we can take a look at Table 14.1. Energy taxes make up the largest share as they cover energy products for transport as well as a significant part of air pollution, including emissions of carbon dioxide (CO2) and other GHGs (i.e. carbon taxes). While this may seem odd, the centrality of reduced energy production and consumption to combatting climate change cannot be underestimated, as energy consumption remains the number one contributor to national CO2 emissions (Schaffer & Lüth, 2021). In a Pigouvian setting, the tax rate should be set to the marginal social damage from producing an additional unit of e.g. pollutant emissions (Metcalf, 2009). Marginal social damage is, however, very hard to determine as it varies with different pollutants (Lee & Misiolek, 1986) and depends on the elasticity of the tax base (Oates, 1995). The most important discussions regarding the design of green taxes center on the use of the revenue they bring in. In this context, the double dividend of environmental taxes debated in the economics literature merits mention (Goulder, 1994; Jaeger, 2013). The argument here is that revenue from environmental taxation can be used to finance reductions in preexisting distortionary taxes (e.g. taxes on labor), thereby making the entire tax system more efficient (Pearce, 1991). For a green tax to yield this double dividend and become a cost-effective instrument for the reduction of pollution, it should be issued uniformly (Lee & Misiolek, 1986). However, the reality is that most countries have differentiated tax levels for different groups, with consumers being taxed relatively more than industry (Svendsen et al., 2001), owing to their larger group size (Olson, 1965).2 Nevertheless, according to a recent review of simulation studies, Maxim and Zander (2019) found that green tax reforms yield a double dividend in employment, at least in their European sample. While using the revenue from green taxes to lower other more distortionary taxes maximizes their net social benefit from an economics perspective (Jaeger, 2013; Oates, 1995), other options are conceivable. These include the funding of environmental activities that clean up pollution, investment in research and development of more efficient energy technology, and the compensation of potential losers from the introduction or increase of regressive green taxes on energy consumption. Indeed, it is important to stress that suggestions from economists as to the optimal design of green taxes are different from what people and, by implication, democratic policymakers perceive as acceptable. Institutions and the reality of political friction are too often ignored in the corresponding literature (Daugbjerg & Svendsen, 2003). Hence,

The politics of green taxation  211 the field certainly would profit from more contributions discussing the trilemma between environmental effectiveness, economic efficiency and political feasibility of green taxes from a political science and political economy perspective (Baranzini & Carattini, 2017; Carattini et al., 2018; Thalmann, 2004). 2.2

Historical Evolution of Green Taxes

Green taxes as an environmental policy instrument have increasingly appeared from the 1980s onwards (Jordan et al., 2005). Although some countries’ ecological taxes date back to the 1920s, the environmental movements of the 1970s and 1980s were crucial to the diffusion of environmental taxes as instruments of environmental policy alongside other market-based solutions such as cap-and-trade. The turn away from more traditional command and control regulation is attributed first to an increased orientation in general public policy towards market mechanisms and second to the realization that markets may invoke the polluter-pays principle at less cost to the economy (Ekins, 1999; Parson & Kravitz, 2013; Stavins & Whitehead, 1992). Moreover, international bodies have increasingly stressed the usefulness of market-based instruments for combatting environmental problems early on and recommended – inter alia – green taxes. The 1987 report of the World Commission on Environment and Development3 (1987) and the Organisation for Economic Co-operation and Development’s Economic Instruments for Environmental Protection report (OECD, 1989) both promoted the use of market-based instruments among their respective members. In Europe, the European Union (EU) played an important role in spreading and facilitating the adoption by member states of new market-based instruments of environmental policy. As early as 1990, the European Commission proposed a European carbon energy tax (Ekins, 1999). Over the past 30 years, it continuously attempted to harmonize environmental policies, focusing on the promotion of market-based instruments. As an example, the 7th Environmental Action Programme that covers the period until 2020 mentions the shift from taxes on labor towards taxes on pollution as one of its main objectives (European Commission, 2013).4 In fact, the much broader literature on the global convergence of environmental policies has identified supra- and international organizations as one important driving factor (Holzinger et al., 2008; Ward & Cao, 2012; Tews et al., 2003). This literature argues that the international diffusion of ideas and approaches in environmental protection needs to be accounted for when explaining national environmental policy and instrument choice. These driving factors notwithstanding, the pace of policy diffusion across countries slowed down significantly after frontrunning Scandinavian countries had adopted green taxes by the early 1990s (Finland and Sweden in 1990; followed by Norway and Denmark in 1991 and 1992, respectively) (Tews et al., 2003). Following the script provided by economists and international organizations, however, green tax adoptions were indeed part of larger ecological tax reforms that shifted the tax burden away from labor and/or capital towards pollution (e.g. Finland 1990, Germany 1999) (Ekins, 1999; Stavins, 2003). Overall, despite their theoretical benefits, it took some time until green taxes were introduced across different country contexts.

212  Handbook on the politics of taxation 2.3

Differences between Countries

As Figure 14.1 shows, environmental taxes on average relate to about 6 percent of total tax revenue and social contributions (TSC) across EU member states today.5 While revenue from green taxes has grown by around 100 billion euros in the EU, the share of green taxes of TSC has been relatively stable since 2002. Figure 14.1 also reveals the contribution of different kinds of environmental taxes to total revenue. Energy taxes have provided the largest and ever increasing share, whereas the relative contribution of other environmental taxes on transport and pollution is small and has not changed much over time. In terms of their effectiveness, research suggests that existing green taxes (on CO2 emission, waste treatment or vehicle excise duties) have a positive impact on environmental quality (Martin & Scott, 2003; Scrimgeour et al., 2005, among others) and economic performance (Scrimgeour et al., 2005). Although green taxes are widely applied, this fact should not conceal that other consequential policy instruments counter their effect, most importantly the generous fossil fuel subsidies many countries still provide (Coady et al., 2017). Moreover, expenditures and rebates built into a country’s tax system may weaken incentives created by green taxes (also see von Haldenwang et al., this volume). In Germany, for example, the commuter flat rate (Entfernungspauschale), which is intended to help taxpayers shoulder the costs of a longer commute, does not differentiate between environmentally friendly means of transport (bike, train, electric car) or taking a regular car. It is therefore likely to counteract the incentives provided by green taxes. While Figure 14.1 reveals temporal variance with respect to green tax revenue for all EU states, Figure 14.2 presents a cross-section for the year 2018. In comparing countries’ environmental tax revenues, we can see from Figure 14.2 that both the composition of green tax revenue as well as the share of total revenue vary widely across countries. While transport taxes and energy taxes make up a nearly equal share in Denmark and Malta, other countries like Estonia and Latvia heavily rely on energy taxes in their green tax mix. A few countries directly tax carbon, while many countries have excise taxes on energy that also have some effect on carbon emissions.

Source: Eurostat.

Figure 14.1

Environmental tax revenue by type and total environmental taxes as shares of total government revenue from taxes and social contributions and of the gross domestic product of the European Union, 2002–2018

The politics of green taxation  213

Source: Eurostat.

Figure 14.2

Environmental tax revenue by category as percentage of taxes and social contributions and of the gross domestic product of the European Union, 2018

Overall, although green taxes have become more popular and more widely applied, there is considerable variation between countries with respect to the adoption, level and scope of green taxes. How can we account for these differences?

3.

THE COMPARATIVE POLITICS OF ENVIRONMENTAL TAXATION

What explains the adoption of green taxes and why do some countries tax detrimental environmental behavior more or more comprehensively than others? As one can see from Figure 14.2, there exists considerable variation across countries with respect to the scope and levels of green taxation. Attempts to explain this cross-country variation within a large-N political or political economic framework, however, are rare (Castiglione et al., 2014; Ward & Cao, 2012).6 Ward and Cao’s (2012) study is one of the few systematic comparative efforts explaining spatial and temporal differences in green taxes as a function of domestic and international determinants. They find that, left–right and environmental positions of legislative medians7 as well as the power of the energy-producing sector are significant predictors of a country’s level of green taxes. With respect to international factors, trade and international environmental governance networks are found to matter for national green taxation. Recent work by Skovgaard et al. (2019) scrutinizes the determinants of carbon tax adoption in different clusters and finds the determinants to differ between clusters. First adopters, for instance, reacted mostly to domestic economic and fiscal concerns, whereas more recent adoptions can best be explained by international environmental commitments. In addition to these large-N analyses, several case studies explain the adoption of green or carbon taxes in different countries (Andersen, 2019; Mildenberger, 2020) or single countries (Beuermann & Santarius, 2006 for Germany; Clinch & Dunne, 2006 for Ireland; Deroubaix & François, 2006 for France; Dresner et al., 2006 for the United Kingdom; Kotchen et al., 2017 for the United States) or discuss the public

214  Handbook on the politics of taxation and business communities’ knowledge of ecological tax reform (c.f. Dresner et al., 2006; and the contributions to the 2006 special issue of Energy Policy, 34(8) with papers on Denmark, Germany, France, United Kingdom and Ireland). The following subsections give a brief overview of important domestic and international factors identified within (comparative) political science research as potential determinants of the scope and level of green taxation. 3.1 Institutions With respect to the supply side of environmental policy, scholars have argued that non-democratic political systems are likely to underprovide public goods, including environmental quality (Bernauer & Koubi, 2009; Lake & Baum, 2001; Bueno de Mesquita et al., 2003). The reasoning behind these claims is that the median voter in a democracy incurs lower marginal costs from stricter environmental policies than economic and political elites in non-democracies (Bättig & Bernauer, 2009). Empirically, democracies are found to be more likely than other forms of government to implement more stringent environmental regulations domestically and to support their adoption at the international level (Neumayer, 2002; Bernauer et al., 2010). They are also more likely to provide environmental public goods (Ward, 2008). With respect to the levels of carbon prices, including both carbon taxes and emissions trading systems, Dolphin et al. (2020) show that democracies are indeed associated with higher carbon prices (on the impact of political regimes on taxation also see Andersson, this volume and von Haldenwang, this volume).8 In comparing democracies, the question remains, which institutional settings determine the adoption of green taxes as well as their level and scope? Concerning the electoral system, empirical evidence suggests that countries with proportional representation (PR) systems are generally more active in environmental policymaking than countries with majoritarian systems (Schaffer & Bernauer, 2014). Fredriksson and Millimet (2004) identify a corresponding relationship when looking at gasoline taxes. They argue that parties in PR systems need to consider the welfare of the entire population and thus pay greater attention to issues of regional or national scope like transboundary pollution. The emergence of small parties focused on environmental protection in PR systems has moreover proven particularly conducive to the adoption and level of green taxes (Harrison, 2010). Similarly, Lachapelle (2011) shows that PR systems are linked to the general adoption of energy taxes as well as to higher energy taxes, but he argues that this effect is conditional on the ideological make-up of the government. Broz and Maliniak (2010) make another interesting argument concerning the electoral system. They explain the level of a country’s gasoline taxes with the malapportionment of its electoral districts. If a single vote weighs differently depending on the electoral district, the parliament of a certain country is not perfectly apportioned (Samuels & Snyder, 2001). Malapportionment often implies overrepresentation of rural populations. Rural citizens are more dependent on cheap mobility, and therefore more likely to oppose excise taxes on gasoline. Concerns for re-election then lead representatives from rural areas to oppose taxes on gasoline (on the impact of electoral systems on taxation also see Haffert, this volume and Kemmerling & Truchlewski, this volume).

The politics of green taxation  215 3.2 Interests Public policy may fall short of adequately addressing environmental problems when there are distributional coalitions, including special interest groups, that gain the upper hand in influencing the policy. Research usually finds that energy-intensive sectors have considerable sway over the level of energy taxation (Svendsen et al., 2001; Ward & Cao, 2012). Members of powerful lobbies also tend to be exempted from green taxes for reasons of national competitiveness (Ekins & Speck, 1999; Stavins, 2003). As energy-intensive industries will have more to lose from energy or carbon taxes and are fewer in number than the mass of consumers (Olson, 1965), they may more easily organize successful resistance against ecological or carbon tax reform. Similarly, small groups of producers may be able to obtain opt-outs or special treatments (Aidt, 1998), shifting the burden of green taxation to consumers, who are difficult to organize because of their large group size (Olson, 1965). Accordingly, lobbying to either prevent or attain exemptions for energy-intensive activities has important implications. First, the resulting green tax will not be uniform (see above) and thus not as environmentally effective as theory suggests (Harrison, 2010). Second, consumers will bear the brunt of the burden (Svendsen et al., 2001), potentially exacerbating existing popular resistance against green taxes. Obviously, the politics of carbon taxes do not stop with the individual. The centrality of fossil fuels within the economies leads to a “double representation” of fossil fuel interest within political processes. In his recent book, Mildenberger (2020) explains hesitant climate policies inter alia with the double representation of carbon interests (polluters) within business and labor organizations. Thus, irrespective of the party or coalition in power, carbon polluters within trade unions or business organizations have a say, underlining the significance of sectoral cross-class coalitions in preventing progressive reforms (also see Haffert, this volume). So far, however, the role of intermediaries in the adoption of green taxes remains understudied. As public opinion is crucial for policymakers in democracies (Shapiro, 2011) and policymakers try to be responsive to their electorate (Wlezien, 1995), we would expect that the public’s stance on green taxes is a powerful determinant of their success. Accordingly, there is a vast literature on the acceptance of green taxes, which usually comes from surveys or single-country case studies (Cherry et al., 2012, 2014; Jagers & Hammar, 2009; Jagers et al., 2018; Kallbekken & Aasen, 2010; Kallbekken & Sælen, 2011). There is an increasing number of comparative accounts that specifically cover public opinion with respect to carbon taxes as we will elaborate in Section 4. What role do political parties play and which parties are associated with the adoption of green taxes? Authors such as Holzinger et al. (2008) and Ward and Cao (2012) have studied the influence of green parties in the lower house of national legislatures on environmental (tax) policies. While shifting the legislative median towards the right is associated with a lower probability of adopting green taxes, they do not find a stable positive and significant effect of green parties on green taxes.9 In his case study of the adoption of carbon taxes in seven countries, Andersen (2019) similarly finds that while green parties were important for advocating carbon taxation, their role in adoption was not always explicit. He instead stresses the importance of social democratic parties in bringing about carbon taxation in the Nordic countries. Skovgaard et al. (2019) attest to the importance of both left and green parties for the adoption of green taxes, whereas Schaffer et al. (forthcoming) show that left parties are more responsive in climate change policy compared to center and right-wing parties. In general,

216  Handbook on the politics of taxation left parties are also and more likely to adopt market-based climate instruments (Schaffer & Bernauer, 2014). Similarly, Svendsen et al. (2001) argue that the adoption of green taxes is less likely for center-right parties because of their linkages with producer interests. Political parties transport citizens’ policy preferences into government (Sartori, 1976). In light of the current public salience of climate change and the increasing objective need to enact more ambitious and more effective climate policies, studying how political parties position themselves towards green taxation is a promising research area (Buzogány & Ćetković, 2021; Carter et al., 2018; Schaffer & Lüth, 2021). One caveat is that explicit stances towards climate and energy policy are not featured in prominent datasets for measuring party positions and issue salience such as the Comparative Manifesto Project (Volkens et al., 2019). Hence, with green and especially climate change policy increasingly becoming an integral part of party competition in many countries, more research into parties’ strategic positioning with respect to climate change is clearly needed. 3.3

Alternative Instruments

While green taxes are an effective instrument in internalizing problems of environmental pollution, other market-based instruments as well as regulatory or voluntary instruments exist (Stavins, 2003; Baumol & Oates, 1971; Goulder & Parry, 2008; Harring, 2016). Policymakers may decide upon alternative policy instruments to deal with both environmental pollution and climate change (Schaffer & Levis, 2021). For example, with respect to climate change, energy consumption within the transport, building and electricity sector make up the largest contribution to CO2 emissions. Thus, changing energy consumption remains the most important goal to reduce emissions. This goal can be achieved either by incentivizing people to save energy and be more energy efficient (the way energy is consumed) or by shifting energy supply towards renewable energy (the way energy is produced). A carbon tax relates to the former perspective as it essentially puts a tariff on the use of fossil energy, thereby incentivizing energy-efficient behavior. Alternative policy instruments instead may focus on changing the way energy is produced. For example, subsidies for renewable energy generation aim to decrease the share of fossil fuels within a country’s energy mix (Schaffer & Bernauer, 2014). In implementing climate change policies, most nations follow a roughly similar pattern starting from green industrial policy (via investment in research and development and subsidies) to later add pricing policies and finally ratchet up the policy mix (Meckling et al., 2015; Pahle et al., 2018). This increased stringency of climate policy portfolios to include carbon pricing policies is warranted because reductions still are not enough to achieve the goals of the Paris Agreement. Moreover, functionally equivalent or similar alternatives to pricing carbon emissions exist with the most relevant other market-based mechanism being an emissions trading system (in theory both are functional equivalents, see Weitzman, 2017).10 Most governments have historically opted either for one or the other but “hybridization” – i.e. using both policy instruments (Meckling & Jenner, 2016; Howlett, 2004) – has become more widespread. Alternative instrument choices certainly also depend on the configuration of interests and institutions mentioned above. However, it is important to figure in previous choices, i.e. the existing policy mix (Meckling et al., 2015), as well as policy alternatives (Genovese et al., 2017), when explaining the comparative politics of green as well as carbon taxes. Thus, generally more research into the composition of policy portfolios as well as their effect on overall

The politics of green taxation  217 effectiveness and distributional aspects is needed. Moreover, future research in the comparative political economy of green and especially carbon taxes may strive to empirically model such alternative choices or trade-offs in instrument composition more directly (for example by borrowing from the statistical literature on compositional data, c.f. Philips et al., 2016). The following section now zooms in to explain the adoption and level of carbon taxes in more detail. Particularly two important challenges are stressed in this section, which emanate from the global public goods problem at hand and thus are different from more localized environmental problems such as air or water pollution. First, issues of public acceptance loom large with respect to carbon taxes compared to environmental taxes that are introduced to combat more localized problems. Second, the global dimension makes the international strategic concerns even more salient.

4.

CHALLENGES OF TAXING CARBON

Climate change is one of the most pressing problems facing mankind in the twenty-first century. In order to reverse climate change, harmful GHGs have to be significantly reduced. The Paris Agreement of 2015 as the successor of the Kyoto Protocol commits countries to take action and limit the increase in global temperature to 2°C compared to pre-industrial levels. However, recent estimates see the world on track for an increase of around 3.5°C if current efforts are not stepped up significantly. Strikingly, climate change has become an increasingly salient topic for the general public and economists have advocated for carbon taxes as an effective and efficient solution for decades (Tol, 2011). The tool is readily applicable, but carbon taxes still remain an unpopular choice for policymakers. The following subsections investigate why. 4.1

Public Acceptance: Why Are Carbon Taxes (Still) Comparatively Uncommon?

Policies that target the economy’s carbon intensity not only help to solve climate change, but also generate private distributional effects for industries (producers) and individuals (consumers). Among industries, especially carbon-intensive sectors may lose out from carbon taxation. Among individuals, poorer households may be affected disproportionately, given that they generally spend a larger share of their income on activities that are made more costly by a carbon tax, including heating, electricity and transport (Aldy & Stavins, 2012; Kosonen, 2012). After all, carbon taxes remain regressive taxes on consumption. Likewise, rural inhabitants are adversely affected by carbon taxes due to differences in mobility and land use patterns. Compared to people living in urban areas, rural citizens are more dependent on private means of transportation and cannot rely on well-functioning public transport. Given the distributional consequences for different groups in society, the public’s support for carbon taxation cannot be taken for granted, as the recent yellow vest protest in France and several failed referenda in Switzerland have painfully shown (Thalmann, 2004; Carattini et al., 2017; Stadelmann-Steffen, 2011). In order to keep voters on board and sustain national efforts to reduce the carbon intensity of industrialized economies the determinants of public acceptance of carbon taxes have to be understood. This is what a large part of the literature on carbon taxes has sought to achieve in recent years.

218  Handbook on the politics of taxation As we can see from Figure 14.3, there is considerable cross-country variation in respondents’ support or opposition to higher taxes on fossil fuels such as oil, gas or coal (ESS, 2016). This is irrespective of whether the country already has carbon taxes in place or not. Interestingly, mean support is highest in the Scandinavian countries (and Switzerland), which already have high carbon taxes in place. Umit and Schaffer (2020) use data from the European Social Survey (ESS) to explain preferences for higher carbon taxes within a multilevel and large-N context. They find that a high level of political trust11 and external political efficacy (the extent to which citizens feel they have a say in politics) matter for the support of carbon taxes. Overall, political trust generally is a robust predictor of individual support for climate policy (Drews & Van den Bergh, 2016) as well as for environmental taxes (Dresner et al., 2006). Using similar data from the ESS, Fairbrother et al. (2019) also find political trust to matter in a model including multilevel factors. In comparing the conditional effect of trust and quality of government on the public’s support for different policy instruments (taxes, subsidies and bans), Davidovic and Harring (2020) find that political trust and quality of government are crucial only for carbon taxes. Using a machine-learning method on the individual-level ESS data, Levi (2021) can also show that compared to other climate policies, political trust seems to matter most with respect to carbon taxes. While the centrality of political trust for attitudes towards carbon taxes might be empirically well founded, more general research into the causal foundations of political trust, and which institutions and actors can create or enhance individual levels of political trust, is clearly needed. And while trust is hard to increase, empirical studies show that support is higher when legislation clearly specifies how revenues will be used (Carattini et al., 2018; Dresner et al., 2006; Kallbekken & Sælen, 2011; Thalmann, 2004). Similarly, empirical evidence with respect to carbon taxation shows that revenue recycling is considered to be a feasible option by the surveyed public and has been positively linked to the acceptance of carbon taxes or to increases in the tax in Sweden (Jagers et al., 2018), Switzerland (Carattini et al., 2017), Germany, and the United States (Beiser-McGrath & Bernauer, 2019). However, the increase in acceptance is not unconditional. For example, Jagers et al. (2019) find that support for compensatory measures depends on individual ideology, while Beiser-McGrath and Bernauer (2019) find variation with respect to other countries’ similar efforts, indicating that national efforts need to be backed up by broad global coverage, a point to which we will return later. Overall, research suggests that revenue recycling as well as environmental (Dresner et al., 2006; Kallbekken & Sælen, 2011) or technological (Hsu et al., 2008) earmarking are associated with higher levels of acceptance and may help to counter concerns about disproportional burdens for some groups in society (Carattini et al., 2019; Drews & Van den Bergh, 2016). In recognizing that carbon taxes are politically very hard to sell to citizens, Rabe and Borick (2012) scrutinize to what extent American states and Canadian provinces have strategically stepped away from calling a new policy targeted at pricing carbon tax. They find some indication that the expected steep political price of carbon tax introduction lets policymakers achieve their ends via relabeling or indirect carbon taxes. In this context, future (comparative) research could further determine whether people’s aversion against carbon taxes differs from an aversion against other taxes and what role fairness norms play in this regard (Drews & Van den Bergh, 2016). The great challenge with respect to the public acceptance of carbon taxation comes from the fact that national efforts to achieve the Paris Agreement’s goals will need to become more encompassing and stringent within a very short time. Adopting or increasing the levels of

The politics of green taxation  219

Source:

Country averages: ESS (2016); own illustration.

Figure 14.3

Attitudes towards higher taxes on gasoline

carbon taxes represents a potent policy instrument for steering individual behavior in theory. A careful consideration of policy design needs a clear evaluation and communication on how revenues from taxes will be spent. Also, the impact of the tax on inequality or vulnerable groups in society needs to be considered (Schaffer, 2021). If neglected, policy change might be unpopular and/or lead to increasing politicization as the yellow vest protests in France have recently demonstrated (Carattini et al., 2019; Douenne & Fabre, 2020). Even a backlash against climate policy as a whole is conceivable. The consequences of popular discontent for the global fight against global warming would be dire. And while domestic public acceptance of carbon taxes depends on a plethora of domestic factors as we have seen above, research has found evidence that support for (higher) taxes might be conditional on other countries’ efforts (Beiser-McGrath & Bernauer, 2019).12 This has to do with the global public good nature of the climate change problem. 4.2

Global Problem: What Are the International Implications of Carbon Taxes?

The environmental problem associated with climate change can best be described as a global public goods problem. Due to the indivisible atmosphere in which GHGs are deposited, mit-

220  Handbook on the politics of taxation igating GHG emissions in one country will help to combat global climate change, whereas emitting GHG emissions in another country will worsen global warming. Proceeding from this problem set-up, there should ideally be a uniform global tax on carbon that puts the same price on emissions everywhere. As we know from international relations theory, however, the prevalence of anarchy in the international system makes all cooperation voluntary. National governments remain sovereign in their choice of mitigation measures. While under the Kyoto Protocol states had predetermined cuts in GHG emissions to fulfill, the 2015 Paris Agreement departs from this idea to the extent that there is only the goal of limiting global warming to increases of 1.5°C or below 2°C compared to pre-industrial levels. Nationally determined contributions document national governments’ climate policies and progress towards this goal. Recent years, however, have seen little progress towards the Paris goal and the gap between the emissions trajectory towards even a 2°C increase and the current trajectory widens (UNEP, 2019). This underscores the need for more effective and stringent climate policies. Consequently, the adoption as well as the strengthening of carbon taxes becomes an increasingly important issue both within states’ domestic politics and on a global scale. Dealing with carbon emissions as a global externality complicates international cooperation to solve the climate change problem as free-riding issues and competitiveness concerns especially in the area of international trade loom large. Thus, any decision with respect to domestic carbon pricing has implications for a country’s international trade relations. A high domestic carbon tax weakens the competitive position of e.g. energy-intensive industries, which might then decide to relocate to places with less ambitious climate policies. Such emission leakage (Aldy & Stavins, 2012) as well as problems of carbon leakage through international trade affect countries’ willingness to commit to higher carbon prices (Helm et al., 2012; Barker et al., 2007; Carattini et al., 2019). These interconnections forcefully highlight globalization and climate change as two interdependent challenges to nation states’ policymaking (Kono, 2019; Bernauer & Nguyen, 2015). Bringing the literature on globalization’s (distributional) impact on policymaking and the nation state’s room to maneuver together with the (still scarcely populated) political science literature on climate change’s (distributional) impact will be a fruitful and much needed addition in future research. But not only nation states need to be considered under this double challenge. The reconciliation of effective climate policy with free international trade needs to be achieved in international organizations. For example, measures such as the border carbon adjustment mechanism announced by the EU as part of its Green Deal (European Commission, 2019) need to be scrutinized for their legality under existing rules of the World Trade Organization (Cottier, 2009). In their recent contribution, Van den Bergh et al. (2020) have forcefully argued for an international harmonization of carbon pricing and for carbon coalitions. These voluntary “clubs” would start to cooperate internally on a unified carbon price and externally employ border adjustment on imports into the club. Such international cooperation may not only help to minimize trade frictions and competitiveness concerns but may also decrease public opposition to carbon taxes (Van den Bergh et al., 2020).

The politics of green taxation  221

5. CONCLUSION In trying to rid their countries’ economies of the reliance on energy generated by fossil fuels, green taxes provide policymakers with powerful instruments for the steering of public behavior. However, they are by no means a panacea. Great care and thought have to be put both into issues of designing green taxes and communicating the workings of these taxes to the public. Policymakers need to design effective taxes, while being lobbied by interest groups for narrow coverage or targeted exemptions. At the same time, their parties electorally compete on green taxes as well. Politicization of public opinion and increased resistance might thus lead to less ambition on the part of policymakers. Throughout this chapter, I have pointed to various areas where research in comparative political economy may add to these debates. In terms of institutions we still know comparatively little on how institutions might help or hinder both the adoption and the level and scope of green taxes. Also, regarding interests, the way parties politicize environmental taxes or strategically position themselves regarding carbon taxation is an understudied area. While there is already extensive survey research on the individual acceptance of green and carbon taxes, important questions remain regarding e.g. the concrete aspects of (social) compensation that people would consider to lessen the regressive impact of a carbon tax. Also, tax scholars may determine whether people’s aversion against carbon taxes differs from an aversion against other taxes and what role fairness norms play in this regard. Alternative policy instruments and their goals as well as the overall national policy mix needs to be taken into account theoretically as well as in empirically modeling the comparative political economy of green and carbon taxes. On a more general note, the chapter wants to stress that the issue of taxation should not be viewed in isolation, but that e.g. issues of social policy to help distributive implications need to also be considered. Lastly, from a “second image reversed” (Gourevitch, 1978) perspective, the chapter has argued that future contributions may pay more attention to the dual impact of global climate change and globalization on the nation state’s room to maneuver in policymaking. The general issue of green taxes and especially carbon taxes is here to stay and political science research can and already does contribute to gathering important knowledge on public policy processes, the comparative politics of green taxes as well as the international dimension especially with respect to global public bads (global warming, ozone depletion). Recent analyses of the levels and coverages of existing carbon pricing systems (Dolphin et al., 2020), however, show that pricing policies represent a small share of world emissions and that the price level still is way too low to reach the targets of the Paris Agreement. Moreover, they argue that two things are problematic in considering the future of carbon pricing. First, they find that especially countries in which both economic and political costs associated with carbon pricing are low have adopted such schemes. Likewise, Levi et al. (2020) find that in places with higher per capita emissions prices are significantly lower. A second problem that Dolphin et al. (2020) identify is that current levels of stringency are hard to strengthen because of popular and interest group resistance. Against this background, some scholars (Green, 2020; Mildenberger & Stokes, 2020) have recently suggested that carbon taxes are not working in practice and have limited impact on reducing CO2 emissions (Green, 2021). Rather than shouldering the immense political costs associated with such taxes, policymakers should concentrate on regulation, investment and justice issues when fighting climate change (Mildenberger & Stokes, 2020). Others (Douenne & Fabre, 2020) have suggested that a com-

222  Handbook on the politics of taxation bination of climate policies addressing distributive concerns and a better communication of climate change policies may be more acceptable than a single price signal given through a carbon tax. Currently, it stands as a given that we need to change the way we produce and use energy if we want to avert dangerous climate change. Which policy instrument or which mix of policy instruments will prove to be the most successful in solving the trilemma of environmental effectiveness, economic efficiency and political feasibility and whether green or carbon taxes will play the decisive role remains an open question. On the basis of current research, policymakers are advised to design green taxes that are as uniformly applied as possible, that are earmarked for environmental or technological purposes or that recycle revenues back to vulnerable groups adversely affected by the tax. Moreover, communicating the workings of the tax and its revenues is crucial.

ACKNOWLEDGEMENTS I would like to thank Lukas Hakelberg, Achim Kemmerling and the participants of the Bamberg workshop for their very helpful comments. The research for this chapter is part of the project `Beyond Policy Adoption: Implications of Energy Policy on Parties, Publics, and Individuals', funded by the Swiss National Science Foundation (PYAPP1–173642/1).

NOTES 1. Despite the fact that comparatively, green taxes are “new instruments” and do not feature prominently in accounts on the history of taxation (Seelkopf et al., 2019). 2. A point to which we will return in Section 2 on the comparative political economy of green taxes. 3. The Brundtland Report, known after the name of the chairperson of the World Commission on Environment and Development. 4. The objectives of the program can only be achieved, “if impacts on the environment are properly accounted for and if market signals also reflect the true costs to the environment. This involves applying the polluter-pays principle more systematically, phasing out environmentally harmful subsidies, shifting taxation from labour towards pollution, and expanding markets for environmental goods and services” (European Commission, 2013, p. 3, emphasis added). 5. For each of the categories shown in Figure 14.1, the reader may consult Table 14.1 to see an example of what such a green tax might entail. 6. While Castiglione et al. (2014) are eventually interested to “evaluate the role that environmental taxation plays for the environment and for economic development,” they include some governance indicators in their study on the determinants of environmental taxation and find that especially a high regulatory quality is associated with a higher level of environmental tax revenues as a percentage of gross domestic product. 7. The use of legislative medians is warranted since under coalition governments (in contrast to single-party governments), policy is made jointly by parties who are separately accountable for the respective policy (Martin & Vanberg, 2014). The party occupying the legislative mean position (controlling the median legislator) is considered to have a disproportional influence on policy, thus Ward and Cao (2012) calculate the respective medians by using the left-right as well as the environmental issue dimension to gain leverage over the influence on green taxation. 8. Similarly, Levi et al. (2020) find that democracies are positively related to carbon prices in their large-N study. However, while the direct effect of democracy is small and non-significant, characteristics of democracies such as good governance measured via the absence of corruption or regulatory control are found to be significantly related to higher carbon prices.

The politics of green taxation  223 9.

Although they do not include environmental taxes specifically, Jensen and Spoon (2011) as well as Leinaweaver and Thomson (2016) find an overall positive influence of green parties on green policy outcomes. 10. Other notable ways to price carbon may also include fuel taxes (Sterner, 2007) or the removal of fossil fuel subsidies (Coady et al., 2017; Ross et al., 2017). 11. Fairbrother et al. (2019) also find political trust to matter in a model including multilevel factors. Levi et al. (2020) look at the determinants of support for different climate policies and also find that political trust seems to matter most with respect to carbon taxes. Political trust generally matters for climate policy (Drews & Van den Bergh, 2016). 12. Indeed, accounts such as Herber and Raga (1995) have historically argued that interdependent behavior brought down the EU’s proposal for a global carbon tax in 1992 as the United States refused to participate and the EU did not want to “go it alone.”

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224  Handbook on the politics of taxation Carattini, S., Kallbekken, S., & Orlov, A. (2019). How to win public support for a global carbon tax. Nature, January 16. Carter, N., Ladrech, R., Little, C., & Tsagkroni, V. (2018). Political parties and climate policy: A new approach to measuring parties’ climate policy preferences. Party Politics, 24(6), 731–742. Castiglione, C., Infante, D., Minervini, M. T., & Smirnova, J. (2014). Environmental taxation in Europe: What does it depend on? Cogent Economics and Finance, 2(1), 967362. Cherry, T. L., Kallbekken, S., & Kroll, S. (2012). The acceptability of efficiency-enhancing environmental taxes, subsidies and regulation: An experimental investigation. Environmental Science and Policy, 16, 90–96. Cherry, T. L., Kallbekken, S., & Kroll, S. (2014). The impact of trial runs on the acceptability of environmental taxes: Experimental evidence. Resource and Energy Economics, 38, 84–95. Clinch, J. P., & Dunne, L. (2006). Environmental tax reform: An assessment of social responses in Ireland. Energy Policy, 34(8), 950–959. Coady, D., Parry, I., Sears, L., & Shang, B. (2017). How large are global fossil fuel subsidies? World Development, 91, 11–27. Congleton, R. D. (1992). Political institutions and pollution control. Review of Economics and Statistics, 74(3), 412–421. Cottier, T. (2009). International Trade Regulation and the Mitigation of Climate Change. Cambridge University Press. Daugbjerg, C., & Svendsen, G. T. (2003). Designing green taxes in a political context: From optimal to feasible environmental regulation. Environmental Politics, 12(4), 76–95. Davidovic, D., & Harring, N. (2020). Exploring the cross-national variation in public support for climate policies in Europe: The role of quality of government and trust. Energy Research and Social Science, 70, 101785. Deroubaix, J.-F., & François, L. (2006). The rise and fall of French ecological tax reform: Social acceptability versus political feasibility in the energy tax implementation process. Energy Policy, 34(8), 940–949. Dolphin, G., Pollitt, M. G., & Newbery, D. M. (2020). The political economy of carbon pricing: A panel analysis. Oxford Economic Papers, 72(2), 472–500. Douenne, T., & Fabre, A. (2020). French attitudes on climate change, carbon taxation and other climate policies. Ecological Economics, 169, 106496. Dresner, S., Jackson, T., & Gilbert, N. (2006). History and social responses to environmental tax reform in the United Kingdom. Energy Policy, 34(8), 930–939. Drews, S., & Van den Bergh, J. C. (2016). What explains public support for climate policies? A review of empirical and experimental studies. Climate Policy, 16(7), 855–876. Ekins, P. (1999). European environmental taxes and charges: Recent experience, issues and trends. Ecological Economics, 31(1), 39–62. Ekins, P., & Speck, S. (1999). Competitiveness and exemptions from environmental taxes in Europe. Environmental and Resource Economics, 13(4), 369–396. ESS (2016). European Social Survey Round 8 Data (Data file edition 2.0). Norwegian Centre for Research Data, Norway. www​.​europeanso​cialsurvey​.org/​ download.html?file=ESS8e02&y=2016 (accessed July 1, 2018). European Commission (2013). Living well, within the limits of our planet. https://​ ec​ .europa​ .eu/​ environment/​pubs/​pdf/​factsheets/​7eap/​en​.pdf (accessed October 2, 2019). European Commission (2019) The European Green Deal. https://​eur​-lex​.europa​.eu/​legal​-content/​EN/​ ALL/​?uri​=​CELEX:​52019DC0640 Eurostat (2013). Environmental Taxes: A Statistical Guide. Luxembourg: Publications Office of the European Union. Eurostat (2019). http://​appsso​.eurostat​.ec​.europa​.eu/​nui/​s​ubmitViewT​ableAction​.do (accessed October 2, 2019). Eurostat (2020). https://​ec​.europa​.eu/​eurostat/​statistics​-explained/​index​.php​?title​=​Environmental​_tax​ _statistics (accessed May 31, 2021). Fairbrother, M. (2017). Environmental attitudes and the politics of distrust. Sociology Compass, 11(5), 1–10.

The politics of green taxation  225 Fairbrother, M., Sevä, I. J., & Kulin, J. (2019). Political trust and the relationship between climate change beliefs and support for fossil fuel taxes: Evidence from a survey of 23 European countries. Global Environmental Change, 59, 102003. Fredriksson, P. G., & Millimet, D. L. (2004). Comparative politics and environmental taxation. Journal of Environmental Economics and Management, 48(1), 705–722. Genovese, F., Kern, F. G., & Martin, C. (2017). Policy alteration: Rethinking diffusion processes when policies have alternatives. International Studies Quarterly, 61(2), 236–252. Goulder, L. H. (1994). Environmental taxation and the double dividend: A reader’s guide. National Bureau of Economic Research Working Paper Series No. 4896. Goulder, L. H., & Parry, I. W. H. (2008). Instrument choice in environmental policy. Review of Environmental Economics and Policy, 2(2), 152–174. Gourevitch, P. (1978). The second image reversed: The international sources of domestic politics. International Organization, 32(4), 881–912. Green, J. F. (2020). It’s time to abandon carbon pricing. https://​jacobinmag​.com/​2019/​09/​carbon​-pricing​ -green​-new​-deal​-fossil​-fuel​-environment (accessed May 31, 2021). Green, J. F. (2021). Does carbon pricing reduce emissions? A review of ex-post analyses. Environmental Research Letters. Harring, N. (2016). Reward or punish? Understanding preferences toward economic or regulatory instruments in a cross-national perspective. Political Studies, 64(3), 573–592. Harrison, K. (2010). The comparative politics of carbon taxation. Annual Review of Law and Social Science, 6, 507–529. Helm, D., Hepburn, C., & Ruta, G. (2012). Trade, climate change, and the political game theory of border carbon adjustments. Oxford Review of Economic Policy, 28(2), 368–394. Herber, B. P., & Raga, J. T. (1995). An international carbon tax to combat global warming: An economic and political analysis of the European Union proposal. American Journal of Economics and Sociology, 54(3), 257–267. Holzinger, K., Knill, C., & Sommerer, T. (2008). Environmental policy convergence: The impact of international harmonization, transnational communication, and regulatory competition. International Organization, 62(4), 553–587. Howlett, M. (2004). Beyond good and evil in policy implementation: Instrument mixes, implementation styles, and second generation theories of policy instrument choice. Policy and Society, 23(2), 1–17. Hsu, S.-L., Walters, J., & Purgas, A. (2008). Pollution tax heuristics: An empirical study of willingness to pay higher gasoline taxes. Energy Policy, 36(9), 3612–3619. Jaeger, W. K. (2013). Double dividend. In J. F. Shogren (ed.), Encyclopedia of Energy, Natural Resource, and Environmental Economics, Vol. 1, 37–40. Elsevier. Jagers, S. C., & Hammar, H. (2009). Environmental taxation for good and for bad: The efficiency and legitimacy of Sweden’s carbon tax. Environmental Politics, 18(2), 218–237. Jagers, S. C., Martinsson, J., & Matti, S. (2019). The impact of compensatory measures on public support for carbon taxation: An experimental study in Sweden. Climate Policy, 19(2), 147–160. Jensen, C. B., & Spoon, J.-J. (2011). Testing the “party matters” thesis: Explaining progress towards Kyoto protocol targets. Political Studies, 59(1), 99–115. Jordan, A., Wurzel, R. K., & Zito, A. (2005). The rise of “new” policy instruments in comparative perspective: Has governance eclipsed government? Political Studies, 53(3), 477–496. Kallbekken, S., & Aasen, M. (2010). The demand for earmarking: Results from a focus group study. Ecological Economics, 69(11), 2183–2190. Kallbekken, S., & Sælen, H. (2011). Public acceptance for environmental taxes: Self-interest, environmental and distributional concerns. Energy Policy, 39(5), 2966–2973. Kono, D. Y. (2019). The politics of trade and climate change. In Oxford Research Encyclopedia of Politics. Oxford University Press. Kosonen, K. (2012). Regressivity of environmental taxation: Myth or reality? In J. E. Milne & M. S. Andersen (eds), Handbook of Research on Environmental Taxation, 161–174. Edward Elgar Publishing. Kotchen, M. J., Turk, Z. M., & Leiserowitz, A. A. (2017). Public willingness to pay for a US carbon tax and preferences for spending the revenue. Environmental Research Letters, 12(9), 1–5.

226  Handbook on the politics of taxation Lachapelle, E. (2011). Pathways to carbon-energy taxation in the OECD: Preferences, parties and electoral regimes. 6th General Conference of the European Consortium for Political Research, Reykjavik, Iceland, 25–27. Lake, D. A., & Baum, M. A. (2001). The invisible hand of democracy: Political control and the provision of public services. Comparative Political Studies, 34(6), 587–621. Lee, D. R., & Misiolek, W. S. (1986). Substituting pollution taxation for general taxation: Some implications for efficiency in pollutions taxation. Journal of Environmental Economics and Management, 13(4), 338–347. Leinaweaver, J., & Thomson, R. (2016). Greener governments: partisan ideologies, executive institutions, and environmental policies. Environmental Politics, 25(4), 633–660. Levi, S. (2021). Why hate carbon taxes? Machine learning evidence on the roles of personal responsibility, trust, revenue recycling, and other factors across 23 European countries. Energy Research & Social Science, 73, 101883. Levi, S., Flachsland, C., & Jakob, M. (2020). Political economy determinants of carbon pricing. Global Environmental Politics, 20(2), 128–156. Martin, A., & Scott, I. (2003). The effectiveness of the UK landfill tax. Journal of Environmental Planning and Management, 46(5), 673–689. Martin, L. W., & Vanberg, G. (2014). Parties and policymaking in multiparty governments: The legislative median, ministerial autonomy, and the coalition compromise. American Journal of Political Science, 58(4), 979–996. Maxim, M., & Zander, K. (2019). Can a green tax reform entail employment double dividend in European and non-European countries? A survey of the empirical evidence. International Journal of Energy Economics and Policy, 9(3), 218–228. Meckling, J., & Jenner, S. (2016). Varieties of market-based policy: Instrument choice in climate policy. Environmental Politics, 25(5), 853–874. Meckling, J., Kelsey, N., Biber, E., & Zysman, J. (2015). Winning coalitions for climate policy. Science, 349(6253), 1170–1171. Metcalf, G. E. (2009). Designing a carbon tax to reduce US greenhouse gas emissions. Review of Environmental Economics and Policy, 3(1), 63–83. Mildenberger, M. (2020). Carbon Captured: How Business and Labor Control Climate Politics. MIT Press. Mildenberger, M., & Stokes, L. (2020). The trouble with carbon pricing. Boston Review, September 24. Neumayer, E. (2002). Do democracies exhibit stronger international environmental commitment? A cross-country analysis. Journal of Peace Research, 39(2), 139–164. Oates, W. E. (1995). Green taxes: Can we protect the environment and improve the tax system at the same time? Southern Economic Journal, 61(4), 915–922. OECD (1989). Economic Instruments for Environmental Protection. OECD Publishing. Olson, M. (1965). Logic of Collective Action: Public Goods and the Theory of Groups. Harvard University Press. Pahle, M., Burtraw, D., Flachsland, C., Kelsey, N., Biber, E., Meckling, J. … & Zysman, J. (2018). Sequencing to ratchet up climate policy stringency. Nature Climate Change, 8(10), 861–867. Parson, E. A., & Kravitz, E. L. (2013). Market instruments for the sustainability transition. Annual Review of Environment and Resources, 38, 415–440. Pearce, D. (1991). The role of carbon taxes in adjusting to global warming. The Economic Journal, 101(407), 938–948. Philips, A. Q., Rutherford, A., & Whitten, G. D. (2016). Dynamic pie: A strategy for modeling trade-offs in compositional variables over time. American Journal of Political Science, 60(1), 268–283. Pigou, A. C. (1920). The Economics of Welfare. Macmillan. Rabe, B. G., & Borick, C. P. (2012). Carbon taxation and policy labeling: Experience from American states and Canadian provinces. Review of Policy Research, 29(3), 358–382. Ross, M. L., Hazlett, C., & Mahdavi, P. (2017). Global progress and backsliding on gasoline taxes and subsidies. Nature Energy, 2(1), 1–6. Samuels, D., & Snyder, R. (2001). The value of a vote: Malapportionment in comparative perspective. British Journal of Political Science, 31(4), 651–671. Sartori, G. (1976). Parties and Party Systems: A Framework for Analysis. Cambridge University Press.

The politics of green taxation  227 Schaffer, L. M. (2021) Who’s afraid of more ambitious climate policy? Distributional consequences and inequality perceptions in ratcheting up for the Paris Agreement. Working Paper. Schaffer, L. M., & Bernauer, T. (2014). Explaining government choices for promoting renewable energy. Energy Policy, 68, 15–27. Schaffer, L. M., & Levis, A. (2021). Public discourses on (sectoral) energy policy in Switzerland: Insights from structural topic models. In P. Hettich & A. Kachi (eds), Swiss Energy Governance. Springer Nature, pp. 316–346. Schaffer, L. M. & Lüth, M. (2021). Domestic political consequences of climate change: The evolving party competition over climate and energy policy. Working Paper. Schaffer, L. M., Oehl, B., & Bernauer, T. (forthcoming). Are policy-makers responsive to public demand in climate politics? Journal of Public Policy. Scrimgeour, F., Oxley, L., & Fatai, K. (2005). Reducing carbon emissions? The relative effectiveness of different types of environmental tax: The case of New Zealand. Environmental Modelling and Software, 20(11), 1439–1448. Seelkopf, L., Bubek, M., Eihmanis, E., Ganderson, J., Limberg, J., Mnaili, Y. … & Genschel, P. (2019). The rise of modern taxation: A new comprehensive dataset of tax introductions worldwide. Review of International Organizations, 16, 239–263. Shapiro, R. Y. (2011). Public opinion and American democracy. Public Opinion Quarterly, 75(5), 982–1017. Skovgaard, J., Ferrari, S. S., & Knaggård, Å. (2019). Mapping and clustering the adoption of carbon pricing policies: What polities price carbon and why? Climate Policy, 19(9), 1173–1185. Stadelmann-Steffen, I. (2011). Citizens as veto players: Climate change policy and the constraints of direct democracy. Environmental Politics, 20(4), 485–507. Stavins, R. N. (2003). Experience with market-based environmental policy instruments. In K. G. Mäler and J. R. Vincent (eds), Handbook of Environmental Economics, Vol. 1, 355–435. Elsevier. Stavins, R. N., & Whitehead, B. W. (1992). Pollution charges for environmental protection: A policy link between energy and environment. Annual Review of Energy and the Environment, 17(1), 187–210. Sterner, T. (2007). Fuel taxes: An important instrument for climate policy. Energy Policy,  35(6), 3194–3202. Svendsen, G. T., Daugbjerg, C., Hjøllund, L., & Pedersen, A. B. (2001). Consumers, industrialists and the political economy of green taxation: CO2 taxation in OECD. Energy Policy, 29(6), 489–497. Tews, K., Busch, P. O., & Jörgens, H. (2003). The diffusion of new environmental policy instruments. European Journal of Political Research, 42(4), 569–600. Thalmann, P. (2004). The public acceptance of green taxes: 2 million voters express their opinion. Public Choice, 119(1–2), 179–217. Tol, R. S. (2011). The social cost of carbon. Annual Review of Resource Economics, 3(1), 419–443. Umit, R., & Schaffer, L. M. (2020). Attitudes towards carbon taxes across Europe: The role of perceived uncertainty and self-interest. Energy Policy, 140, 111385. UNEP (2019). Emissions Gap Report 2019. Van den Bergh, J. C., Angelsen, A., Baranzini, A., Botzen, W. J. W., Carattini, S., Drews, S. … & Padilla, E. (2020). A dual-track transition to global carbon pricing. Climate Policy, 20(9), 1057–1069. Volkens, A., Krause, W., Lehmann, P., Matthieß, T., Merz, N., Regel, S., & Weßels, B. (2019). The manifesto data collection. Manifesto Project (MRG/CMP/MARPOR). Wissenschaftszentrum Berlin für Sozialforschung. Ward, H. (2008). Liberal democracy and sustainability. Environmental Politics, 17(3), 386–409. Ward, H., & Cao, X. (2012). Domestic and international influences on green taxation. Comparative Political Studies, 45(9), 1075–1103. Weitzman, M. L. (2017). Voting on prices vs. voting on quantities in a World Climate Assembly. Research in Economics, 71(2), 199–211. Wlezien, C. (1995). The public as thermostat: Dynamics of preferences for spending. American Journal of Political Science, 39(4), 981–1000. World Commission on Environment and Development (1987). Our Common Future. Oxford University Press and United Nations.

PART III INTERNATIONAL TAX POLITICS A: THE BASICS

15. Politics and the diffusion of tax policy Duane Swank

1. INTRODUCTION A rich academic literature on the transnational diffusion of tax policies has emerged since the 1990s. Scholars working on this topic, moreover, have increasingly highlighted how political dynamics have shaped the diffusion of policy reforms. This new interest in the diffusion of tax policies comes in the context of a step-level rise in research on international policy diffusion generally. This increase in diffusion research has been fueled by the dramatic global spread of neoliberal institutions (e.g., central bank independence) and policies (e.g., privatization, international and domestic market deregulation, and welfare retrenchment) since the late 1970s (Simmons et al., 2008). Relatedly, the significant expansion of research on tax policy diffusion has been at least in part driven by scholars’ desires to explain the notable market-oriented transformation of the structure of taxation across the world in the last 40 years: marginal corporate and personal income tax rates have been significantly cut, tax bases broadened, and consumption taxes – especially as value-added tax (VAT) – increased in large swaths of the globe (e.g., Genschel & Schwarz, 2011; Swank, 2016b). In the current chapter, I offer an overview of the theory and research on the transnational diffusion of tax policies in the contemporary era.1 After a brief discussion of the particulars of the transformation of the modern tax state, I review the main theories – drawn from the general study of diffusion as well as international and comparative politics – that have guided contemporary research on tax policy diffusion. In turn, I review the empirical literature on the topic; drawing on a dominant framework for thinking about policy diffusion (Simmons et al., 2008), I organize this review according to the major mechanisms that have arguably driven tax policy diffusion, namely, economic competition, social learning, emulation, and, to a lesser extent, coercion. Within each of these sections, I first discuss the studies that have offered simple, direct assessments of the basic mechanisms of transnational tax policy diffusion; I then discuss (typically more recent) studies that have consciously theorized and tested how politics shape the diffusion process. My central argument is that we now know that policy diffusion in all forms is highly conditioned by domestic institutions and the interests and actions of international and domestic political agents. In the concluding section, I make recommendations on productive new pathways of exploration into how and why national policymakers respond to policy innovations and reforms in other nations. These recommendations include significantly increasing efforts to understand major historical eras of diffusion of new tax policies and to increase the sophistication of contemporary scholarship on the politics of international tax policy diffusion.

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2.

TAX POLICY DIFFUSION: INITIAL CONSIDERATIONS

2.1

What Has Diffused? A Brief Survey

As noted, from the late 1970s, tax policy has undergone a neoliberal transformation in most areas of the world.2 Perhaps most notably, statutory corporate and top personal tax rates have significantly declined. Corporate tax rates decreased from 46 to 24 percent between 1985 and 2014 while top personal income tax rates were reduced from 45 to 29 percent between 1985 and 2005 (see below on the income tax in recent years); this trend in corporate tax rates is nearly identical across rich countries, middle-income nations, and lower-income political economies (Swank, 2016b).3 At the same time, the tax base was broadened: various tax exemptions, credits, and allowances were cut for both corporate and personal income taxes in developed democracies (Ganghof, 2000; Swank & Steinmo, 2002); in the developing world, this trend occurs in middle-income countries while tax incentives have been increasingly deployed to attract capital in lower-income countries (for a survey of the literature see Swank, 2016b). As Swank and Steinmo (2002), Peter, Buttrick, and Duncan (2010), and others note, the number of income tax brackets declines in many nations. In addition, the expansion of consumption taxes – especially the growth in the utilization of VAT and the magnitude of the VAT rate – has been common globally (e.g., Bird & Gendron, 2007; Keen & Lockwood, 2010).4 Finally, other market-oriented taxes such as the flat tax for personal (and corporate) income have experienced some popularity, although flat tax adoptions have been heavily concentrated in Eastern Europe and former Eurasian Soviet republics (e.g., Appel, 2018). At the same time, it is important to note that while the neoliberal transformation continues unabated in some respects, scholars such as Julian Limberg (2019) have recently observed that top personal income tax rates have actually increased significantly in nations across the globe impacted by the 2008–2009 financial crisis. The crisis itself might be thought of as a common shock that initially elicits similar responses from policymakers and, in turn, sets the ground for new policy innovations that diffuse across nations.5 Complementing Limberg’s finding, Lukas Hakelberg and colleagues (e.g., Ahrens et al., 2020; Hakelberg & Rixon, 2020) have argued that personal income tax rate increases have been most pronounced in the taxation of capital income (i.e., the income from portfolio capital). As these authors explain, in recent years the United States (US) as well as the European Union (EU) and, to a lesser extent, other international organizations (IOs) have dramatically increased efforts to mandate or provide incentives for the automatic exchange of information among nations for residents’ foreign portfolio capital income. As a result, nations gain a measure of freedom to increase personal income tax rates on capital income taxed at personal income tax rates given residents can no longer easily avoid or evade these taxes by moving capital to tax havens. In other words, pressure from international tax competition is reduced. Whether these developments bode an end to the neoliberal turn in the structure of taxation is still an open question. 2.2

Policy Diffusion: An Overview of Theory

In their synoptic review of the diffusion6 of neoliberal institutions and policies (as well as the broader diffusion literature), Simmons et al. (2008) distill theoretical arguments about the foundations of transnational policy diffusion down to four mechanisms.7 These authors, and most contemporary scholars of diffusion, conceptualize the transnational transmission of

Politics and the diffusion of tax policy  231 policies as occurring through economic competition, social learning, emulation, and coercion. As illustrated below, there is some heterogeneity in the understanding of what these processes entail and how they should be measured and assessed. Moreover, there is increasing attention to how these diffusion mechanisms are conditioned by international and domestic political institutions and dynamics. Again, my central claim is that scholarship clearly shows diffusion is highly conditional on these political forces. Nonetheless, one finds no difficulty in identifying which diffusion mechanisms authors believe are relevant in the major studies of tax policy diffusion. In the contemporary study of tax policy diffusion, economic competition is clearly the most commonly cited mechanism of transnational diffusion. In brief, diffusion by economic competition refers to the strategic adoption by national policymakers of the policies of nations with which one competes for foreign direct or portfolio investment, market shares of goods and services, and high-skilled workers. As I illustrate below, this type of diffusion may take the form of the strategic response to policy reforms by competitors in one or more of these areas generally; it also may take the form of adoption of the policy of a dominant country that has made “the first move” in initiating policy reforms. Some studies explicitly or implicitly adopt the formal theory of tax competition in economics as the foundation for understanding diffusion driven by competition (see Keen & Konrad, 2013 and Lierse, this volume for an overview); in this view, a nation’s choices to strategically compete and, if so, how, are driven by country size and endowments, among other factors. In addition, many studies, especially in political science, adopt similar assumptions but recognize the implicit political character of economic competition as a process driven by the “structural dependence of the state on internationally mobile capital” (e.g., Przeworski & Wallerstein, 1988). A second widely studied form of diffusion is social learning. As Simmons et al. (2008) note, a standard understanding of this mode of policy diffusion is that country policymakers engage in Bayesian learning where they constantly update their beliefs through observations of problems and policy responses in other nations; as such, policy diffusion is grounded by a fully rational decision-making process. That said, it is important to note that seminal studies of policy diffusion such as Kurt Weyland’s (2005) work on social policy diffusion in Latin America has effectively argued that policy diffusion through learning is typically characterized by significantly bounded rationality; policymakers face severe informational, psychological, and cognitive limitations and commonly use decision shortcuts (cognitive heuristics). Thus, new policy innovations occur, some limited evidence on them builds, and increasing numbers of nations (especially within regions where policymakers know their peers) adopt the innovation. Policy diffusion through learning is rarely if ever fully rational in the Bayesian sense. A third mechanism of policy diffusion is emulation. As Simmons et al. (2008) note, emulation involves policymakers mimicking policies touted by policy experts or broader policy communities, IOs, and peer or leading nations. It is also fair to say that emulation also entails a crude form of learning where policies of widely respected or successful countries are mimicked with little systematic information gathering and assessment; it may also involve competition in that one’s key competitors are simply mimicked as part of a “yardstick competition” in which policymakers and citizens of one nation make quick, simple comparisons between themselves and competing peers. In addition, one might note the process is highly political; as Linos (2013) argues, decisions to adopt others’ policies are made by electorally constrained politicians. They are very likely to appeal directly or indirectly to voters (who have limited information or understanding of complex policy issues) when making these policy choices.

232  Handbook on the politics of taxation Thus, for Linos, policymakers are likely to emulate large, rich, proximate nations (or respected IOs) with which voters are casually familiar. Finally, policies may diffuse through coercion.8 For many scholars, coercion entails the manipulation by IOs and dominant states of costs borne and benefits gained by weaker states. One might argue that for tax policy diffusion, “hard coercion” is not relevant for most transnational policy diffusion; for instance, other than the mandate of the use of VAT after 1967 by the EU or mandates of the range of some income tax rates in a few regional customs unions such as the West African Economic and Monetary Union, nations have near complete legal room to maneuver. On the other hand, as discussed below, “soft coercion” occurs primarily through mechanisms such as the use by the International Monetary Fund (IMF) of performance criteria, where states participating in IMF agreements in exchange for financial assistance must make progress in certain types of economic and social policy reforms and in achieving specific economic performance goals (also see Bastiaens, this volume).9 Finally, it is important to note that in recent years significant advances have been made in theorizing “conditional spatial interdependence” (Helmdag & Kuitto, 2018). For instance, Shipan and Volden (2008) have argued that the diffusion of policy innovations across US cities are contingent on the characteristics of cities themselves; Neumayer and Plümper (2012) have argued for systematic attention to weighting diffusion processes by the depth of connection of innovator and follower as well as the political economic constraints to policy adoption in follower nations. Basinger and Hallerberg (2004), Plümper et al. (2009), and Swank (2006, 2016a) highlight the importance of citizen norms, elite and mass ideology, and political economic institutions of policy adopters for the pace and depth of policy diffusion. Gilardi and Wasserfallen (2014), Helmdag and Kuitto (2018), and others have stressed the importance of membership in IOs for conditioning policy diffusion. This “turn” in the research on policy diffusion has led to major advances in our understanding of the complexity and inherent political character of international policy transfer. 2.3

A Note on Methods

The recent research on tax policy diffusion has been greatly aided by advances in methods for assessing spatial diffusion. In seminal papers, Beck et al. (2006) and Franzese and Hays (2008) elaborated and added to the econometrics of spatial lags, and generally popularized the methodology. Soon, spatial lag programs were added to leading econometric packages such as Stata. Neumayer and Plümper (2012) developed a formalized routine for using interactions in regression models with spatial lags to assess the conditionality of policy diffusion. Cao (2010) and Ahrens et al. (2020), among others, applied network analysis to the study of tax policy diffusion. Ward and Cao (2012) popularized multiparameter spatio-temporal models. Scholars such as Baybeck et al. (2011), Rapaport et al. (2009), and Volden et al. (2008) applied formal modeling to the analysis of contemporary policy diffusion while Plümper et al. (2009) utilized computational modeling to assess conditional tax policy diffusion. These methodological advances allowed scholars to improve their modeling and assessment of realistically complex policy diffusion processes.

Politics and the diffusion of tax policy  233

3.

POLITICS AND TAX POLICY DIFFUSION: THE COMPETITION MECHANISM

It is arguably the case that the most prevalent mechanism driving policymakers’ adoption of other nations’ tax policies is strategic adjustment to the actions of one’s economic competitors. Although most early studies of the tax policy impact of economic globalization did not explicitly theorize and model policy diffusion, they commonly assumed states were responding to greater pressure from competitor nations for shares of markets for goods and services and for positioning as attractive locations for capital investment.10 Given that the broader literature on tax competition is large and has been extensively reviewed elsewhere (e.g., Genschel & Schwarz, 2011; Lierse, this volume), I focus here on the literature that explicitly theorizes and tests for strategic adjustments by nations to their competitors’ policies through spatial lags and related methods; I am especially interested in the literature that seeks to understand how politics conditions competitive diffusion processes. One set of studies assumes that nations play a Nash-type game where competitor nations simultaneously observe each other’s tax policy choices and adjust their own policies subject to constraints (e.g., domestic economic and political factors). Researchers typically develop tax policy reaction functions that seek to assess the strength of strategic responsiveness and the significance of constraints (e.g., Devereux et al., 2008; Franzese & Hays, 2008; Hays, 2003, 2009; Plümper et al., 2009). Strategic responsiveness is typically measured by a spatial lag of policy weighted by economic connectedness, namely, foreign direct and portfolio capital flows, trade, or even geographic proximity. Authors commonly find significant impacts of strategic competition in tax policy among economic competitors. Similarly, in a study of corporate tax rates in a large sample of 133 nations between 1998 and 2006, Cao (2010) finds that tax policies diffused among nations with similar positions in international networks of portfolio capital investment and trade (but not foreign direct investment networks). In addition, Barthel and Neumayer (2012) estimate a Cox proportional hazard model with spatial interdependence of adoption of double taxation agreements by dyads of nations across the globe between 1969 and 2005. The authors discover that dyad members adopt treaties if regional peers have done and if the economic competitors of one of the nations in the dyad have done so. In contrast to these Nash-type studies, another set of works on competitive diffusion assumes that a Stackelberg leader (for all intents and purposes, a large, dominant economy in international markets) makes the first move and other nations, subject to constraints, adopt the policies of this leader. Among the first relevant papers, Tanzi (1987) suggested that the US might play this role in the post-1970s era.11 In one of the earliest systematic econometric tests of the thesis, Swank (2006) argued that the 1986 US corporate tax reforms (significant rate cuts with base broadening) served as the first move of a Stackelberg leader which set in motion an international diffusion of neoliberal tax policies as other nations responded to the US move. Tests of the effect of the 1986-initiated US reforms for countries in the Organisation for Economic Co-operation and Development (OECD), in the presence of controls for capital control liberalization, trade and capital flows, and a spatial lag of other nations’ tax policies weighted for competitor status, revealed that the diffusion of neoliberal corporate tax policy was dominated by the Stackelberg leadership of the US, especially the 1986 Tax Reform Act; Swank (2016a) produced the same results in a significantly updated economic test of Stackelberg leadership of corporate tax policy diffusion. Kumar and Quinn (2012) in a global sample of 94 nations for the 1953–2009 period also effectively showed that in the long term,

234  Handbook on the politics of taxation countries’ corporate tax rates do not deviate much from the US rate. Similarly, Altshuler and Goodspeed (2015), in an analysis of 1968–2008 data from the US and European nations, show that the US’s 1986 tax reform act served as the first move of a Stackelberg leader, initiating corporate tax rate cuts in Europe. Finally, one might note that Stackelberg-like leadership dynamics have been found in specific regions; for instance, Klofat (2017) studies business tax policy diffusion in a sample of 29 East European and Eurasian nations and reports that at least for East Europe, states follow Russia’s business tax policies. 3.1

Studying the Political Mediation of Competitive Diffusion

The previous studies of competitive diffusion all acknowledge the role of politics in tax policy diffusion. Yet, this acknowledgment is often limited to implicit assumptions about the political incentives of policymakers or about the role of political institutions and dynamics as constraints on tax policy change (for instance, political factors are modeled as additional exogenous policy determinants in reaction functions). These studies typically do not explicitly theorize and test how political institutions and dynamics condition directly competitive diffusion of tax policy. A complementary set of studies does. Basinger and Hallerberg (2004) provide what is arguably the first major study of how politics shapes the strategic response of tax policymakers to competitors. Their model rests on the Nash-type game of strategic interaction where tax reforms of nations are chosen simultaneously under conditions of significant uncertainty. Each nation’s tax policy choice is shaped by political and economic costs of tax policy change in their own country and in other nations; these costs include constituency costs (e.g., citizen backlash against attacks on fairness) and political transaction costs that occur in policy negotiations among ideologically distinct governing partners. Economic payoffs that might flow from tax policy change are affected by the transaction costs of capital controls. The model, in effect, predicts, and Basinger and Hallerberg find, that changes in competitors’ capital tax policies (during the 1980–1997 period in OECD countries) have greater effects on a focal nation’s capital tax policy choices not only where the focal nation’s domestic constituency and political transaction costs decrease, but when competitors’ costs decline as well. In another study that systematically theorizes and tests the political mediation of competitive tax policy diffusion, Swank (2006) argues for a Stackelberg leader model of neoliberal tax policy diffusion where the 1986 US Tax Reform Act’s corporate tax rate cuts diffuse across the developed democracies. A key feature of Swank’s model is the mediation of timing and depth of other nations’ tax policy response by the country’s political economic institutional structure, or the “variety of capitalism” that characterizes the nation. That is, as is commonly argued, countries may be classified as coordinated or liberal market economies, depending on the degree to which employers, labor, and the state develop institutions of coordination in the face of firms’ control, information, and collective action problems in competitive markets (e.g., Hall & Soskice, 2001). The traditional tax model of coordinated market economies (CMEs) – the “high tax equilibrium” of high rates and extensive investment allowances – has played two key roles: first, it has facilitated state promotion of long-run growth through regional and sector targeting of investment during economic modernization and restructuring. Second, tax policies of relatively high statutory capital tax rates have been instrumental to the maintenance of labor’s acceptance of ownership and managerial prerogatives, general social solidarity, and long-term

Politics and the diffusion of tax policy  235 stability in labor and industrial relations (Swank, 2002, ch. 5). Given these considerations, policymakers in CMEs face potentially high constituency costs with neoliberal reform as well as high political transactions costs; CMEs are characterized by consensus institutions that foster inclusiveness of societal interests and diffuse power across institutions as well by corporatist institutions that extensively delegate policymaking power to employers and labor (e.g., Martin & Swank, 2012). As a result, Swank (2006) predicts, and finds in a study of 18 OECD nations from 1981 to 1998, that responses across nations to US neoliberal tax policy reforms are slower and more shallow in CMEs than in liberal market economies where political transactions and economic costs are typically lower. A significant update of the study examines the same questions for 18 OECD nations from 1982 to 2008 and finds identical results.12 Plümper et al. (2009) offer another important analysis of whether political mediation of competitive policy diffusion occurs. As noted above, these authors theorize that strategic responsiveness to competitors’ tax policy choices will be conditioned by fairness norms (and budget rigidities). The authors use formal and computational modeling to examine tax policy responsiveness to competitors at different levels of the strength of fairness principles. Specifically, the authors show that in stylized tax competition between three homogenous countries, each country chooses a mix of taxes on mobile and immobile factors that minimizes a government loss function. They also show that the Nash equilibrium in taxes is predictably altered at different levels of fairness norms (and budget rigidities) in response to tax competition. Several other studies have also taken up the important question of political mediation of competitive tax policy diffusion. For instance, Gilardi and Wasserfallen (2014) estimate a spatial lag model for 1990–2007 income tax burdens in Swiss cantons. The authors find that Swiss cantons follow the income tax policies of others with which they compete where those competitors are not members of the same IOs. Gilardi and Wasserfallen reason that IO membership promotes acceptance of norms that limit tax competition. In a new study examining competitive diffusion of 2001–2018 income tax reforms during distinct governing cabinets in OECD nations, Ahrens et al. (2020) explicitly model the impact of financial transparency in a focal country’s financial investment network on the likelihood that the country will eschew tax competition and increase dividend tax rates in response to fiscal pressures. That is, where key partners in a nation’s financial network have joined automated-exchange-of-information agreements (see the above discussion of this development), financial actors’ incentives to move capital to evade or avoid taxes is diminished (as is, in turn, the pressure for policymakers to engage in tax competition). Overall, we now know that policymakers strategically adjust tax policy in response to tax policy changes in one’s competitors generally, or in response to Stackelberg-type leaders particularly. At the same time, competitive tax policy diffusion is significantly affected by political institutions, ideology, and other features of politics. Most notably domestic political and economic institutional context, elite and mass ideology, and political exchange within international institutions seem especially important in shaping the pace and depth of tax policy adoption in the face of pressure from competitors. I now turn to the alternative mechanisms said to undergird policy diffusion in the contemporary era, namely, social learning and emulation.

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4.

LEARNING AND EMULATION IN THE DIFFUSION OF CONTEMPORARY TAX POLICY

While not as prevalent as economic competition, both learning and emulation mechanisms feature prominently in some important studies of tax policy diffusion. This certainly seems the case with respect to the diffusion of the flat tax on corporate and personal income in Eastern Europe and Eurasia in the 1990s and 2000s. In an early study, Baturo and Gray (2009) argued that the diffusion of the flat tax is driven by the evaluation – most commonly by right-wing governments – of the success of the tax in peer nations and, in turn, by politically conditioned adoption (i.e., policy adoption conditioned by international and domestic political dynamics). The authors reject the notion of contagion through simple, rapid emulation of peer nations. A more complex process of flat tax diffusion is presented by Appel and Orenstein (2013) where the flat tax is championed by networks of right-wing thinktanks and policy entrepreneurs as the primary option for former communist nations to attract capital, quickly establish effective revenue raising, and generally cultivate economic efficiency and growth. In turn, the tax is pushed legislatively by center-right parties and politicians in countries yet to adopt. Appel (2018) expands this research to the former Soviet republics in Eurasia and argues that over time the structure and symbolism of the flat tax is viewed as conferring notable economic advantages. As it increasingly becomes delinked with extreme market-oriented ideology, the tax further spreads in Eurasia through center and center-left government adoptions. In some ways, nations learn from the popularization of theory and evidence about the flat tax; they also clearly emulate what is an established, presumably successful framework for national taxation.13 With respect to the broader diffusion of neoliberal tax reforms, some scholars have paid close attention to learning and emulation. Several early overviews of the neoliberal transformation of tax structure stressed the foundational role of tax policy experts in IOs such as the OECD and the academy – that is the tax policy community – in increasingly rejecting the extant system of high top marginal rates and extensive government tax incentives as inefficient while touting a new system of lower income tax rates, an expanded tax base, and greater reliance on consumption taxes. In an influential paper, Tanzi (1987) documents, for instance, the impact on policymakers of academic, IO, and thinktank research showing negative efficiency effects of the current structure of taxation. Swank (1998) reiterates the point by noting the spread of new ideas about lower rates and broader tax bases was driven by experts in the OECD Fiscal Affairs Secretariat and the broader tax policy community. Surveying the literature in the early 2000s, Swank and Steinmo (2002, p. 643) argue that a “paradigmatic shift” had occurred in thinking about the most effective tax structure for the modern era. The upshot of these studies is that a new model of taxation was touted by the expert community: scholarly papers on taxation increasingly provided theory and initial evidence on the effectiveness (primarily on efficiency grounds) of the neoliberal tax structure. It allowed nations to learn about major reforms that might potentially promote growth and, perhaps most important, to emulate successful models with minimal decision-making costs. Surprisingly, there are few rigorous quantitative studies that attempt to assess policy learning and emulation mechanisms in the diffusion of tax policy (while accounting for spatial diffusion through economic competition and general international and domestic policy determinants). The principal studies are Swank (2006) and Cao (2010), who study corporate tax policy change, and Keen and Lockwood (2010) who analyze the spread of VAT taxes

Politics and the diffusion of tax policy  237 (also see Kato, 2003). Swank (2006) studies the diffusion of corporate statutory tax rate cuts in OECD countries between 1982 and 1998; in the presence of a full range of controls for competition-driven diffusion (both Nash and Stackelberg-type processes and international and domestic factors), he assesses whether countries followed tax policy reformers who enjoyed greater capital investment success. To test for emulation effects, Swank examines whether adopters followed sociocultural peer nations. In both cases, analysis produced null findings; economic competition-driven diffusion predominates. In the well-known study by Cao (2010), analysis also shows evidence of substantial economic competition (as noted above, substantial effects of tax policies of those nations with similar positions in portfolio capital and trade networks). Cao also finds, however, that countries proximate in position in IO networks, where the IOs are assumed to foster learning and models of tax policy for emulation, significantly influence tax policy in adopting countries. This is especially true for IOs that promote exchange of information and, in turn, social learning. Finally, in a seminal study of the spread in VAT taxes in 143 nations in recent decades, Keen and Lockwood (2010) assess whether regional neighbors are especially important in influencing tax policy choice. Net of the effects of international and domestic factors, the number of regional adoptions significantly predicts VAT adoptions in focal countries. The authors, drawing on this evidence and country information, conclude that learning and “yardstick competition” likely drive the process of VAT diffusion.

5.

INTERNATIONAL ORGANIZATIONS AND SOFT COERCION

IOs such as the EU might also play a role in learning and emulation as they provide information and foster coordination for policy adoption among members (e.g., Genschel et al., 2011); so too might developing nation IOs such as the West African Economic and Monetary Union (e.g., Quak, 2018). IOs, however, may also promote policy diffusion through coercive mechanisms such as legal directives, or “soft coercion” where in exchange for financial assistance or crucial technical expertise and information, countries are required or pressured to adopt (most commonly) neoliberal tax reforms. The importance of these pressures from IOs are particularly pronounced in developing countries (Wibbels & Arce, 2003). The EU’s directives on VAT are probably the best-known coercive mechanisms for the spread of the VAT. That said, in a comprehensive study of EU tax authority, Schmidtke (2016) finds that while tax legislation and efforts at coordination have increased over time, hard legal authority has not. Other IOs, however, also use legal directives and, in a few cases, mandate tax rates. The best example of this coercive mechanism is the West African Economic and Monetary Union where the IO specifies a range of tax rates for income taxation. Yet, the impact of this legal direction is largely limited to statutory rates, and not particularly effective in shaping tax rates due to very limited state capacity to monitor and implement the directives (Quak, 2018). Evidence for soft coercion in tax policy diffusion is more prevalent, especially for VAT in the developing world. Indeed, comprehensive studies of the spread of VAT in developing nations highlight the significant effect of IMF advising and, especially, IMF program participation in national VAT adoptions. For instance, in quantitative studies of the developing world generally (Keen & Lockwood, 2010) and of Latin America specifically (Mahon, 2004), scholars find IMF program participation predicts VAT adoption; this is especially true when economic

238  Handbook on the politics of taxation performance goals are specified in IMF agreements (Mahon, 2004). In qualitative analysis of tax reform in a relatively large number of developing countries, scholars effectively reproduce these findings (e.g., Bird & Gendron, 2007). As to taxation generally, there have been increased efforts among leading nations and IOs to build new institutions for tax policy coordination, especially in the areas of suppressing tax evasion and avoidance as well as assuring fair distribution of the tax base in the face of new pressures such as the digital economy (Christensen & Hearson, 2019). These efforts in all likelihood will involve the promotion of learning, emulation, and soft coercion.

6.

TAX POLICY DIFFUSION: SOME CONCLUDING THOUGHTS ON FUTURE DIRECTIONS

As illustrated in preceding pages, the literature on the transnational diffusion of tax policy in the contemporary era has developed from simple tests of the impacts of economic openness that employ inferences about strategic tax competition, to sophisticated studies of politically contingent international diffusion through economic competition, learning, and emulation. The main conclusion to be drawn from the extant literature is that tax policy diffusion is heavily conditional on domestic institutions and political dynamics. To advance the understating of tax policy diffusion achieved in this work, two areas of research seem particularly promising. First, we might look to the past. As is well understood, there was a significant, even explosive increase in state revenue-raising capacity during the later decades of the nineteenth and early decades of the twentieth century; adoptions of major forms of income and other direct taxes as well as consumption taxes spread across the globe (e.g., Scheve & Stasavage, 2016; Seelkopf et al., 2016; Seelkopf & Lierse, 2020). Unfortunately, much of the literature has not consciously modeled the rich, complex diffusion processes that are likely in play during the evolution of the modern tax state. Instead, as the synoptic review of literature by Kiser and Karceski (2017) suggests, scholars have focused essentially on the role of the “common shocks” of democratization, the spread of bureaucratic capacity, and changes in demands for public-sector spending; recent research has also shined a new spotlight on the role of war in shaping (especially income) tax structures (e.g., Mares & Queralt, 2015; Scheve & Stasavage, 2016). Most of the major studies of the development of the modern tax state – whether focusing on war, democracy, or another factor – acknowledge the strategic interdependence in the spread of taxation. A small set of recent studies has actually begun to model the diffusion of tax policies, and illustrate the potential for much more focused work on the role of economic competition, learning, emulation, and coercion and the political conditioning of these processes historically.14 For instance, an important study by economists Aidt and Jensen (2009) finds in a sample of industrializing nations that adoption of the income tax was a function of the introduction of the franchise, spending demands, a reduction of tax collection costs, and social learning (by following linguistically similar early adopters). In two recent papers, Laura Seelkopf and colleagues (Seelkopf et al., 2016; Seelkopf & Lierse, 2020) study adoptions of major forms of direct and indirect taxes in a sample of over 130 nations from the nineteenth century. While the authors focus most centrally on other factors (i.e., trade liberalization, democracy), they control for the number of prior regional adopters and find that this factor is significant for the adoption of indirect taxes, namely, the general sales and VAT in particular.

Politics and the diffusion of tax policy  239 These studies make an important start in the analysis of diffusion in the historical evolution of tax systems; there is a lot to do, however, in terms of theorization, measurement, and empirical analysis so that we might better understand tax policy diffusion in the nineteenth and early twentieth century as well as today. A second path for future research is the exploration of the processes of diffusion that occur beyond simple state-to-state strategic adjustments. That is, as Ward and Cao (2012) have argued in their study of the diffusion of green taxes, tax diffusion often occurs through networks that link domestic and international experts, economists, business, and environmentalists; this approach is partially prefigured in studies of the transmission of policies and ideas through membership in IOs (e.g., Cao, 2010); in studies of the role of networks of right-wing thinktanks, parties, and politicians in the diffusion of the flat tax; and in studies of the joint importance of global and domestic strength of anti-capitalist parties in the diffusion of international economic liberalization (Quinn & Toyoda, 2007). In the contemporary context, this approach would be particularly helpful, for instance, in understanding whether norms of fairness in tax policy, concretely expressed in the form of calls for policies that increase top marginal income and inheritance tax rates, have diffused across major areas of the globe. Indeed, the study of the rise in post-crisis personal income tax rates (Limberg, 2019) and inheritance taxes on the rich (Emmenegger & Marx, 2019) has taken on new importance in the wake of decades of growth in inequality and the 2008–2009 financial crises and “great recession.” Limberg (2019) studies the role of the financial crisis, arguing that those countries experiencing significant effects of the crisis are those that have seen an increase in top marginal personal income tax rates; the principal test is to model tax responsiveness to fiscal pressure of income taxation, as conditioned by exposure to the crisis, in a global sample of nations since the late 2000s. The causal mechanism, which is not directly tested, is postulated as the expansion of support for higher income taxes as compensation for elite profits made pre-crisis, and the general costs of the crisis borne by common citizens. In the context of this sort of study, it would be potentially very helpful – to give one example of relevant political dynamics – to explore the rise of left populist parties regionally and domestically as key conduits of this compensation-based fairness norm as these parties typically champion higher taxes on elites (on the role of left populist movements and parties in tax reform, see among others Mahon et al., 2015). At the same time, to study the political basis of the global diffusion of new progressive income taxes, one should carefully explore the global, regional, and national rise of right-wing populist parties. As Swank and Betz (2018) have argued, while moving toward the center in some areas, they have continued to call for significant reductions in personal income taxation. In fact, in the recent study of the fate of the 2011 Swiss inheritance, Emmenegger and Marx (2019) highlight, among other political forces, the role of the strong opposition to the tax by the right-wing populist Swiss People’s Party in the ultimate defeat of the tax. In general, one could certainly develop and test hypotheses that global, regional, and domestic networks of right-wing populist parties, groups and activists and networks of left-wing populist parties, progressive groups, and political entrepreneurs should have significant effects on, or be conduits of in the case of left networks, the diffusion of new income and related direct taxes on top incomes and wealth. In fact, it is reasonable to suggest that this line of theorizing and research on tax policy diffusion will move us closer to a more realistic understanding of the politics of taxation in the twenty-first century.

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NOTES 1. In the concluding section of the chapter, I provide a synopsis of recent research on the historical diffusion of tax policies, and I emphasize that this is an area in need of much further exploration. 2. This section draws on my past work (e.g., Swank & Steinmo, 2002; Swank, 2016b). The neoliberal transformation of tax policy refers to the paradigmatic change in emphases in taxation toward efficiency and away from equity, toward market resource allocation and away from tax-based policy instruments, and toward relatively low, flat rate taxes and away from high top income tax rates. 3. Effective marginal corporate tax rates fell as well (Devereux et al., 2008) as did effective average personal income tax rates (Peter et al., 2010). 4. On the political economy of the diffusion of VAT in developed democracies, see Kato (2003). 5. I thank Laura Seelkopf for raising this point. 6. For the purposes of this review, I define policy diffusion as the outcome of actions by national policymakers to consciously adopt, in whole or in part, the policies of other nations. Thus, I distinguish policy diffusion from the common adoption by policymakers of similar policies in response to mutually shared “shocks” (e.g., globalization, de-industrialization, short-term economic crises). 7. As is well known, there is a large literature in the social sciences on the diffusion of ideas, technology, institutions, and public policies. Simmons et al. (2008) survey many of the most policy-relevant studies. Also see, among others, Baybeck et al. (2011), Gilardi (2012), Linos (2013), and Wasserfallen (2018) for insightful overviews relevant to contemporary policy diffusion. 8. There is some disagreement among scholars over whether coercion should be lumped conceptually with the other mechanisms for interdependent, transnational policy diffusion. That is, one might question whether coercion – which may explain the spread of a policy – actually involves policymakers’ conscious response to actions of policymakers in other nations. For instance, in well-known work on policy diffusion, Shipan and Volden (2008) explicitly include coercion as a mechanism of diffusion; Maggetti and Gilardi (2016) do not; Linos (2013) introduces a conceptual alternative to coercion (conditionality). 9. Another form of soft coercion may occur when former colonial powers use their political power, technical and financial resources, and sociocultural connections to influence former colonies in selecting tax policies. For references to the scant literature as well as a general test of colonial legacies on tax policy adoption, see Seelkopf et al. (2016). I thank Hanna Lierse for alerting me to this argument. 10. For a representative sample of these “first-generation” studies in political science, see Hallerberg and Basinger (1998), Garrett and Mitchell (2001), and Swank and Steinmo (2002); for a similar sample from economics, see Slemrod (2004) and Winner (2005). 11. In another relatively early paper, Baldwin and Krugman (2004) noted that larger, core countries in Europe will pull tax rates of other nations toward their own. 12. In the 2006 study, Swank finds little evidence that other political forces such as dominant party or mass ideology affect the pace of tax policy diffusion. However, the Swank (2016a) study finds that not only are US neoliberal tax reforms more slowly adopted in CMEs, but that adoption is slower in the presence of consensus democratic political institutions and left-leaning mass electorates. 13. As all the studies of the flat tax make clear, an effect of IOs in educating nations about the flat tax or pressing policymakers for flat tax adoption is largely absent. 14. It is also important to point out that these studies take advantage of new data sets on the historical adoption of taxes and their evolution (see the information on original data sets used in Scheve & Stasavage, 2016; Seelkopf et al., 2016, 2019).

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16. The politics and history of global tax governance Martin Hearson and Thomas Rixen

1. INTRODUCTION Global tax governance is something of an anomaly in the current economic order. Many institutions of international economic cooperation are suffering from states’ unwillingness to pool sovereignty and inability to compromise: consider the failure of the World Trade Organization to complete the Doha round of talks, slow progress in the United Nations (UN) climate change negotiations or the persistent divisions hampering more effective governance of the Eurozone. In contrast, taxation is one area in which the past decade has been one of unprecedented intensification of cooperation. One consequence has been a wave of new scholarship on international taxation, which had not until recently received the same kind of attention from scholars of Political Science and International Political Economy as areas such as trade, finance and investment. Most of this scholarship focuses on cooperation between members of the Organisation for Economic Co-operation and Development (OECD), the historical centre of cooperation. As we will outline in this chapter, however, it is increasingly difficult to analyse global tax governance holistically without incorporating emerging markets and other countries of the Global South. International political economists understand the development of global economic governance institutions over the past century through an historical arc that applies to many different policy areas. The period between the First and Second World Wars was marked by a failure to cooperate among the major colonial powers, leading to competitive currency devaluations and protectionist trade measures. From 1945 to the early 1970s, countries of the Global North maintained the relatively stable and cooperative ‘Bretton Woods’ regime of fixed exchange rates and capital controls, while in the Global South a wave of independence movements led to widespread decolonisation and economic nationalism. The collapse of Bretton Woods opened the floodgates to mobile capital, and was soon followed by debt crises in the South and the liberalisation of former Soviet economies, ushering in an era of neoliberal globalisation from the 1970s to the 1990s. The global financial crisis of 2008 marked the moment at which a gradual power shift eastwards, combined with a growing retreat into populist nationalism in the North, began to exhibit itself more clearly through changes to global governance institutions. It was most clearly symbolised when the more globally representative G20 superseded the G7 as the agenda-setting cartel of major powers. Some institutions, such as the World Trade Organization, became deadlocked as the Northern powers found themselves confronted by powerful blocs of Southern countries. Global tax governance has consistently bucked the trend: its institutions, forged in the interwar years, were one of the League of Nations’ most enduring legacies; they changed little following the end of Bretton Woods, in spite of the new challenges created by capital account liberalisation. Newly independent developing countries raced to sign tax agreements with 244

The politics and history of global tax governance  245 Northern powers during the 1970s even as they refrained from liberalisation in other areas, maintaining high levels of trade protection, capital controls and fixed exchange rates. The financial crisis of 2008 marked the end of an era of stability, but this has provoked a period of rapid, radical and unpredictable cooperation, which continues as this book goes to press. Drawing on theoretical traditions of International Relations research, this chapter provides an overview of three different kinds of explanation for the development of global tax governance: interests (rational choice), global power relations ((neo)realism) and ideas and expertise (constructivism). We apply these theoretical lenses to the history of global tax governance over the past century, which we divide into three phases: (1) the regime’s foundation, beginning with the League of Nations in the 1920s, ending for OECD countries in the 1960s and much later for developing countries; (2) a period of stability in OECD countries from the 1960s to 2000s, during which global tax institutions endured in spite of growing contestation caused by the growth of tax competition; (3) the crisis of global tax governance, from 2009 to the present day, characterised by growing contestation and the entry of new actors into the OECD-dominated regime, including emerging economies and developing countries, regional organisations and civil society organisations. We characterise these three periods through the lens of a trilemma: three policy goals, among which governments can only reach two simultaneously (Genschel & Rixen, 2015; Deng, 2019). 1. Avoiding the ‘double taxation’ that occurs when more than one government claims the right to tax cross-border economic activity. Absent cooperation between governments, a multinational company may face taxation on the same profits in two or more countries, most pertinently the countries in which it has operations and again in the country in which it is headquartered. 2. Preventing ‘double non-taxation’, the mirror image of double taxation, in which neither government is able to tax cross-border economic activity. This may occur against a government’s will either because its own tax rules and those agreed internationally prevent it from taxing (tax avoidance) or because wealth is hidden abroad (tax evasion). We will refer to this problem as ‘tax competition’, because the major function of cooperation here is to prevent jurisdictions from deliberately enabling tax avoidance and evasion as they compete to attract investment. 3. Preserving national tax sovereignty, because taxation is a core feature of the social contract in democratic national polities. Cooperation in either of the above areas entails some kind of pooling of sovereignty over writing or administering tax laws. It is the choice between these three goals, as well as the effectiveness with which they are achieved, that forms the central puzzle of scholarship on global tax governance. As set out in Table 16.1, the regime initially sacrificed a focus on tax competition to prioritise the avoidance of double taxation, while leaving state sovereignty intact. It exhibited a remarkable resilience throughout the second half of the twentieth century, but as the century drew to an end, came under increasing pressure as tax competition grew in salience. Developments since 2009 have allowed states to finally address tax competition, but at the cost of increasing amounts of sovereignty. The chapter’s conclusion takes stock of scholarship and discusses options for future research. The relatively young debate in Political Science about global tax governance is characterised by a focus on mid-range theories and mechanisms, and an ontological eclecticism.

246  Handbook on the politics of taxation Table 16.1

Priorities for cooperation in different phases of global tax governance Double taxation

Tax competition

Sovereignty preservation

Foundation

High

Low

High

Stability

High

Increasing

High

Crisis

High

High

Decreasing

The good news is that this has facilitated a more productive engagement between different theories than the paradigmatic debates that have dominated the International Relations and International Political Economy disciplines as a whole. We are in a good position to analyse current global tax negotiations through different lenses, which produce competing predictions. On the other hand, while tax justice has risen to the political foreground, catching our disciplinary colleagues’ attention, our collective mid-range view limits our ability to speak to bigger debates within and beyond academia. Future scholarship should focus more on the role of taxation within the global political economy at large. We must also take seriously the challenge that our scholarship does not adequately understand the Global South – an empirical as well as a normative deficit.

2.

WHAT DRIVES GLOBAL TAX GOVERNANCE?

How can we explain or understand the institutional design, its development over time and the changing policy outcomes? To begin with, we will provide an overview of three theoretical lenses well known in Political Science – interests, power and ideas – through which scholars have attempted to explain outcomes in international tax governance. These are not mutually exclusive ways to analyse the world, and indeed it is often at the intersections between them that we gain the most analytical leverage. As we will discuss throughout, institutionalist arguments, which can be seen as a theoretical lens in their own right, feature in accounts of global tax governance in all three traditions. 2.1 Interests According to the rational choice tradition, states maximise their national interests. Studies in this tradition often analyse the strategic structure, i.e. the constellation of interests resulting from the interaction of different national interests. The institutional design of a regime, i.e. the principles, norms, rules and procedures governing an issue area (Krasner, 1982), is then seen as a functional response to the problems inherent in the specific strategic structure (Lake & Powell, 1999). The critical distinction here is between the strategic structure of the double tax avoidance problem and that of tax competition. Rixen (2008) has argued that double taxation avoidance can be understood as a coordination game with distributive conflict. In coordination games agreements are largely self-enforcing. Since states prioritised the problem of double taxation when creating the international tax regime, it is largely regarded as successful in achieving this aim, and the Political Science literature on it remains small. In contrast, a sizable number of authors have analysed the failures and (partial) successes in the fight against tax competition. Tax competition exhibits the properties of an asymmetric prisoners’ dilemma that pits big countries against small tax havens. This is a more demanding strategic structure than coordi-

The politics and history of global tax governance  247 nation games. Most importantly, it requires strong enforcement capabilities at international or supranational level, which states have struggled to put in place in an effective manner. This certainly begs the question why an efficient solution has been so hard to find. If states are rational, why can they not overcome a dilemma, to which solutions have been found in other areas of international cooperation (Axelrod & Keohane, 1985)? Answers in the rational choice tradition have been suggested by giving up two assumptions of early work in Regime Theory: first, the heavy functionalism that sees governments as pursuing national welfare (defined as some ideal combination of private income and public tax revenue); and second, the assumption of (more or less) unitary states. By instead conceptualising the situation as a two-level game and focusing on the domestic political determinants of government preferences (Putnam, 1988; Lake, 2009b), several studies have shown that states do not necessarily have an interest in fighting tax competition, but rather are strongly influenced by the aim of maintaining a competitive advantage for their finance industries and multinational investors (Hakelberg, 2016; Webb, 2006). Institutionalist theories provide another way to explain the failure to cooperate that is based on state interests. Historical institutionalists point out that many institutions develop in a path-dependent fashion: institutions created in the past condition states’ interests and the possibilities for change in the present. Since states’ priorities from global tax governance changed over time, their options to address the growing tax competition problem were conditioned by the design of existing institutions designed to prevent double taxation. In such circumstances, we expect institutions that are not fit for purpose to change only incrementally (Streeck & Thelen, 2005) unless states are presented with a critical juncture, a crisis during which structural constraints on actors may be relieved and an institution can undergo far-reaching changes (Capoccia & Kelemen, 2007). 2.2 Power A second category of explanation focuses on the distribution of power within the international economy. From this perspective, the institutions of global tax governance still reflect state interests, but the asymmetrical distribution of power determines which of those interests prevail, and allows powerful states to change the interests of others. Hegemonic Stability Theory suggests that the global institutions necessary for an open global economy to function well are most likely to exist where a single powerful state is willing to use its wealth and power to establish and maintain them (Kindleberger, 1976). Regime Theory, which we mentioned above under ‘interests’, also posits that a group of powerful states could work together to maintain institutions in the absence of a single hegemon (Keohane, 1984). It is for this reason that scholars examining global tax politics through a power-based lens have tended to either focus exclusively on the United States (US), or to look more broadly at the OECD as a hegemonic bloc (Crasnic & Hakelberg, this volume). It is also worth noting here the alternative conceptualisation of hegemony found in the critical scholar Robert Cox’s work (1981). Drawing on Gramsci, Cox described a structure of hegemony that transcended interstate politics, incorporating social forces that support the power of capital from the hegemonic state. Here, interest group preferences across borders may be transformed by hegemonic power, both by altering material circumstances and through the power of ideas. The hegemonic system also contains within it the seeds of a revolution, as those who lose from the system eventually come together to rebel against it. It is hard not

248  Handbook on the politics of taxation to regard the persistence of a system that tolerates tax avoidance (at which US multinationals excel) and tax evasion as a symptom of the dominance of Western capital interests. 2.3 Ideas Constructivist analyses of global tax governance shift the unit of analysis away from rationalist, state-centred models in two ways (Hearson, 2018a). First, they reject the notion of monolithic state preferences and focus instead on the individuals who craft the institutions of global governance. Second, they do not assume that policymakers and those seeking to influence them are purely rational; rather, they seek to understand the ideas through which policy problems are analysed, and the processes through which certain ideas become – and remain – institutionalised. A constructivist framing thus begins from the premise that we can understand and explain policy outcomes in global tax governance by analysing the contestation and consensus among groups of people who hold shared and different ideas about the same things. This is perhaps more compelling for international taxation than some other areas of economic and even tax policy, because historical obscurity helped to insulate it from interest group politics and from the attention of political principals, leaving it as a personal project of state negotiators and their interlocutors (Genschel & Rixen, 2015, p. 163). Being relatively insulated from political and public oversight, civil servants interacted with private business interests, forming a shared worldview, while many decision makers have changed between the private and public sectors throughout their careers. All this despite the fact that taxation – writ large – is a key part of popular politics. Constructivist approaches to International Political Economy vary between relatively ‘soft’ approaches that treat ideas as variables alongside material interests, through to more critical scholarship drawing on Cox, Bourdieu and others, in which ideas, norms and language are more fundamental to the social world, shaping the way in which every actor understands their material interests. We take no position on such ontological and epistemological debates here, but most published scholarship on the international tax regime is predominantly of the ‘soft’ constructivist kind (though see Picciotto, 2015). We now move on to discuss how each of these three broad theoretical perspectives can be used to interpret the historical trajectory of global tax governance. We divide that trajectory into three periods as outlined in Table 16.1: foundation, stability and crisis.

3.

FOUNDATION: AVOIDING OVERTAXATION AND PRESERVING NATIONAL TAX SOVEREIGNTY

After the First World War, many countries introduced income taxes. This led to growing concern that double taxation would inhibit trade and investment (Jogarajan, 2018). In response, the League of Nations began to commission reports and convene conferences. During the League years, basic principles and rules were developed that have guided global tax governance up to today. Governments persistently rejected the idea of a binding multilateral treaty, but were nonetheless supportive of developing a non-binding model convention that could be employed as a template for bilateral double tax agreements.

The politics and history of global tax governance  249 An important reason for the rejection of a binding multilateral treaty was the distributive conflict between capital-importing and exporting countries. Double taxation most commonly results from an overlap of jurisdiction to tax between a residence state, where the recipient of investment income lives or is headquartered, and a source state, where that investment was made and the income generated. Resolving it is a distributional settlement over whose tax claims should take precedence. Net capital exporters, principally the United Kingdom (UK) and the US, favoured the residence principle, which allocated a greater share of the tax revenue to their coffers. Net capital importers, which initially included the many European countries undergoing post-war reconstruction, favoured the source principle (Jogarajan, 2018). The first models published by the League’s Fiscal Commission in 1928 placed greater restrictions on source taxation than the Commission’s developing country members preferred. In 1946, the Commission published two new models, a ‘Mexico’ Draft developed predominantly by Latin American countries, and a ‘London’ Draft by Europeans and North Americans. In the 1950s the Organisation for European Economic Cooperation, which subsequently became the OECD, replaced the League of Nations (and briefly the UN) as the main multilateral policy forum for discussions of international tax issues (Picciotto, 1992). When the OECD concluded the first version of what is now the preeminent model in 1963, it was based on the treaties already in force among its members, which resembled the London Draft that they had agreed amongst themselves. The publication of the OECD model bookends the ‘foundation’ era for its members, now clearly part of a regime. For the rest of the world, much of it just emerging from colonial rule, foundation would continue for some time longer. During the second half of the twentieth century, new tax systems were established, inaugural tax treaties concluded and closed economies opened to foreign investment. In recognition of this, the UN published its own model treaty in 1980. It modestly amends the OECD model, but does not go nearly as far towards the interests of source countries as the Mexico Draft. Countries of the Global South have largely acquiesced to the OECD-UN approach in their tax treaties, except for a very source-based model agreed by the Community of Andean Nations in 1971 that failed to gain traction elsewhere. Two points are worth noting about the regime’s design. First, it combines multilateral soft law with bilateral hard law. This allowed the necessary flexibility to make nationally differing tax systems compatible with one another and to facilitate distributive compromise (within limits). Second, the particular solution embodied in the model convention is sovereignty preserving. It defines a series of legal constructs intended to allocate the right to tax among the jurisdictions involved. Governments retain authority over designing all elements of their tax law – namely, the tax base, tax rate and system of taxation – that result from domestic, politically salient choices. Emblematic for the sovereignty-preserving setup is the ‘separate entity approach’ to transfer pricing, combined with the ‘arm’s length principle’ (ALP). This allocates the profits of multinational enterprises (MNEs) among the countries in which they operate by treating the different group entities like independent actors transacting in a market. The main alternative approach, considered at the time and still debated today, is a unitary one. Unitary taxation treats an MNE as a holistic entity, apportioning its taxable profits between the states in which it operates using a formula that takes into account factors such as sales, fixed assets and employees. What do we need to explain? Two key questions animate literature discussing the original regime design: why did states adopt this unique combination of multilateral soft law and bilat-

250  Handbook on the politics of taxation eral hard law, and why did source states in the Global South agree to participate in a regime that they did not design, and whose rules exhibited a bias against them? Interests. Game Theory helps us to understand both questions. As the strategic structure of the double taxation problem is that of a coordination game with a distributive conflict, only soft law was needed at the multilateral level, and the regime developed without hierarchical modes of governance. At the same time, the distributional conflict inherent in the game can best be accommodated in bilateral bargains, which on their own would lead to protracted and transaction cost-intensive negotiations. To avoid this, the OECD model serves as a ‘constructed focal point’ for bilateral treaties, either directly or via other models, such as that of the UN, that are based on it (Rixen, 2008, pp. 155–180). The focus on rational interests and their strategic interaction does not merely explain the particular design of bilateralism on the basis of multilateralism, it also illuminates the dominant position occupied by the exclusive OECD club. There is no need to find full consensus in coordination games ex ante: once the first mover has set the standard, it is in everyone’s interest to follow. Nonetheless, as Krasner (1991) argues, power matters a great deal in such games to determine the distributional outcome. It thus becomes comprehensible why the OECD, and the US in particular, could shape multilateral principles and rules to such an extent (Rixen, 2008, pp. 171–172). This can also explain why most bilateral treaties favour the residence principle along the lines of the OECD model convention (Hearson, 2018b). It was in the interests of poorer and less powerful countries to join the regime, even though they had little say in its development. Power. For a power-based analysis, it is not at all surprising that the eventual design of international tax rules should benefit both the declining and rising hegemons in the first half of the twentieth century. The UK had accrued a large stock of investments abroad, especially in its colonies; the US was superseding it as the world’s largest exporter of capital, a process accelerated through the Marshall Plan. A hegemon may bear the cost of creating institutions (Kindleberger, 1976), as the US was willing to do by accepting some source taxation of its overseas investors, or force those costs onto other states, as the UK preferred by seeking rules based on exclusive residence taxing rights (Jogarajan, 2018). Power-based explanations align with the interest-based analysis of institutional design. There was no need for the US, UK or later the OECD bloc to bind others into a multilateral treaty, because those others had a strong incentive to participate voluntarily. By delegating the development of technical concepts and model conventions to an organisation with an exclusive club model, they wielded their superior economic power to make rules favourable to them. By using the OECD model as a template for their bilateral treaties, they promoted the worldwide diffusion of these rules. Conversely, the non-binding design allowed the US to renege from it when it suited its interests, forcing OECD states to accommodate its new position without the need for an ex ante renegotiation (Hakelberg, 2020). Ideas. While the contours of the League of Nations settlement undoubtedly follow national interests, studies of the negotiation process, as well as the accounts of individuals who were present, are unanimous in emphasising the role of a few key individuals (Graetz & O’Hearh, 1997; Jogarajan, 2018). Indeed, the preface to one of the early reports from the League of Nations fiscal committee stresses that, ‘although the members of the Committee are nominated by their respective Governments, they only speak in their capacity as experts, i.e., in their own name’ (League of Nations, 1927, p. 6). That these individuals designed a system that suited the interests of powerful states is hardly a coincidence, since they hailed from those states, and

The politics and history of global tax governance  251 were conscious of the need to please their principals. Ideas-based explanations thus support, rather than compete with, those based on power and interests. As for the expansion of the regime to developing countries, here the ideas-based literature differs from rationalist accounts. Legal scholars from developing countries start from the premise that their countries’ approach to treaty making is hampered by lack of knowledge and capacity among bureaucrats, and interference by politicians with aims unrelated to double taxation (Mutava, 2019). The powerful intellectual consensus developed by individuals at the League/OECD also exerts an ideational influence over developing countries, putting pressure on them to sign treaties based on the OECD model, and undermining attempts to expand source taxing rights (Hearson, 2021).

4.

STABILITY: CONSOLIDATION AND RESILIENCE IN THE FACE OF GROWING CONTESTATION

Between the 1960s and the early 2000s, the principles and rules of the double taxation regime became entrenched, as the OECD Model Convention became a broadly accepted and taken-for-granted norm of international affairs (Genschel & Rixen, 2015, pp. 162–163). We refer in this section to developments among the OECD countries, which had adopted the tools of the regime by the 1960s. For most countries of the Global South, tools such as the OECD’s transfer-pricing guidelines are still fairly new today, as is an active role in the making of global tax rules. While they no doubt began to suffer from some of the emerging problems inherent to the regime, countries of the Global South were largely observers during this period of stability. The OECD’s success came at a cost. The liberalisation of international economic activity among its member states, combined with the sovereignty-preserving double taxation regime, led to the problem of harmful tax competition. The rules of double tax avoidance pre-structured taxpayers’ (legal) avoidance and (illegal) evasion techniques. For example, the ALP could be manipulated to ensure that profits accumulated in low- or zero-tax countries, while losses occurred in high-tax states. The result was a new axis of interstate conflict, between large countries and small (tax haven) countries. The former are somewhat constrained in their ability to offer low tax rates, because they have a large domestic tax base relative to the foreign one, and so lowering taxes would involve a substantial revenue loss. In contrast, small tax havens can ‘commercialize their sovereignty’ (Palan, 2002). They can ‘poach’ the tax base of big countries with lower tax rates, because the inflow of capital brings benefits that outweigh the reduction in their domestic tax base (Dehejia & Genschel, 1999). In reaction to the emerging tax havens problem, many OECD countries adopted unilateral anti-avoidance measures, such as controlled foreign companies legislation in the 1960s, and stricter transfer pricing rules in the 1990s. Great care was taken to adhere to the sovereignty-preserving character, at least formally, and thus these adaptations further entrenched the established institutional setup. Reforms proved to be very complex and largely ineffective in the prevention of harmful tax competition. They often led to fierce opposition from domestic business interests claiming that they represent a competitive disadvantage vis-à-vis states without such rules. As evaders and avoiders can always shift their activities to third countries, unilateral measures tend to be ineffective (Rixen, 2008, pp. 122–131). The problem of tax competition came to dominate the agenda of tax governance, at least in the Global North. In 1996, recognising the lack of effectiveness of unilateralism, the G7

252  Handbook on the politics of taxation finance ministers mandated the OECD to launch a multilateral project to tackle it (OECD, 1998). The original purpose was to persuade tax havens to abolish their secrecy and other harmful tax practices so that residence states could tax the foreign income of their residents effectively. The project also aimed at preferential tax regimes in high-tax countries, rules that tried to attract foreign capital of MNEs by offering them better treatment than was available to domestic investors. Aiming at the same kind of policies in its member states, the European Union launched a ‘harmful tax practices’ project at around the same time (European Commission, 1997). The harmful tax competition project never achieved its lofty ambitions. In 2001, the incoming US administration under George W. Bush declared that ‘The United States does not support efforts to dictate to any country what its own tax rates or tax system should be, and will not participate in any initiative to harmonize world tax systems’ (O’Neill, 2001). With respect to the harmful tax practices of OECD countries, no sanctions were ever threatened or carried out. While the project had originally constituted a major challenge to governments’ sovereignty over national tax systems, it was scaled down to the issues of transparency and information exchange between tax havens and non-haven countries (Webb, 2004, p. 816). This also meant that the issue of corporate tax avoidance was off the agenda, because transparency and information exchange mostly target tax evasion by individuals. Nevertheless, the OECD project marked the beginning of a shift towards harder, more inclusive and sovereignty-constraining governance. The OECD established the ‘Global Forum on Taxation’, which was open to non-members and tax havens, and established a peer review mechanism of states’ tax practices. While this initial attempt at multilateral cooperation against tax competition is generally perceived as a failure (Sharman, 2006), it does mark the (implicit) acceptance of the notion that tax policy is not a purely national affair but may be subject to international, ideally multilateral, cooperation and rules. What do we need to explain? The key question for scholarship on this era, most of it from the late 1990s and 2000s, is why the regime was not radically reformed, as would have been necessary to resolve the problem of tax competition. Interests. A first interests-based explanation emphasises the vested interests of OECD members in retaining the system as it was designed. It was not in their interests to reopen the central bargain that benefitted them as capital exporters. In the spirit of a rational choice-oriented historical institutionalism, Rixen (2011) points out that institutions embodying solutions to coordination games will often develop in a path-dependent fashion, i.e. exhibit stability in the face of dysfunctionality. States were hamstrung in their fight against tax competition by the path dependence of the institutions they had created earlier to solve the problem of double taxation, which lacked the mechanisms or the credibility to force compliance. Similarly, a shift towards more sovereignty-constraining forms of cooperation risked curbing states’ own autonomy to compete for inward investment. Nonetheless, the incremental drive towards harder and more sovereignty-constraining modes of governance can be understood as a functional adaptation, albeit very partial, to the strategic structure of tax competition. Second, large, developed countries also have finance sectors that themselves benefit from tax competition: the City of London, for example, gains business through its connections with the UK’s overseas territories and crown dependencies (Shaxson, 2011); several states within the US are offshore financial centres; multinational companies from powerful OECD member states profit from offshore tax avoidance (Garcia-Bernardo et al., 2017).

The politics and history of global tax governance  253 Power. The era of stability coincides with one of US hegemony in global economic governance. Arguably, throughout history the single major determinant of how international tax rules have developed was the preferences of the US. It was the US veto that mattered for the demise of the OECD’s harmful tax competition project, not that of smaller, more vigorously opposing, countries such as Switzerland and Luxembourg (Hakelberg, 2020). The US has staunchly defended the sovereignty-preserving characteristics of the regime, while pioneering measures against tax avoidance through unilateral action. For example, the US adopted tougher new transfer-pricing guidelines in the early 1990s that move the actual rules closer to considering the consolidated profits of MNEs, but take great care to formally reinforce the principle of separate entity accounting (Radaelli, 1998). The new unilateral rules were subsequently diffused and coordinated throughout the OECD, and eventually beyond, despite initial opposition from many countries (Rixen, 2011). Ideas. Many scholars discussing the continued stability of the international tax regime have drawn reference to an ‘epistemic community that holds an important and influential position in the law-making order’ (e.g. Christians, 2010). The social community developed in parallel with the institutions themselves, creating entrenched interests that defended existing institutions even though they were not suited to resolving the harmful tax competition problem (Büttner & Thiemann, 2017; Wigan & Baden, 2017). Literature has also suggested that the designation of tax cooperation as a largely technical domain, combined with the elaboration of increasingly complex concepts and language, has insulated the policymaking process from intervention by political actors including civil society and even politicians, even as tax avoidance and evasion increased in political salience (Picciotto, 2015). On the central question of the failure of the OECD project, constructivist scholarship points to an explanation which is less premised on lobbying by US corporate interests and more on discourse and ideology (Sharman, 2006, pp. 83–86). Tax havens questioned the legitimacy of the requests by dismissing them as undue interference with their national tax sovereignty. Constructivists point out the importance of institutions as carriers of ‘constituent’ ideas emphasising the consensus within the OECD around tax competition in general, and pointing to hypocrisy within the OECD, whose members include tax havens such as Switzerland and Luxembourg. Further, the OECD’s technocratic identity presumes a way of working premised on soft power, which was inadequate to the task of forcing tax havens to comply with anti-harmful tax competition rules.

5.

CRISIS: (RELATIVELY) RAPID CHANGE

In the current phase, the focus of cooperation is tax competition, although governments have not let go of the double taxation problem either. To keep hold of both, they have chosen to adopt ever more sovereignty-constraining, multilateralised institutions. The marked increase in the pace and ambition of change coincided with the global financial crisis (Christensen & Hearson, 2019). Following the crisis, indebted governments were eager to increase revenues. A creeping politicisation of international taxation during the 2000s was accelerated by anger at austerity and news stories about rich individuals and corporations dodging their taxes, such as the UBS scandal, Panama and Paradise Papers and LuxLeaks. The most important policy change occurred in the fight against tax evasion. This began directly after the financial crisis by mandating tax havens, under threat of G20 sanctions, to

254  Handbook on the politics of taxation sign bilateral agreements providing for tax information exchange, but only on request. While the effectiveness of these treaties remained limited (Woodward, 2016), the G20 doubled down on this initial measure. First, the US, spurred by the UBS scandal, took unilateral action in the form of the Foreign Account Tax Compliance Act (FATCA). It pressured other governments to automatically share information about foreign income of US taxpayers (Emmenegger, 2017). Using the momentum of FATCA, the OECD developed the Common Reporting Standard, which declared automatic exchange of taxpayer information to be the new global standard. While participation remains (formally) voluntary, informal pressure has increased significantly. The new standard is assessed through the OECD Global Forum’s peer review mechanism, which is backed by a threat of G20 sanctions, as well as the threat of unilateral sanctions from powerful states. At the time of writing, 114 countries have signed up. Countries have moved more slowly in the area of tax avoidance by MNEs. In 2012, the G20 and OECD launched an initiative to tackle it, the Base Erosion and Profit Shifting project (BEPS). Although the project did achieve some small improvements, it falls short of ending tax avoidance, and in many ways preserves the status quo (Eccleston & Johnson, this volume). Recognising that especially in the digital economy the outcomes of BEPS were insufficient, the OECD has embarked on further consultations, sometimes referred to as BEPS 2.0. Two ‘pillars’ are under discussion, both of which amount to significant changes to the established principles of global tax governance. Pillar 1 strives for a binding multilateral redistribution of some of the corporate tax base, of the type rejected by the League of Nations. It also entails a partial abandonment of the ALP. It has proved difficult to build consensus around any of the conflicting proposals on the table. Pillar 2 is more clearly an anti-avoidance proposal, a set of several measures that, when combined, would require companies to pay a global minimum tax rate. This is a level of sovereignty-constraint that states have not previously been willing to countenance. So far, both pillars are mired in conflict, and they may yet be disrupted by Covid-19. In the meantime, developed and developing countries have begun to adopt unilateral measures (Rukundo, 2020). Institutionally, the OECD’s dominance has been broken, at least in terms of formal membership. The shift from G7 to G20 as the political motor of change brought large emerging markets to the top table, although this can be seen merely as a change in the composition of the rule-making club. Beyond this, similar to the Global Forum, the BEPS 2.0 measures are being developed in an inclusive and truly multilateral setting, the ‘Inclusive Framework’ on BEPS, in which over 130 countries, including many developing countries, participate on an equal footing, at least in principle (ATAF, 2019). Overall, these developments show that global tax governance has become harder and more multilateral in the past decade. In both evasion and avoidance, there are new binding multilateral agreements to quickly translate some of the new standards into hard law. The expanded membership of the Global Forum and Inclusive Framework may mark the end of the OECD’s club model of making tax rules, at least in principle (Eccleston & Johnson, this volume). Further, developments since the crisis show that states are increasingly willing to accept constraints on their sovereignty. Global tax governance is still decentralised and sovereignty-preserving in comparison to, say, the trade regime, but it looks quite different from the pre-2008 era. What do we need to explain? Whereas the research agenda in the era of stability focused on explaining lack of change, it is now the pace and variation in change that merits investiga-

The politics and history of global tax governance  255 tion. What has happened since 2008 to create the conditions for reform, where states failed to agree beforehand? Why has progress been faster in the area of tax evasion than tax avoidance? Interests. Both within the OECD and further afield, states’ preferences have changed, and the OECD has become more united in the area of tax evasion, but less united in tax avoidance and double taxation. Following the financial crisis, tax avoidance and evasion entered popular political discourse, creating much stronger electoral incentives for politicians to be seen to be tackling them. On top of this, the crisis created a strong fiscal pressure in certain countries to maximise revenues wherever possible. But this development manifested itself differently in the fight against tax evasion and tax avoidance (Hakelberg & Rixen, 2020). To begin with, information exchange – the solution to tax evasion – is a functionally easier area to resolve, since solutions merely constrain states’ administrative sovereignty. Effective measures against avoidance would require states to pool or delegate legislative sovereignty, i.e. they would have to cooperate with others in setting their substantive tax laws (Rixen, 2008, pp. 192–200). Furthermore, the distributional politics of tax avoidance are much more complex than tax evasion (Hakelberg, 2020). The fight against evasion is mostly targeted towards individuals engaging in illegal behaviour, and it pits large states seeking to enforce their tax laws against small offshore centres. The fight against tax avoidance targets legal behaviour by large companies whose ‘competitiveness’ is crucial for the productivity of entire economies. The digitalisation of the economy has added to this distributional complexity by adding another new cleavage between countries, this time between ‘market’ countries and the rest, pitting small exporters against large, demand-driven economies. The European Union and OECD are split, with some large European countries in favour of an expansion of taxation in the market, alongside developing countries. Meanwhile, the US and China are allied alongside Northern European economies, all digital service exporters opposed to the reform. Power. As we noted earlier, power-based scholarship on global tax governance has focused overwhelmingly on the US, and this is especially true in the current era. FATCA was a decision by the latter unilaterally to impose an obligation on foreign banks to exchange information automatically, leveraging the size of its financial markets to force most to comply. There is no doubt that this unilateralism by a ‘Great Power’ catalysed the creation of a global regime for the automatic exchange of information between governments (Grinberg, 2012; Hakelberg, 2016). The power-based perspective thus complements others by demonstrating how one powerful state can change the incentives for less powerful states. The US created an insurgent regime with sufficient momentum to become a focal point outside the existing institutional setup, around which other states converge, and institutions (the OECD) adapt (Emmenegger, 2017). The power-based explanation becomes very convincing once one realises that the US has never agreed to reciprocate in the exchange of information, making it among the world’s most secret jurisdictions and giving its own finance sector a competitive advantage as a result (Cobham et al., 2015). Corporate tax avoidance differs from tax evasion in two ways pertinent to power-based approaches (Lips, 2019). First, action against it would have a greater cost for US businesses and would be likely to disadvantage their competitive position, especially if a redistribution of taxing rights were to take place. With the world’s two biggest economies now sceptical of reform, it is unsurprising that progress is slow. Second, power is becoming much more diffuse in the area of foreign direct investment, and no one country possesses the same clear advantage over others as the US does in portfolio finance. Thus, even if the US were in favour of reform, it would not be able to lead it alone. Both these reasons point to a prediction emerging from

256  Handbook on the politics of taxation power-based scholarship that it will be harder to achieve the same success in international action on corporate tax avoidance as on tax evasion. Ideas. Since the creation and stability of the double taxation regime was explained by constructivists through the ideational consensus among tax experts in government and business, it follows that an era of rapid change must be the product of some disruption to that consensus. The challenge came from three directions. First, there was a growth in interest in international taxation from non-governmental organisations (NGOs), a process that began with the creation of the Tax Justice Network, a network of critical tax specialists, in 2002, and continued as development NGOs began to question the impact of tax competition on developing countries. Studies of NGOs’ effectiveness have pointed to their ability to combine popular mobilisation and media work with an insider strategy in which they entered into the expert discourse (Seabrooke & Wigan, 2016). The second change, following the financial crisis, was the wider politicisation of international tax, a consequence of post-crisis austerity politics and later a series of tax haven leaks that threw light on the extent of tax haven use by the wealthy, powerful and famous. Politicians, not bound by the same normative rules as tax technocrats, and unfamiliar with the internal logic of the international tax regime, have begun to exercise what is effectively a disruptive influence. Finally, governmental actors that did not have the longstanding history of engagement within the OECD became active participants in global tax negotiations. Large emerging markets were first involved following the shift from G7 to G20 governance, while other developing countries have become more vocal, more organised through groups such as the African Tax Administration Forum and G24, and were invited into OECD decision making through the Global Forum and Inclusive Framework.

6. CONCLUSION The literature on the political economy of global tax governance investigates the creation, endurance and recent instability of what often seem to be second-best institutions. Christensen and Hearson (2019) argue in their survey of post-2008 developments that the literature exhibits a status quo bias, having emerged at a moment when ‘institutional non-change’ was the main phenomenon in need of explanation. One can argue, however, that theories developed to explain stability have been successfully deployed to explain the variation in the rate of change to date between tax avoidance and evasion, as well as the effects of rising powers on states’ ability to reach agreement. Nonetheless, unanticipated developments in areas such as the taxation of the digital economy (Christensen & Lips, this volume) point to a need for further theoretical work, as well as anticipated changes resulting from Covid-19, which has recast the financial positions of both governments and multinational companies. We suggest three particular directions here. To begin with, scholarship’s overwhelming focus on the problem of tax competition means the triangle through which we have framed this chapter is lopsided. Much less work has been done to understand the political economy of double taxation avoidance and of tax sovereignty. Yet it is becoming urgent that we understand both: ‘BEPS 2.0’ began as a negotiation among states around tax competition, but has evolved into an explicit and unprecedented multilateral renegotiation of the double taxation settlement. While the outcome is still unknown, the new settlement may work against the regime’s sovereignty-preserving character in a number of ways: it may constrain states’ ability to impose unilateral measures, entail an agreed minimum

The politics and history of global tax governance  257 tax rate and incorporate a multilateral dispute settlement mechanism. As states’ fiscal positions worsen, the cocktail of digitalisation and Covid-19 is placing the regime under unprecedented stress. Governments will be desperate for more tax revenue, but less willing to give up sovereignty over their own tax systems. New taxes, such as on carbon emissions and financial transactions, may emerge as the frontier of international cooperation, each with their own dynamics that differ to those of corporate and personal income tax. To understand these developments, we need to test and refine the theories developed in earlier work on the creation and stability of a global regime focused on income taxes. The growing importance of non-OECD states to global tax governance implies a need for less Western-centric scholarship. The tension between capital-exporting and capital-importing countries, a subsidiary question when the central question was about agreement among OECD countries, is foregrounded by the integration of large emerging economies and smaller developing countries into OECD decision-making bodies. There is also the emergence of a new dividing line based on consumer market size rather than investment position. The preferences of developing countries may not align easily with our existing interests-based explanations, for a number of reasons: many are not democracies, they often have limited negotiating experience and policymaking capacity, and in general their governments rely much more on tax revenue from foreign multinational companies. Finally, we urge scholars of global tax governance to think bigger. The focus on mid-range, tax-specific problems should be complemented by reflections on how those problems fit into the bigger considerations that orientate disciplinary debate in International Political Economy and International Relations, as well as the policy landscape. For example, in an era when the liberal economic order and longstanding US hegemony appear under threat, tax scholars should join the collective effort to move beyond concepts that we use on a daily basis: the shift from sovereignty to a multidimensional and historicised hierarchies approach, which decentres the state (Lake, 2009a; Mattern & Zarakol, 2016); the concept of ‘weaponised interdependence’ to understand state power (Farrell & Newman, 2019). How can the upheavals in global tax governance help us refine these concepts? Meanwhile, critical scholarship continues to debate the underlying forces that brought about the global financial crisis, encouraging us to consider the creation of offshore spaces, as well as overall fiscal policy, in the context of the whole capitalist system. Inequality has emerged as a potent symbol of neoliberal capitalism’s failures, a rallying cry for the contemporary backlash against it (Rodrik, 2018; Saez & Zucman, 2019). There is a rich story to be told here about the contribution of international tax avoidance and evasion, as well as national tax policy made under global tax competition, and the inequalities embedded in global tax rules.

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258  Handbook on the politics of taxation Christensen, R. C., & Hearson, M. (2019). The new politics of global tax governance: Taking stock a decade after the financial crisis. Review of International Political Economy, 26(5), 1068–1088. Christians, A. (2010). Taxation in a time of crisis: Policy leadership from the OECD to the G20. Northwestern Journal of Law and Social Policy, 5(19 February). Cobham, A., Janský, P., & Meinzer, M. (2015). The financial secrecy index: Shedding new light on the geography of secrecy. Economic Geography, 91(3), 281–303. Cox, R. W. (1981). Social forces, states and world orders: Beyond International Relations theory. Millennium, 10(2), 126–155. Dehejia, V. H., & Genschel, P. (1999). Tax competition in the European Union. Politics and Society, 27(3), 403–430. Deng, L. (2019). International tax governance and the Britacom. International Taxation in China, 4, 12–18. Emmenegger, P. (2017). Swiss banking secrecy and the problem of international cooperation in tax matters: A nut too hard to crack? Regulation and Governance, 11(1), 24–40. European Commission (1997). A package to tackle harmful tax competition in the European Union. Communication, COM(97)564final, 5 November, Brussels. Farrell, H., & Newman, A. L. (2019). Weaponized interdependence: How global economic networks shape state coercion. International Security, 44(1), 42–79. Garcia-Bernardo, J., Fichtner, J., Takes, F. W., & Heemskerk, E. M. (2017). Uncovering offshore financial centers: Conduits and sinks in the global corporate ownership network. Scientific Reports, 7(1), 6246. Genschel, P., & Rixen, T. (2015). Settling and unsettling the transnational legal order of international taxation. In T. C. Halliday & G. C. Shaffer (eds), Transnational Legal Orders, 154–184. Cambridge University Press. Graetz, M. J., & O’Hearh, M. M. (1997). The ‘original intent’ of US international taxation. Duke Law Journal, 46(5), 1021–1109. Grinberg, I. (2012). Beyond FATCA: An evolutionary moment for the international tax system. Georgetown Working Paper. http://​ssrn​.com/​abstract​=​1996752 (accessed 30 May 2012). Hakelberg, L. (2016). Coercion in international tax cooperation: Identifying the prerequisites for sanction threats by a great power. Review of International Political Economy, 23(3), 511–541. Hakelberg, L. (2020). The Hypocritical Hegemon: How the United States Shapes Global Rules against Tax Evasion and Avoidance. Cornell University Press. Hakelberg, L., & Rixen, T. (2020). Is neoliberalism still spreading? The impact of international cooperation on capital taxation. Review of International Political Economy, 1–27. Hearson, M. (2018a). Transnational expertise and the expansion of the international tax regime: Imposing ‘acceptable’ standards. Review of International Political Economy, 25(5), 647–671. Hearson, M. (2018b). When do developing countries negotiate away their corporate tax base? Journal of International Development, 30, 233–255. Hearson, M. (2021). Imposing Standards. The North–South Dimension of Global Tax Politics. Cornell University Press. Jogarajan, S. (2018). Double Taxation and the League of Nations. Cambridge University Press. Keohane, R. O. (1984). After Hegemony: Cooperation and Discord in the World Political Economy. Princeton University Press. Kindleberger, C. (1976). Systems of international economic organization. In D. Calleo (ed.), Money and the Coming World Order. New York University Press, pp. 15–40. Krasner, S. D. (1982). Structural causes and regime consequences: Regimes as intervening variables. International Organization, 36(2), 185–205. Krasner, S. D. (1991). Global communications and national power: Life on the Pareto frontier. World Politics, 43(3), 336–366. Lake, D. A. (2009a). Hierarchy in International Relations. Cornell University Press. Lake, D. A. (2009b). Open economy politics: A critical review. Review of International Organizations, 4(3), 219–244. Lake, D. A., & Powell, R. (eds) (1999). Strategic Choice and International Relations. Princeton University Press.

The politics and history of global tax governance  259 League of Nations (1927). Double Taxation and Tax Evasion. Report Presented by the Committee of Technical Experts on Double Taxation and Tax Evasion. League of Nations, C. 216. M 85. 1927 II. Lips, W. (2019). Great powers in global tax governance: A comparison of the US role in the CRS and BEPS. Globalizations, 16(1), 104–119. Mattern, J. B., & Zarakol, A. (2016). Hierarchies in world politics. International Organization, 70, 623–654. Mutava, C. N. (2019). Review of tax treaty practices and policy framework in Africa. ICTD Working Paper 102. IDS. O’Neill, P. H. (2001). Confronting OECD’s ‘harmful’ tax approach. Washington Times, A17, 11 May. OECD (1998). Harmful Tax Competition: An Emerging Global Issue. OECD. Palan, R. (2002). Tax havens and the commercialization of state sovereignty. International Organization, 56(1), 151–176. Picciotto, S. (1992). International Business Taxation: A Study in the Internationalization of Business Regulation. Quorum. Picciotto, S. (2015). Indeterminacy, complexity, technocracy and the reform of international corporate taxation. Social and Legal Studies, 24(2), 165–184. Putnam, R. D. (1988). Diplomacy and domestic politics: The logic of two-level games. International Organization, 42(3), 427–460. Radaelli, C. M. (1998). Game Theory and institutional entrepreneurship: Transfer pricing and the search for coordination in international tax policy. Policy Studies Journal, 26(4), 603–619. Rixen, T. (2008). The Political Economy of International Tax Governance. Palgrave Macmillan. Rixen, T. (2011). From double tax avoidance to tax competition: Explaining the institutional trajectory of international tax governance. Review of International Political Economy, 18(2), 197–227. Rodrik, D. (2018). Populism and the economics of globalization. Journal of International Business Policy, 1(1), 12–33. Rukundo, S. (2020). Addressing the challenges of taxation of the digital economy: Lessons for African countries. ICTD Working Paper 105. IDS. Saez, E., & Zucman, G. (2019). The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay. Norton. Seabrooke, L., & Wigan, D. (2016). Powering ideas through expertise: Professionals in global tax battles. Journal of European Public Policy, 23(3), 357–374. Sharman, J. C. (2006). Havens in a Storm: The Struggle for Global Tax Regulation. Cornell University Press. Shaxson, N. (2011). Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens. St Martin’s Press. Streeck, W., & Thelen, K. (2005). Institutional change in advanced political economics. In W. Streeck & K. Thelen (eds), Beyond Continuity: Institutional Change in Advanced Political Economics, 1–39. Oxford University Press. Webb, M. C. (2004). Defining the boundaries of legitimate state practice: Norms, transnational actors and the OECD’s project on harmful tax competition. Review of International Political Economy, 11(4), 787–827. Webb, M. C. (2006). Shaping international corporate taxation. In C. May (ed.), Global Corporate Power, 105–126. Lynne Rienner. Wigan, D., & Baden, A. (2017). Professional activists on tax transparency. In L. Seabrooke & L. F. Henriksen (eds), Professional Networks in Transnational Governance, 130–146. Cambridge University Press. Woodward, R. (2016). A strange revolution: Mock compliance and the failure of the OECD’s international tax transparency regime. In P. Dietsch & T. Rixen (eds), Global Tax Governance: What Is Wrong with It and How to Fix It, 103–121. ECPR Press.

17. The OECD’s governance of international corporate taxation: initiatives, instruments, and legitimacy Richard Eccleston and Lachlan Johnson

1. INTRODUCTION Tax policy, and the development of accepted practices for the taxation of international business transactions, has been a concern of international organizations since the 1920s. While the basic structure of today’s international corporate tax system can be traced back to the League of Nations, that organization’s demise saw the Organisation for European Economic Co-operation (OEEC), and then in 1961 the expanded Organisation for Economic Co-operation and Development (OECD), take over as the pre-eminent global tax policy actor. In the years since assuming this mantle, however, the OECD’s privileged position in the international tax arena has been challenged by structural changes in the global political economy. Indeed, the changing landscape of international tax also challenges the very possibility of managing the distributional conflicts generated by highly mobile capital and the growth of intangible assets within global value chains. This chapter will provide an overview of the OECD’s rise to prominence in the international corporate tax system, as well as its strategies, practices, and key initiatives to date, before taking a more in-depth look at some of the barriers to international cooperation in corporate tax policy that now confront both the OECD specifically and the system at large. The chapter proceeds in three parts. First, we briefly recount how the modern-day international corporate tax regime developed and describe the structure of this system as it was inherited by the OECD in 1961. This section emphasizes how the regime’s core tenets of separate entity taxation, permanent establishment, the benefits principle, and a network of bilateral treaties replicating a model tax convention (MTC) created many of the distributional conflicts that continue to plague its effectiveness. This regime may have helped reduce the incidence of double taxation, but it has also given rise to many of the problems plaguing cross-border corporate taxation in a globalized economy (also see Hearson & Rixen, this volume). This section also discusses implications of the processes utilized by the OECD to achieve consensus among its members, particularly mutual agreement and peer review, for the legitimacy and effectiveness of its tax policy initiatives. We discuss here how the OECD’s claims to legitimacy and authority have traditionally been built upon its technical expertise, its trans-governmental structure, and its close linkages with both member and non-member states (Eccleston & Woodward, 2014). While this may have been a viable governance structure for tax policy making among the major industrialized capital-exporting countries of the 1960s and 1970s, however, maintaining legitimacy in a changing international climate has required a more or less constant process of organizational adaptation (Carroll & Kellow, 2011), as evidenced most recently by the development of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS). Moreover, the OECD’s 260

The OECD’s governance of international corporate taxation  261 reliance upon claims to authority built around its specialist technical knowledge has been undermined in recent years by austerity, external critique, and economic populism, which have contributed to a political climate of increased suspicion, or even outright rejection, of technocratic expertise (Christensen & Hearson, 2019, p. 1070). Second, we review the OECD’s most recent international tax reform initiative: BEPS. It is argued here that despite the OECD’s early ambitions for a wholesale overhaul of the international corporate tax regime, BEPS has left the system’s existing structure basically intact. Rather, while conceding that it has delivered some important incremental changes, we concur with critics including Hakelberg (2020), Christians (2016), Büttner and Thiemann (2017), Cockfield (2018), and Woodward (2018) that BEPS has not yet meaningfully altered the status quo and is unlikely to significantly hinder aggressive tax planning in the future. Where progress does appear to have been made, however, is in the recently announced updates to the Inclusive Framework’s ‘two-pillar’ approach to taxing the digital economy. If broad agreement can be marshalled around these initiatives, Pillar 1’s profit allocation and taxing rights rules combined with Pillar 2’s ‘tax back’ provisions in cases where jurisdictions have failed to exercise primary taxing rights would constitute an effective minimum tax rate. While negotiations will no doubt be fraught with difficulty, if fully implemented in its proposed form this framework would have significant implications for corporate tax planning in the future and may help alleviate growing political tensions over the allocation of the corporate tax base. Third, we assess some of the systemic and institutional challenges faced by the OECD going forward, including a general trend of declining multilateralism and international cooperation as well as the rise of the European Union (EU) as a potentially significant rival corporate tax policy actor. Finally, the chapter asks what the post-BEPS future may hold for the OECD (and international tax cooperation more generally), concluding with an assessment of its capacity to overcome North–South inequalities, coordination challenges, legitimacy deficits, and the growing risk of defection from reform projects requiring high levels of cooperation between states with diverging economic interests. This section also offers an assessment of the potential of an OECD-led global tax governance framework to enact significant structural change to the existing regime. We argue here, in a broadly realist vein, that the OECD model is both institutionally and structurally beholden to its powerful members’ economic agendas and is unlikely to be capable of reforming a system established expressly to protect those members’ interests without their active cooperation. This cooperation is unlikely to be forthcoming any time soon, and this limits the OECD’s ability to fully realize the BEPS mandate of transformative change to the international tax system.

2.

THE OECD’S PRIMACY IN INTERNATIONAL CORPORATE TAX POLICY

The structure of today’s international corporate tax regime, along with many of its shortcomings, can be traced back to a pioneering 1923 report commissioned by the League of Nations Financial Committee and subsequent work by the Committee of Technical Experts on Double Taxation and Tax Evasion. This report and the committee’s other work devised three broad principles to address the growing challenge of mitigating distributional conflicts arising from taxation of cross-border commerce. First, it was advised that taxing rights be split between source and residence countries to ensure that profits from international business would not be

262  Handbook on the politics of taxation taxed by two different jurisdictions (double taxation). The solution proposed was that source countries, in which ‘real economic activity’ took place, were allocated primary taxing rights over ‘active’ business income while residence countries would have primary taxing rights over ‘passive’ investment income, such as dividends (Avi-Yonah & Xu, 2017). Second, the committee recommended that regardless of the degree of centralized control exerted within multinational corporation (MNC) groups over subsidiaries, each subsidiary company should be treated for taxation purposes as a separate entity. Finally, to safeguard state sovereignty, it was advised that these conventions be enshrined in bilateral double taxation treaties (DTAs) negotiated according to a pro forma model treaty but with broad discretion left to the states involved (for a more detailed overview see Hearson & Rixen, this volume; Woodward, 2018, pp. 25–26; Jogarajan, 2018). While this familiar outline and its conventions would eventually prove to be robust, only 60 such bilateral DTAs were actually signed during the interwar period (Picciotto, 1992, p. 25), meaning that the League of Nations’ system would not truly become institutionalized until the OEEC/OECD period of international tax governance, by which time developments in global commerce had already seriously undermined its suitability and effectiveness. In 1961, the newly minted OECD inherited the League of Nations/OEEC tax architecture to become the new pre-eminent multilateral forum for international tax policy discussions.1 The guiding principles of OECD tax governance have been, from the outset, characteristically broad, giving the organization wide scope for tax policy initiatives in a number of different technical arenas: ‘[s]ince 1956 the OECD has sought to build up a set of internationally accepted “rules of the game” which govern the ways in which Member countries tax profits arising from international transactions’ (OECD, 1993, p. 1). Far and away the most consequential change from the OEEC period, however, was the inclusion of the US as a full member. The organization’s economic policy agenda quickly came to reflect the dominance of this powerful new addition, pushing it towards a corporate tax framework largely consistent with American interests. One of its first actions was the synthesis of several existing model double tax avoidance treaties into a single, integrated OECD MTC in 1963, which effectively codified and perpetuated the increasingly evident shortcomings of its predecessors (Rixen, 2011, p. 207; Woodward, 2018, p. 28). Over the following decades, and especially through the 1980s, a vast network of some 3000 bilateral DTAs were concluded based on the OECD MTC, with the result that the bilateral tax treaty network quickly became entrenched into a durable, institutionalized global regime. 2.1

OECD Structure and Processes

While the OECD’s politics and objectives differ from the OEEC’s in several important ways,2 its processes, instruments, and organizational structure largely mirror those of its predecessor. Namely, it comprises 36 member states, each of whose ambassadors/delegates combine to form the OECD Council, chaired by the Secretary-General. The Council is the organization’s primary decision-making and agenda-setting body. The Secretary-General, in addition to chairing the Council, heads the OECD Secretariat, which exercises significant influence through the Program of Work and Budget process and whose directorates and divisions work with national policy makers in support of more than 300 committees and working groups convened on a range of specific policy issue areas. While the Secretariat has a full-time staff, committees and working groups comprise more fluid memberships of seconded or invited policy makers,

The OECD’s governance of international corporate taxation  263 academics, business leaders, and representatives of non-governmental organizations (NGOs) and civil society. The OECD also houses a number of semi-autonomous special entities, notably the International Energy Agency and the Nuclear Energy Agency (see also Davies & Woodward, 2014, pp. 328–338; OECD, 2019b). Development and implementation of OECD decisions occurs via roundtables and mutual agreement rather than through international treaty arrangements enforced by legal instruments or formal sanctions. Given its emphasis on deliberative and consensus-driven decision making, the peer review system inherited from the OEEC is ‘the heart of the OECD … defined as examination of one state’s performance or practices in a particular area by other states’ (Carroll & Kellow, 2011, p. 31). The peer review process is the primary way that OECD member states are subjected to critical scrutiny of their actions and, even more importantly, is critical to maintaining a sense of egalitarianism, democratic legitimacy, and accountability among members. These processes are important because as a ‘forum’ or ‘think-tank’ without a clear mandate, and with an approach defined by soft-law initiatives, measurement, and benchmarking, and the provision of technical advice, the OECD’s relevance, authority, and reputation rely on voluntary compliance with non-binding initiatives. These processes served the OEEC well in the disbursement of Marshall Plan reconstruction funds, and throughout the 1960s and 1970s they were also generally sustainable and effective methods for designing an international corporate tax regime consistent with the interests of the OECD’s wealthy capital-exporting members. The existence of broad consensus among members around a relatively narrow range of economic interests allowed the OECD system to operate smoothly, but developments over coming decades put the OECD’s tax governance approach under pressure by exposing conflict between member states. The changing face of multinational business and the advent of fierce tax competition between capital-importing countries looking to grow their tax bases towards the end of the century thus began to reveal limitations to the OECD’s ability to negotiate the complex and asymmetric distributional conflicts associated with aggressive tax planning and tax haven jurisdictions. The challenges facing the OECD in the international tax arena affirm existing analysis of both the strengths and weaknesses of the organization. Marcussen and Trondal (2011) argue that the OECD juggles ‘dual identities’, as its high-quality research and technical capability mean that it is well placed to influence and shape complex technical fields such as taxation, yet its consensus-based model of decision making limits its potential to resolve contested and highly politicized policy debates. In practice, this means that the ambition available to the OECD’s ‘epistemic’ function, characterized by a highly capable staff with deep expertise and analytical capacity, is not matched by its bureaucratic or administrative function, which relies on consensus and mutual agreement from member states pursuing individual self-interest. As a result, ambitious and far-reaching policy proposals often fall victim to the OECD’s institutional inability to ‘combine a compound set of roles and identities driven by colliding external and internal demands and expectations’ (Marcussen & Trondal, 2011, p. 594). This broad analysis is readily applicable to the OECD’s tax initiatives. Its legitimacy and reputation rest upon its technocratic and expertise-driven identity, but the politics and conflicts of its membership either dilute its epistemic influence or relegate it to less ambitious work, such as benchmarking, measurement, or standard setting. In response to these issues, however, in recent years the OECD has actively tried to build broad-based political support for its international tax programme by aligning itself more closely with other international organizations. A significant example was the OECD’s engagement with the G20 to secure support for its

264  Handbook on the politics of taxation BEPS project from the world’s leading economies (see Eccleston et al., 2015). The resulting collaborative approach has been close and relatively fruitful, providing the OECD with a source of legitimacy and mandate for its BEPS initiative and at the same time advancing important related transparency reforms, notably the G20’s 2013 commitment to implement new Automatic Exchange of Information standards (Motala, 2019, pp. 59–61). While these innovations and adaptations are significant, the OECD’s capacity to promote fundamental international tax reform remains limited.

3.

TAX COMPETITION IN THE ERA OF MULTINATIONAL CORPORATIONS: CHALLENGES TO OECD TAX GOVERNANCE

Two complementary processes undermined the OECD’s capacity to effectively govern the rise of MNC tax avoidance through the latter part of the twentieth century. The first of these was the changing face of MNCs themselves. The rapid march of globalization, financial market liberalization, and the increasing digitalization of economic activity began to produce a cohort of MNCs which ‘bore little resemblance to their predecessors’ rendering the OECD MTC system increasingly insufficient to deal with the rise of aggressive tax planning (Woodward, 2018). Where in 1970 there were only an estimated 2000 MNCs, by the century’s end this number had grown to more than 38,000 MNCs with hundreds of thousands of subsidiaries worldwide (OECD, 2018). Moreover, the typical MNC was fast becoming a large and globally integrated network of affiliated entities under tight central control, whose production relied increasingly upon global supply chains, intangible assets, intellectual property, patents, and trademarks (Mikler, 2018). With the help of a burgeoning tax-planning industry, these MNCs were able to exploit legal mismatches between jurisdictions and the ambiguity of transfer-pricing frameworks for intangible assets between subsidiaries conceived as separate entities to ensure that profits would ultimately be reported in the most tax-advantageous jurisdictions. The second process, closely linked to the first, was the development of a dynamic of intense tax competition between jurisdictions vying to offer the most amenable legal and regulatory conditions for non-resident investors. As the OECD Council noted over 20 years ago, a growing number of offshore financial centres (OFCs) and a ‘race to the bottom’ among tax haven jurisdictions ‘raises challenges for governments to minimize tax-induced distortions in investment and financing decisions and to maintain their tax base in this new global environment’ (OECD, 1998b) (on the race to the bottom see Lierse, this volume). While the use of lax regulation by small or ‘micro’ states wishing to attract mobile capital or foreign direct investment was not in itself a new phenomenon, from the mid-1970s onward a process Palan (2002) has termed the ‘commercialization of state sovereignty’ saw staggering volumes of capital migrate to MNC subsidiaries in tax haven jurisdictions. The proliferation of (mostly) very small island nations willing to offer financial opacity and tax shelter in exchange for rents on income that would previously have been resident in, and taxed by, larger nations created a veritable ‘offshore world’ in which high net worth individuals and MNCs alike were able to avoid or evade taxes with impunity (Palan, 2003). As a result of these changes in the structure of both MNCs and the international political economy, it became increasingly clear towards the end of the twentieth century that the largely instrumentalist approaches of wealthy member states to OECD tax policy making had created

The OECD’s governance of international corporate taxation  265 a corporate tax regime that prioritized the interests of members and their home MNCs above those of poorer non-member nations. Furthermore, these power imbalances had been perpetuated and solidified into a robust international system by the now very large network of bilateral tax treaties based upon the OECD MTC. In other words, the political economy of the OECD increasingly reflected the deep structural inequalities between its member and non-member states, undermining its moral authority to arbitrate conflicts in a corporate tax governance system for whose creation it was largely responsible. 3.1

Harmful Tax Competition

The OECD response to these processes culminated, through the late 1990s and early 2000s, in the ‘Harmful Tax Practices’ initiative and subsequent Harmful Tax Competition: An Emerging Global Issue report (OECD, 1998a; Eccleston, 2013; Carroll & Kellow, 2011). This work responded to a call from the G7, addressed in a 1996 OECD Ministerial Communiqué, for the Council to ‘develop measures to counter the distorting effects of harmful tax competition on investment and financing decisions, and the consequences for national tax bases, and report back in 1998’ (OECD, 1998b). The Harmful Tax Competition (HTC) work programme would involve developing definitions and collecting data that would be used to unilaterally ‘name and shame’ tax havens and preferential tax regimes (PTRs). Tax havens were defined for this project as jurisdictions with no or nominal rates of income tax which did not exchange information with other tax authorities, and which did not require non-resident investors to maintain any substantial economic activity.3 PTRs, on the other hand, were classified as those jurisdictions which met the latter transparency standards but still used very low tax rates expressly to attract foreign capital or investment (Woodward, 2018, p. 32; Avi-Yonah, 2009). This distinction was critiqued by many observers, including Oxfam, who characterized the definitions as a politically convenient semantic distinction allowing the OECD to target small, powerless non-member jurisdictions while ignoring larger offenders like Hong Kong, Singapore, or Switzerland (Oxfam, 2000, pp. 4–5). Following the release of the 1998 report, which highlighted the problem and set out an ambitious work programme for reform and increased global tax cooperation, the OECD set about developing a list of 35 ‘uncooperative tax havens’ (OECD, 2001). By the following year, 28 of the original 35 jurisdictions had committed to introducing transparency and governance reforms that would bring them in line with the OECD’s proposed standards, shortening the list to just seven nations by the date of its official publication in 2002 (Avi-Yonah, 2009, p. 785). Four more were removed between 2003 and 2007, and in 2009, following further commitments to implement transparency standards, the OECD removed the final three jurisdictions on its Un-Cooperative Tax Havens list: Andorra, Lichtenstein, and Monaco (OECD, 2019a). While some have argued that the offer of regulatory and financial shelter to foreign companies by micro states without tax bases of their own was in some cases a legitimate development strategy (Fabri & Hampton, 1999),4, 5 the OECD aggressively branded governments and resident populations of targeted OFCs as ‘free-riders of general public goods created by non-tax havens’ and ‘[poachers] of a tax base rightly [belonging] to other countries’ (OECD, 1998a, pp. 15–16). This disagreement over the political economy and even the morality of using very low effective tax rates to attract foreign capital was a clear reflection of broader normative debates over state sovereignty and economic liberalization within the OECD. The organization’s discursive and ideological commitment to economic liberalism was, from the

266  Handbook on the politics of taxation outset, difficult to square with the HTC initiative – particularly regarding PTRs. Crucially, the US and the United Kingdom both disagreed with the core tenet of the initiative: namely, the characterization of tax competition as inherently harmful. For example, when the US withdrew its support for the initiative in 2001, Treasury Secretary Paul O’Neill stated that I am troubled by the underlying premise that low tax rates are somehow suspect and by the notion that any country, or group of countries, should interfere in any other country’s decisions about how to structure its own tax system. I am also concerned about the potentially unfair treatment of some non-OECD countries. The United States does not support efforts to dictate to any country what its own tax rates or tax system should be, and will not participate in any initiative to harmonize world tax systems. The United States simply has no interest in stifling the competition that forces governments – like businesses – to create efficiencies. (United States Department of the Treasury, 2001)

The US withdrawal from the HTC initiative could hardly have come as a surprise. The election of US President George W. Bush in 2000 saw a marked change in rhetoric on international tax harmonization. Bush’s new administration had been lobbied intensively on the matter since almost immediately after it took office until the US withdrawal. From the Prime Minister of Barbados and Antigua to the economists Milton Friedman and Jim Buchanan, a diverse coalition of HTC opponents made representations to the incoming president characterizing the project as oppressive ideological hypocrisy that would subvert healthy, rather than harmful, tax competition (Bird, 2001). Friedman and Buchanan, in an open letter to President Bush signed by almost 200 other prominent liberal economists, wrote that the OECD’s planned ‘tax cartel’ would ‘threaten global commerce … boost the underground economy … help high-tax nations double tax income … hurt growth in less-developed nations’, and even ‘cause more crime by [shrinking] opportunities for honest employment’ (Friedman & Buchanan, 2001). Not only was the OECD perceived as threatening the ability of sovereign states to flexibly adapt tax policy to suit domestic conditions and international incentives, but in calling for broad harmonization of ‘rogue’ tax systems it could credibly be accused of subverting its own economic values, not to mention those of some of its dominant members.6 Importantly, this episode also served as a clear example of where divergent views among member states limited the OECD’s ability to enact wide-ranging, effective, and equitable tax policy reform. The second, related problem with the design and governance of the HTC initiative was that the nations who were blamed for the system’s failings, as well as responsibility for their remediation, were excluded from the process. Although tax models developed at the OECD have profound implications for non-member states, until the early 2000s these states did not have a seat at the table. This issue was further compounded by the omission of Luxembourg and Switzerland, the OECD members identified as tax havens, from the HTC report under the OECD’s mutual agreement principle. As a result, the jurisdictions targeted in the final HTC report were understandably aggrieved by a system in which tax havens could operate with impunity so long as they were OECD members, while the group of poorer (typically) small island nations excluded from the process were unilaterally targeted. The very narrow range of economic interests represented by the OECD’s then 29 member countries, coupled with a lack of effective consultation or any avenue of appeal or mediation for the targeted nations, undermined the moral legitimacy of the report and the OECD itself to increase international tax cooperation (Fung, 2017; Townsend, 2001). Despite wide-ranging critiques of the HTC project’s governance and legitimacy, however, its effectiveness has been subject to conflicting assessments. Some scholars have argued that

The OECD’s governance of international corporate taxation  267 its ability to curtail tax competition and increase transparency in OFCs was undermined from the outset by design and implementation failures (Sharman, 2006; Webb, 2004), but others have characterized it as basically a success in spite of these issues (Avi-Yonah, 2009).7 At least with regard to the second part of the HTC mandate (increasing financial transparency in OFCs), the latter is a fair assessment even though the OECD settled on a significantly watered-down financial transparency standard in progress reporting (see note 3). In order to meet the OECD’s financial transparency requirements, countries would need to demonstrate reform across three key areas. First, targeting money laundering by high net worth individuals, OFCs were asked to ‘prevent financial institutions from maintaining anonymous accounts and to require the identification of their usual or occasional customers, as well as those persons to whose benefit a bank account is opened or a transaction is carried out’. Second, that they would ‘re-examine any domestic tax interest requirement that prevents their tax authorities from obtaining and providing to a treaty partner, in the context of a specific request, information they are otherwise able to obtain for domestic tax purposes’. Finally, countries were required to ‘re-examine policies and practices that do not permit tax authorities to have access to bank information … for purposes of exchanging such information in tax cases’ (OECD, 2000, pp. 13–15). The fact that all nations placed on the original Un-Cooperative Tax Havens list eventually committed to the implementation of reforms does represent progress even despite the tax transparency provisions within the final agreement having been watered down. The HTC project also had some broader, though hardly intentional, impacts over the following years. Perhaps most importantly, it contributed to opening the tax justice dialogue to a far broader range of actors than had previously been interested or able to pursue it, allowing external players and NGOs to enter the debate and gain profile. Previous NGO activism had been far more concerned with high net worth individuals’ tax avoidance and evasion than with corporate tax (Citizens for Tax Justice being the main prominent example) but the media interest and political salience driven by HTC opened the corporate tax debate to tax justice activists as well. Oxfam is probably the clearest example of this; its landmark Releasing the Hidden Billions report in 2000 was a key stepping stone for NGOs wishing to increase the political salience and visibility of corporate tax avoidance, and particularly those wishing to draw attention to its consequences for the developing world (Oxfam, 2000). The Tax Justice Network, which was founded in 2002 and focussed heavily on tax havens, has recognized HTC and the Oxfam report as key events that elevated tax avoidance on the political agenda and created room for new players like it to enter the debate (Shaxson, 2016). The entry of this NGO and civil society influence into the debate came too late to influence the HTC agenda and its implementation, but it was a positive development nonetheless. Addressing the issue in 2004, the director of the OECD Centre for Tax Policy and Administration, Jeff Owens, welcomed the gradually increasing interest of civil society activism in tax justice. Owens argued that NGOs intent on exposing corporate tax avoidance and lobbying for tighter regulation could change attitudes in a similar fashion to social movements around environmentalism, for example, noting that as an issue area, ‘tax is where the environment was ten years ago’ (Houlder, 2004).

268  Handbook on the politics of taxation

4.

THE INCLUSIVE FRAMEWORK ON BASE EROSION AND PROFIT SHIFTING: EVOLVING GOVERNANCE APPROACHES AND THE CHANGING POLITICS OF CORPORATE TAX JUSTICE

When the US withdrew from the HTC initiative in May 2001, it was because it arguably threatened the interests of US-based MNCs who had been key supporters of George W. Bush’s successful 2000 election. However, the second part of the HTC mandate, that of increasing international financial transparency, became an extremely important project for the US in September of that same year following terrorist attacks on the World Trade Center complex and the Pentagon. The role of secretive OFCs in financing global terrorist networks spurred a strong push by the US to investigate and disrupt these shadowy offshore finance vehicles by establishing systems of tax information exchange. These efforts only became more pressing with the challenges posed by the Financial Crisis from mid-2007 onwards. By the time of the inaugural G20 summit in Washington, DC in 2008, the US had rejoined other global leaders in calling for a renewed project of OECD-led international financial reform focussed on strengthening disclosure standards for complex financial products, reinvigorating the project of international cooperation and coordination of financial regulation, and tax information exchange (Sadiq & Krever, 2019, p. 9; G20, 2008). After the following year’s G20 meeting, the Global Forum on Transparency and Exchange of Information for Tax Purposes, set up for the HTC project, was expanded to include non-member states. Crucially, its increasingly ambitious agenda also grew to include corporate tax avoidance through what became known as the BEPS project. Until 2012, the OECD’s tax policy work had essentially been limited to increasing financial transparency and addressing illegal evasion, mainly by high net worth individuals sheltering wealth in offshore tax havens. A strong US push towards increased transparency, enacted through vehicles including Foreign Account Tax Compliance Act legislation and a series of intergovernmental tax information exchange agreements, had begun to make significant headway on these issues (see Crasnic & Hakelberg, this volume). The arrival of legal corporate tax avoidance on the OECD’s agenda thus represented a very significant shift in its focus. In part this shift represented a recognition, albeit overdue, of how significantly the sheer scale of corporate tax avoidance had increased over the previous two to three decades; the quantum of revenue foregone annually by national governments across the board had simply become too large to ignore. Importantly, though, it also reflected the fact that in the face of growing calls from a mobilized and increasingly activist global civil society, the OECD’s legitimacy as a tax policy actor could no longer sustain inaction. Influential social movements such as Occupy and UK Uncut were rapidly turning aggressive tax planning into a mainstream political issue with significant salience in a variety of domestic political contexts (Elbra, 2018). This activism resulted in increasing community awareness of the scale and consequences of corporate tax avoidance, which in turn prompted anger and a growing sense of injustice in what had previously been a technical and ‘quiet’ political domain (Culpepper, 2011), largely insulated from moral scrutiny. The legitimacy and authority of the OECD was also being impacted by the rise of economic populism and the rejection of ‘elite’ technocratic expertise that accompanied the advent of anti-austerity politics in much of the developed world (Christensen & Hearson, 2019). Developing a credible reform agenda to address corporate tax avoidance and aggressive

The OECD’s governance of international corporate taxation  269 tax planning was therefore crucial to the maintenance of the organization’s privileged position in the global tax policy regime (Eccleston & Elbra, 2018). Nevertheless, this ambitious change in the OECD agenda posed significant challenges. These included not only the formidable political power of MNCs themselves, but also the fact that the outcomes of the HTC initiative had reinforced broad support for tax competition among the OECD’s membership. The core group of economically powerful capital-exporting countries who had dominated the OECD’s tax governance agenda for the better part of the modern regime’s existence stood to gain little by allowing others to impose higher taxes on their home MNCs’ activities abroad, and thereby reduce their competitiveness. As a result, and despite significant external pressure from civil society for ambitious root-and-branch reform, it seemed once again that the OECD’s response was destined to be incremental rather than transformational. It had also become clear that successful implementation and governance would require some reform to the process as well, and this came in the form of participation from some non-member states via the Global Forum. The extent to which this participation was effective in influencing the ultimate shape of the reform package, however, not to mention attending to input and output legitimacy deficits that had defined prior initiatives, has remained contentious (Burgers & Mosquera, 2017; Fung, 2017; Mosquera, 2018). The G20/OECD BEPS project that emerged from this process was formally proposed by the OECD Committee on Fiscal Affairs in 2012, and its mission statement was endorsed in the G20’s subsequent 2013 St Petersburg Declaration. This original articulation of the BEPS mandate encompassed four basic tenets. First, that ‘changes to international tax rules must be designed to address the gaps between different countries’ tax systems, while still respecting the sovereignty of each country to design its own rules’. Second, that ‘the existing international tax rules on tax treaties, permanent establishment, and transfer pricing will be examined to ensure that profits are taxed where economic activities occur and value is created’ (although even this seemingly fundamental tenet has been subject to academic critique; see van Apeldoorn, 2019). Third, ‘more transparency will be established, including through a common template for companies to report to tax administrations on their worldwide allocation of profits and tax’. And fourth, that ‘all the actions are expected to be delivered in the coming 18 to 24 months’ (BEPS Monitoring Group, 2019). The subsequent BEPS Action Plan introduced a suite of 15 actions based on these principles that provided policy guidance and reform frameworks that included neutralizing hybrid mismatch opportunities, country-by-country reporting, redesigned controlled foreign company rules, arm’s length transfer-pricing guidelines, and a multilateral instrument for tax treaty harmonization, among other things (OECD, 2013). These 15 actions were endorsed by the G20 finance ministers in 2015 who also, in response to the governance failures of the earlier HTC project, called on the OECD to extend input and opportunities for participation to all interested jurisdictions, especially developing countries. The resulting ‘Inclusive Framework’ approach, developed in 2016, thus invited non-members to participate in the process as ‘BEPS Associates’. All associated countries, of which there are over 130 at the time of writing, have been required to implement the four ‘minimum standards’ (Actions 5, 6, 13, and 14) as a condition of their participation. In return, associated non-member countries are able to consult and negotiate, to an extent, on the implementation of other ‘recommended’ and ‘best practice’ BEPS actions as well as participate in evolving discussions on Action 15, the Multilateral Instrument. Involvement in the Inclusive Framework also extends beyond implementation and consultation on specific actions to include regular meetings between participants and access to

270  Handbook on the politics of taxation resources aimed at tailoring the implementation of the BEPS project to the specific regulatory and juridical conditions of partner nations. While this approach has certainly gone a long way towards addressing the legitimacy deficits which plagued the OECD’s earlier initiatives (although the Global Forum did allow non-members to participate), it has been far from a panacea and significant criticisms remain as relevant today as they were in the early 2000s. Perhaps most obviously, the framework of BEPS Actions was developed before the Inclusive Framework existed, meaning that the non-member states now associated with the projects enjoyed scarcely more input into its design and development than was the case for previous initiatives. As Burgers and Mosquera have argued, the relative lack of any genuine input into the initial decision-making process from developing countries has led some to argue that ‘their participation on equal footing … in the multilateral instrument and the inclusive framework are not sufficient to legitimize the role of the OECD and BEPS44 in setting international tax standards for developing countries’ (2017, pp. 31–32). 4.1

Outcomes and Assessment: Has Base Erosion and Profit Shifting Achieved Its Aims?

Despite making some valuable, if incremental, progress, the BEPS process has largely attracted a critical reception. This has been due primarily to the fact that the OECD’s reliance on consensus and mutual agreement has limited it to a conservative, risk-averse reform agenda. For instance, academic critiques have noted the OECD’s ‘diminishing capacity … to achieve consensus on matters with strong distributional consequences’ (Büttner & Thiemann, 2017, p. 3). As a result, Cockfield suggests, the BEPS suite of reform recommendations ‘do not change the planning environment in any significant way’, even though ‘incremental reforms to the permanent establishment principle and elsewhere will need to be taken into account by planners’. In other words, the reform ‘does not significantly alter the status quo and will not affect many traditional cross-border structures, including those deployed by firms within the global digital economy’ (Cockfield, 2018, p. 2). Christensen and Hearson, like Sadiq and Krever (2019), have argued that the Financial Crisis and its aftermath dealt a ‘fatal blow’ to the legitimacy of the OECD-led global tax governance institutions. Despite meaningful attempts to address this legitimacy deficit, for example by opening OECD deliberations to non-members through the Inclusive Framework, these authors remain unsure as to ‘whether OECD-centric tax institutions can survive in the long term, even as they have broken new ground in terms of sovereignty-infringement and multilateralism’ (Christensen & Hearson, 2019, p. 1069). Christians largely concurs that the BEPS project should be viewed as an incremental reform exercise that has made marginal improvements in a series of specific areas but that on the whole has not significantly hindered aggressive tax planning (Christians, 2016). All of this is not to say that BEPS has been without positive impacts. On the contrary, the initiative has attracted a very broad base of support over a short period of time and made meaningful, albeit marginal, improvements across a number of domains. These include, for example, increasing transparency in some areas of the global financial system, reducing CFC and hybrid mismatch discrepancies between many bilateral DTAs, and improving automatic information exchange with OFCs (though this latter benefit was enabled in large part by 9/11 and the financial centre; see Fung, 2017, p. 76; Sadiq & Krever, 2019, p. 9). The BEPS process has also contributed to a significant shift in the issue salience of tax justice debates among a far broader range of non-government and civic actors than has previously been the case, and this

The OECD’s governance of international corporate taxation  271 in turn has fuelled the growing power of tax justice activism. As discussed above, attracting greater civic engagement in the politics of tax governance became a key OECD ambition following the failure of the HTC initiative, and achieving this with BEPS has significantly changed the tenor of the debate (see Houlder, 2004; Elbra, 2018). Most academic commentary on the BEPS story continues to reinforce a largely critical interpretation of the OECD tax governance model’s capacity for major reform. It is a story that shows the OECD to have been both reactive (in this case to an overwhelming shift in public opinion) and incremental (in that it opted for a reform package which preserved those pillars of the global corporate tax system that made aggressive tax planning possible and thereby maintained the status quo even with some laudable improvements). The OECD regime is now very deeply institutionalized with a highly decentralized structure and technocratic, risk-averse identity, and with hundreds of billions of dollars at stake for politically powerful MNCs resident in its dominant member states, future reform looks likely to continue on an incremental path. A deeper or more transformational overhaul remains possible only if commitment can be secured from a broad coalition of powerful member states to change fundamental ‘rules of the game’ with far-reaching distributional consequences, and such commitments are unlikely to be forthcoming in the near future.

5.

CONCLUSIONS: CAN THE OECD REMAIN AT THE FOREFRONT OF GLOBAL TAX GOVERNANCE IN A POST-BASE EROSION AND PROFIT SHIFTING FUTURE?

The outcomes of the BEPS process thus far, assessed in the light of previous initiatives, raise important questions about whether continued incremental reform and gradual ‘organizational adaptation’ (Carroll & Kellow, 2011) from the OECD will be sufficient to remedy a shrinking corporate tax base and oversee its equitable distribution in the future. Constructivist scholars would argue that over time, research and evidence-based advocacy will shape prevailing interests and ultimately influence what is regarded as appropriate tax policy (Keck & Sikkink, 1998). The contested nature of norms about the appropriateness or fairness of aggressive strategies, however, complicate the translation of these normative debates into changes in corporate behaviour. As a result, while the tenor of public debate concerning corporate tax avoidance has changed significantly in recent years, there is little evidence yet that the interests of increasingly powerful MNCs in relation to the international tax regime have followed suit. On one level, and notwithstanding the intransigence of the Trump administration, some progress is being made through the multilateral instrument and ‘Two Pillars’ approach to reforming taxation of the digital economy. The OECD has arguably made significant strides towards the development of ambitious proposals for a de facto minimum tax rate through the combination of new rules for allocating taxing rights and the Pillar 2 Global Anti-Base Erosion proposals for providing ‘tax back’ rights where a jurisdiction has not exercised their primary taxing rights. Using a similar process to the EU’s Common Consolidated Corporate Tax Base proposals, a fully realized OECD Unified Approach would see MNE profits, at a group level, allocated between jurisdictions according to a pre-determined formula and subject to the equivalent of a minimum effective rate to be determined (OECD, 2019c). Even within the Inclusive Framework process, however, agreement on these proposals remains elusive. At the time of writing, the Biden administration’s prospects for achieving meaningful reform

272  Handbook on the politics of taxation are uncertain. Despite promising indications, it remains to be seen whether support for any significant change can be marshalled within a divided domestic context. Whether the United States ultimately pursues a unilateral approach or works within the OECD frameworks being debated is another open question. Moreover, even if in-principle agreement can be achieved, the process of establishing rates and benchmarks at which ‘tax back’ provisions would apply, and especially negotiating the apportionment formulae, would require a level of international coordination and cooperation heretofore unseen within the OECD tax architecture. While laudable, it is difficult to see these proposals overcoming the inevitable objections of powerful, wealthy capital-exporting nations in anything like their current ambitious form. The US’s June 2020 withdrawal from OECD talks on the proposed Digital Services Tax, while notionally temporary, is more than likely a sign of things to come and does not bode well for the project’s future prospects. Rather, a more likely scenario is the example of the EU Common Consolidated Corporate Tax Base, which remains subject to significant disagreement despite 20 years of discussion. The OECD retains its strong reputation for technical expertise, and holds significant sway in policy discussions, but its continuous struggle to maintain relevance and authority shows no obvious signs of abating. In order to wield influence in the domains of its technical expertise, it must therefore continue to walk a fine line, balancing a number of competing interests. Partly, this is because its membership represents a relatively narrow range of economic interests. As it is these members who must ultimately implement the OECD agenda voluntarily, the plausibility of the organization’s aims depends upon its being able to achieve and maintain this delicate balance. As a result, it remains a struggle for the OECD to generate broader legitimacy. A widely held perception, for the most part accurate, that the OECD is bound by the economic interests of its powerful member states undercuts its legitimacy and ‘moral licence’ in initiatives that concern non-members – this is especially the case with developing nations. The degree to which this prevents it from independently pursuing effective, decisive, and ambitious reform in policy areas with profound distributional consequences for the Global South can hardly be overstated. This means that the future of the regime, if it continues to be led by the OECD, will be characterized by a systemic, structural bias towards incrementalism and risk-averse, lowest common denominator reform initiatives. Consequently, the OECD’s future role should be seen more in the vein of a coordination and standards-setting function rather than as a standalone actor with the capacity to drive major structural reforms. Naturally this is a problem for policy arenas like international corporate tax, in which the OECD remains the pre-eminent global player, where ambitious reform projects may be sorely needed if developed and developing nations alike are to salvage a robust and sustainable corporate tax base. This chapter has offered a historical and structural political economy perspective on the strengths, limitations, and potential future of the OECD model of global corporate tax governance. While such approaches can provide important accounts of the development of these institutions, as well as analysis of the international political economy of their memberships, up-to-date empirical research on the internal politics of the OECD remains something of a ‘black box’ which scholars ought to examine. Likewise, while important studies cited in this volume have investigated the interactions and power dynamics which define the OECD’s relationships with partner organizations such as the G20, much of this research precedes the current Global Anti-Base Erosion, Multilateral Instrument, and Digital Services Tax policy platforms. As such, an important avenue for future research would be investigations of the OECD’s relationships with partners like the G20 and, even more importantly, the internal

The OECD’s governance of international corporate taxation  273 dynamics of relationships between the OECD Centre for Tax Policy and Administration, the Secretariat, and the various committees relevant to the OECD’s tax policy work.

NOTES 1. Between the dissolution of the League of Nations after the end of the Second World War until the founding of the OECD in 1961, international tax policy discussions also occurred, though on a more ad hoc basis, within the International Chamber of Commerce and the United Nations (Woodward, 2018). 2. The OEEC’s primary role was the management of European reconstruction funding provided by the Marshall Plan, with the additional mandate of liberalizing European trade relationships and providing a forum to advance the development interests of Europe’s major liberal market economies and thereby contribute to containing the spread of communism. 3. It is important to note that this latter point in the OECD definition, that relating to ‘lack of substantial economic activity by taxpayers’, had been omitted by the time the first progress report was released in 2000. This represented a significant retreat from the OECD’s original framework, allowing the continued use of shell corporations and legitimating the international tax-planning industry (see Webb, 2004, p. 810). 4. Others went further still, arguing that those tax haven jurisdictions which resisted the OECD’s unilateral reform push were hold-outs against a second wave of ‘fiscal neo-colonialism’ (Sanders, 2002), or labelled the OECD modern-day ‘pirates’ that had ‘robbed [Caribbean] countries of their tax and economic policy sovereignty’ (James, 2002). 5. The idea of using low tax rates and a sweeping programme of deregulation as a development strategy for attracting mobile capital is by no means limited to micro states: the creation of a ‘Singapore-on-the-Thames’ has developed significant mainstream currency in discussions of the post-Brexit future of Britain’s financial centre (Christensen, 2019). 6. The OECD’s promotion of tax competition as a healthy and desirable dynamic in the global economy made its criticism of PTRs, in particular, hard for some jurisdictions to swallow. The organization’s 2001 HTC progress report, for example, lauds the ‘competitive forces which have encouraged countries to make their tax systems more attractive to investors’, adding that ‘in addition to lowering overall tax rates, a competitive environment can promote greater efficiency in government expenditure programs’ (OECD, 2001, p. 4). 7. Arguably, however, a still more important catalyst for opening up transparency and information exchange in shadowy offshore financial centres was the September 11 terrorist attacks in the US (Sadiq & Krever, 2019). The extraordinary ability of the US to unilaterally reshape core aspects of transparency and openness in the international financial system when this suits US interests stands as a significant critique of the political economy of the OECD. Without alignment between the OECD agenda and the interests of powerful members, change is very difficult to achieve.

REFERENCES Avi-Yonah, R. S. (2009). Harmful tax competition: A retrospective after a decade. Brooklyn Journal of International Tax Law, 34(3), 783–796. Avi-Yonah, R. S., & Xu, H. (2017). Evaluating BEPS. Erasmus Law Review, 10(1), 185–238. BEPS Monitoring Group (2019). The BEPS Monitoring Group. www​.bepsmonitoringgroup​.org/​what​-is​ -beps (accessed 28 August 2019). Bird, L. (2001). Speaking notes on OECD for meeting with US President George W. Bush. www​ .tax​-news​.com/​news/​Caribbean​_Leaders​_Urge​_Bush​_To​_Withdraw​_OECD​_Support​_​_​_​_3240​.html (accessed 17 September 2019). Burgers, I., & Mosquera, I. J. (2017). Corporate taxation and BEPS: A fair slice for developing countries? Erasmus Law Review, 10(1), 29–47.

274  Handbook on the politics of taxation Büttner, T., & Thiemann, M. (2017). Breaking regime stability? The politicization of expertise in the OECD/G20 process on BEPS and the potential transformation of international taxation. Accounting, Economics, and Law: A Convivium, 7(1), 1–17. Carroll, P., & Kellow, A. (2011). The OECD: A Study of Organisation Adaptation. Edward Elgar Publishing. Christensen, J. (2019). Brexit and the future of tax havens. Tax Justice Network. www​.taxjustice​.net/​ 2019/​01/​23/​brexit​-and​-the​-future​-of​-tax​-havens/​ (accessed 10 September 2019). Christensen, R. C., & Hearson, M. (2019). The new politics of global tax governance: Taking stock a decade after the financial crisis. Review of International Political Economy, 26, 1068–1088. Christians, A. (2016). BEPS and the new international tax order. Brigham Young University Law Review, 6, 1603–1647. Cockfield, A. J. (2018). Taxing global digital income in a post-BEPS world. Queen's Law Research Paper Series 2018-096. Ontario: Queen's University Faculty of Law. Culpepper, P. D. (2011). Quiet Politics and Business Power: Corporate Control in Europe and Japan. Cambridge University Press. Davies, M., & Woodward, R. (2014). International Organisations: A Companion. Edward Elgar Publishing. Eccleston, R. (2013). The Dynamics of Global Economic Governance. Edward Elgar Publishing. Eccleston, R., & Elbra, A. (eds) (2018). Business, Civil Society and the ‘New’ Politics of Corporate Tax Justice: Paying a Fair Share? Edward Elgar Publishing. Eccleston, R., Kellow, A., & Carroll, P. (2015). G20 endorsement in post-crisis global governance: More than a toothless talking shop? British Journal of Politics and International Relations, 17(2), 298–317. Eccleston, R., & Woodward, R. (2014). Pathologies of international policy transfer: The case of the OECD tax transparency inititative. Journal of Comparative Policy Analysis, 16(3), 216–229. Elbra, A. (2018). Activism and the ‘new’ politics of tax justice. In R. Eccleston & A. Elbra (eds), Business, Civil Society and the ‘New’ Politics of Corporate Tax Justice: Paying a Fair Share?, 68–90. Edward Elgar Publishing. Fabri, D., & Hampton, M. P. (1999). The Malta Financial Services Centre: A study in micro-state dependency management. In M. P. Hampton & J. P. Abbott (eds), Offshore Finance Centres and Tax Havens: The Rise of Global Capital, 140–165. Palgrave Macmillan. Friedman, M., & Buchanan, J. (2001). Open letter to President George W. Bush. Wolters Kluwer. www​ .tax​-news​.com/​news/​Milton​_Friedman​_Asks​_President​_Bush​_To​_Dump​_OECD​_​_​_​_3849​.html (accessed 17 September 2019). Fung, S. (2017). The questionable legitimacy of the OECD/G20 BEPS project. Erasmus Law Review, 10(2), 76–88. G20 (2008). Declaration of the summit on financial markets and the world economy. www​.g20​.utoronto​ .ca/​2008/​2008declaration1115​.html (accessed 17 September 2019). Hakelberg, L. (2020). The Hypocritical Hegemon: How the United States Shapes Global Rules against Tax Evasion and Avoidance. Cornell University Press. Houlder, V. (2004). Tax avoidance story as a morality tale. Financial Times, 21 November. James, V. E. (2002). Twenty-first century Pirates of the Caribbean: How the Organisation for Economic Co-operation and Development robbed fourteen CARICOM countries of the tax and economic policy sovereignty. University of Miama Inter-American Law Review, 34(1), 1–50. Jogarajan, S. (2018). Double Taxation and the League of Nations. Cambridge University Press. Keck, M. E., & Sikkink, K. (1998). Activists beyond Borders: Advocacy Networks in International Politics. Cornell University Press. Marcussen, M., & Trondal, J. (2011). The OECD civil servant: Caught between Scylla and Charybdis. Review of International Political Economy, 18(5), 592–621. Mikler, J. (2018). The Political Power of Global Corporations. Polity Press. Mosquera, I. J. (2018). Output legitimacy deficits and the inclusive framework for the OECD/G20 Base Erosion and Profit Shifting initiative. Bulletin for International Taxation, 72(3). Motala, M. F. (2019). The G20–OECD contribution to a new global tax governance. International Organisations Research Journal, 14(2), 52–79. OECD (1993). The United States Proposed Regulations Dealing with Tax Aspects of Transfer Pricing within Multinational Enterprises. OECD Publishing.

The OECD’s governance of international corporate taxation  275 OECD (1998a). Harmful Tax Competition: An Emerging Global Issue. OECD Publishing. OECD (1998b). Recommendation on Counteracting Harmful Tax Competition. OECD Council. OECD (2000). Improving Access to Bank Information for Tax Purposes. OECD Centre for Tax Policy and Administration. OECD (2001). The OECD’s Project on Harmful Tax Practices: The 2001 Progress Report. OECD Centre for Tax Policy and Administration. OECD (2013). Action Plan on Base Erosion and Profit Shifting. OECD Publishing. OECD (2018). Multinational enterprises in the global economy: Heavily debated but hardly measured. Policy Notes, May. OECD (2019a). List of Un-Cooperative Tax Havens. www​.oecd​.org/​countries/​andorra/​list​-of​-unco​ -operative​-tax​-havens​.htm (accessed 10 September 2019). OECD (2019b). Organisational structure. www​.oecd​.org/​about/​structure/​(accessed 20 August 2019). OECD (2019c). Public consultation document: Global anti-base erosion (‘GLoBE’) – Pillar Two. OECD Publishing. www​.oecd​.org/​tax/​beps/​public​-consultation​-document​-global​-anti​-base​-erosion​-proposal​ -pillar​-two​.pdf (accessed 1 January 2020). Oxfam (2000). Tax Havens: Releasing the Hidden Billions for Poverty Eradication. 1 June. Palan, R. (2002). Tax havens and the commercialisation of state sovereignty. International Organization, 56(1), 151–176. Palan, R. (2003). The Offshore World: Sovereign Markets, Virtual Place, and Nomad Millionaires. Cornell University Press. Picciotto, S. (1992). International Business Taxation: A Study in the Internationalisation of Business Regulation. Cambridge University Press. Rixen, T. (2011). From double tax avoidance to tax competition: Explaining the institutional trajectory of international tax governance. Review of International Political Economy, 18(2), 197–227. Sadiq, K., & Krever, R. (2019). Actions to counter Base Erosion and Profit Shifting: A general report. In K. Sadiq, A. Sawyer, & B. McCredie (eds), Tax Design and Administration in a Post-BEPS Era: A Study of Key Reform Measures in 18 Jurisdictions, 1–24. Fiscal Publications. Sanders, R. (2002). The fight against fiscal colonialism: The OECD and small jurisdictions. The Round Table, 91(365), 325–348. Sharman, J. C. (2006). Havens in a Storm: The Struggle for Global Tax Regulation. Cornell University Press. Shaxson, N. (2016). Oxfam report: Ending the era of tax havens. Tax Justice Network. www​.taxjustice​ .net/​2016/​03/​14/​oxfam/​ (accessed 5 September 2019). Townsend, A. (2001). The global schoolyard bully: The Organisation for Economic Co-operation and Development’s coercive efforts to control tax competition. Fordham International Law Journal, 25(1), 215–258. United States Department of the Treasury (2001). Press centre: Treasury Secretary O’Neill statement on OECD tax havens. www​.treasury​.gov/​press​-center/​press​-releases/​Pages/​po366​.aspx (accessed 27 August 2019). van Apeldoorn, L. (2019). Exploitation, international taxation, and global justice. Review of Social Economy, 77(2), 163–183. Webb, M. C. (2004). Defining the boundaries of legitimate state practice: Norms, transnational actors and the OECD’s project on harmful tax competition. Review of International Political Economy, 11(4), 787–827. Woodward, R. (2018). The evolution of the international corporate tax regime. In R. Eccleston & A. Elbra (eds), Business, Civil Society and the ‘New’ Politics of Corporate Tax Justice: Paying a Fair Share?, 22–39. Edward Elgar Publishing.

18. The politics of taxation in the European Union Indra Römgens and Aanor Roland

1.

INTRODUCTION: WHY THE EUROPEAN UNION MATTERS FOR TAXATION

Taxation belongs to the core functions of the state. A government that provides public services has the right to set and execute tax laws as well as collect tax revenues within its territory. These powers are commonly accompanied by a degree of democratic accountability towards the citizens with regard to the collection and spending of such taxes (see Kemmerling & Truchlewski, this volume; Haffert, this volume). Simultaneously, in a globalized world with increasing cross-border movements of people, goods, services and capital, there has been a growing awareness that coordination in matters of taxation is necessary (see Eccleston & Johnson, this volume; Hearson & Rixen, this volume). This is especially the case in the European Union (EU) where tax coordination has already been identified as an essential requirement for the establishment of a common European market in the late 1950s. Since then, the removal of distortions created by different tax rules, discriminatory taxes, double taxation and to a certain extent tax competition has been the main rationale behind tax integration in the EU. As the European Commission put it, ‘taxation has become such an important instrument in shaping business and living conditions that some measures of alignment of the six member countries’ tax policies is unavoidable if they are to achieve the economic union described in the Rome Treaty’ (European Commission, 1968, p. 3). The treaties that form the constitutional basis of the EU include a number of articles that allow the European institutions to formulate common tax law (Articles 110–116 of the Treaty on the Functioning of the European Union (TFEU)). The stipulations have remained the same since the Treaty of Rome in 1957, when the focus of the original six Member States of the European Economic Community (EEC) was mostly on removing fiscal barriers for the cross-border trade of goods. Accordingly, there is an explicit legal basis set out in Article 113 (TFEU) for the harmonization of indirect taxes, such as turnover taxes and excise duties. The treaty does not include, however, an explicit reference to direct taxation on personal and corporate income. Direct taxation is covered by Article 115 (TFEU), which refers to ‘the approximation of such laws, regulations or administrative provisions of the Member States as directly affect the establishment or functioning of the internal market’. Unlike many other policy areas, the Council of the EU gathering the ministers from each Member State is the sole legislative body. The Council can only adopt tax directives on the basis of unanimity (and not qualified majority voting), which means that all Member States have to agree and even the veto of one Member State prevents a new law to be adopted or existing law amended. This is called a special legislative procedure and differs from the ordinary legislative procedure where both the Council and directly elected European Parliament share legislative powers. In the case of taxation, the Parliament is merely consulted. As the so-called legislative initiator, the Commission develops new legislative proposals, and has therefore an important role in the legislative procedure. 276

The politics of taxation in the European Union  277 Because of the redistributive nature of tax issues, the unanimity principle in the Council and conflicting national interests, there is consensus among certain political scientists that tax competences are either non-existent or unlikely to develop at the European level. Many would claim that the EU has ‘little capacity to govern through taxation’ (Stone Sweet, 2004, p. 239), ‘no general taxing and spending powers similar to those held by national governments’ (Majone, 1998, p. 10) and is characterized by ‘the near-total absence of the power to tax and coerce’ (Moravcsik, 2001, p. 164). These statements are, however, empirically easily refuted. The first Directive on a common value-added tax (VAT) was adopted in 1967 to replace the existing national turnover taxes with a common VAT system (Haffert & Schulz, 2019). Indirect taxation played an essential role in the establishment of the single market, and significant steps have been taken towards harmonization since the first VAT Directive. The 1990s witnessed the introduction of several EU direct taxation measures; legislation has only increased since then. The jurisprudence of the European Court of Justice (ECJ) in both indirect and direct taxation is ever growing. All in all, it appears that the EU ‘exerts considerable regulatory power over taxation’ (Genschel & Jachtenfuchs, 2011, p. 294) and there is ‘much more harmonization in tax matters than is often claimed’ (Uhl, 2006, p. 567). However, direct (personal and corporate income) taxes have not, so far, experienced the same degree of harmonization as indirect taxes. This chapter starts with an historical overview of tax coordination and harmonization – in terms of ambitions as well as (lack of) achievements – since the establishment of the EEC in 1957. It emphasizes the different sets of speed and degrees of harmonization between indirect and direct taxation, with a respective focus on VAT and corporate taxation. Although there have been interesting developments regarding excise duties, personal taxation, environmental taxes or the taxation of the financial sector, a stylized comparison of VAT and corporate taxation allows us to illustrate the politics of taxation in the EU in a more detailed way. The main part of the chapter is then dedicated to explaining those developments. Based on a critical review of the existing literature at the crossroads between EU studies and political economy, it raises a number of central questions to explain the specific political dynamics of taxation in the EU: Why is tax coordination possible at times, and often not? Why has indirect tax harmonization been more far-reaching than direct tax? Which actors, structures and mechanisms are at play in the EU context, and why? What scope conditions need to be in place for policy and decision making in the field of taxation to succeed? The chapter ends with a brief discussion of current developments in the context of the COVID-19 crisis and possible areas for future research.

2.

HISTORICAL CONTEXT: TAX HARMONIZATION THROUGHOUT EUROPEAN INTEGRATION

Historical developments can be broadly divided in three phases: an initial stage with ambitious ideas for tax harmonization but only progress in indirect taxation, the period between the mid-1980s and the financial crisis characterized by a stalemate in the VAT area but important decisions regarding corporate taxation and the post-crisis years dedicated to the fight against tax evasion and tax avoidance.

278  Handbook on the politics of taxation 2.1

Early Steps towards Value-Added Tax Harmonization

Since the start of the EEC in the late 1950s, cooperation in the area of taxation has been part of achieving a common market. In 1960, the Commission set up a committee of experts led by German economist Professor Fritz Neumark, which was tasked with investigating which taxation aspects stood in the way of achieving a common market. The resulting report in 1962 advised to harmonize a number of taxes in a three-staged approach. The first phase included the introduction of a VAT as the way forward to the harmonization of turnover taxes. The Commission, following this advice, presented a VAT proposal in 1962. At that time, France was the only country out of the six EEC Member States that already had such a VAT in place. After years of negotiation, the Council adopted the First and Second VAT Directive in 1967, mostly because of support from the German government (Haffert & Schulz, 2019). The EEC and its Member States never went beyond the first phase of the suggested timeline of tax harmonization measures as set out by the Neumark report. The remaining phases – entailing measures regarding the harmonization of taxes on company income, capital gains, personal income and wealth – were, at that point, not a priority for the EEC Member States. Subsequent reports that were tasked with identifying tax obstacles to the establishment and functioning of a common market brought forward different scenarios and proposals for tax harmonization. A group of experts led by Professor Segré of the Commission itself looked into the elements hampering the development of an EU capital market. In terms of corporate taxation, the committee concluded that at that point, in 1966, too many tax obstacles stood in the way of tax neutrality. Because of the limited scope of its report, the Segré committee did not propose comprehensive harmonization of corporate tax base and/or rates, but did hint at it. Several recommendations from both the Neumark and the Segré reports were followed by the Commission as articulated in its 1967 ‘Tax Harmonization Programme’. Here, the Commission emphasized urgent action needed for the liberalization of capital movements (amongst others the elimination of withholding taxes in the EU), the removal of obstacles to mergers and acquisitions and the harmonizing of rules that compute the corporate income tax base (Easson, 1992). In a resolution in 1971, the Council also explicitly linked the harmonization of direct taxes to the establishment of an Economic and Monetary Union. The aims of this resolution, as well as the Commission’s own 1967 harmonization programme, were reflected in a proposal presented in 1975. The proposal included, most importantly, a bandwidth for corporate income tax rates (between 45 and 55 per cent) and a common system for withholding taxes on dividends amongst Member States. It was eventually withdrawn, which is characteristic for the lack of developments in the area of direct taxes in the 1970s and long into the 1980s. In the meantime, the harmonization of indirect taxes progressed with the adoption of the Sixth VAT Directive in 1977. Although not achieving full harmonization, this Directive went beyond its predecessors in the sense that it created a common tax base and thus ‘established a common tax trim for the entire European Community and constituted a veritable legislative instrument at community level’ (Pîrvu, 2012, p. 27). 2.2

Market Integration and the Removal of Tax Obstacles

Throughout the 1980s, the harmonization of indirect taxes remained a central concern for the Commission, as underlined in its 1985 white paper on steps ‘to complete the internal market’. In terms of VAT, the Commission suggested that further work on the common tax

The politics of taxation in the European Union  279 base and the definition of the tax rate was needed and issued two legislative proposals in 1987. Widely regarded to be very ambitious, the proposals stranded in Council negotiations and a transitional system was adopted instead. A work programme presented by the Commission to move towards a definitive VAT system in 1996 also made very little progress. Doomed to fail, ‘it soon became clear that the degree of harmonization necessary for the introduction of a definitive VAT system’ would not be achieved (de la Feria, 2015, p. 157). The transitional system, combined with a lack of political agreement on a definite system that left the direction of common VAT law up to ECJ rulings, made the VAT system incompatible with the internal market as there remained impediments to the free movement of goods and services (de la Feria, 2009; Keen & Smith, 1996). With regard to direct taxation, the Commission’s 1985 paper did ‘urge the Council to complete on-going work on a group of proposals which aim at removing obstacles to cooperation between European firms (on tax treatment of parents and subsidiaries, on taxation of mergers and on avoidance of double taxation)’ (European Commission, 1985, p. 38). Two of these aims materialized not long after with the adoption of the Merger Directive and Parent-Subsidiary Directive in 1990. Combined with the introduction of an Arbitration Convention for transfer-pricing conflicts, and two other proposals on interest and royalty payments and on intra-group losses, the year 1990 marked ‘an important turning point in the evolution of the community’s direct tax policy’ (Easson, 1992, p. 610). At the same time, the Commission also explicitly acknowledged that the initial ambitions regarding tax harmonization might not be feasible or necessary ‘particularly in view of the principle of subsidiarity’, and therefore ‘reached the conclusion that community action should concentrate on the measures essential for completing the internal market’ (European Commission, 1990, p. 2). Another expert committee was set up to carry out this task, led by former Dutch minister of finance Onno Ruding. Published in 1992, the committee’s report recommended further steps towards corporate tax harmonization in the form of common rules for a minimum tax base and minimum rate. It did so ‘as to limit excessive tax competition between Member States intended to attract mobile investment or taxable profits of multinational firms, either of which tend to erode the tax base in the Community as a whole’ (European Commission, 1992, p. 13). Again, the Commission did not entirely follow the conclusions of the Ruding report, as it believed that the more far-reaching proposals for harmonization of corporate tax bases and rates were not in line with the subsidiarity principle. This response ‘evinced the Commission’s clear move away from harmonization proposals and its endorsement of piecemeal and ad hoc solutions’ (Panayi, 2013, p. 20). With the Single European Act, the internal market was officially introduced in 1992 and its completion became a main objective of subsequent tax negotiations. This stems from the Commission’s white paper on ‘Growth, Competitiveness, Employment’ from 1993, whose priorities included ‘removing tax barriers and harmonizing certain taxes’ (European Commission, 1993, p. 82). In this wider context of market integration, the Commission set up a Taxation Policy Group in 1996 under Commissioner Monti. The process resulted in a package to tackle harmful competition, whose distortionary effects were indeed identified as one of the main challenges to the completion of the internal market (Hinnekens, 1991). This tax package was a turning point in EU corporate tax policy for a number of reasons, primarily because of the establishment of the Code of Conduct for Business Taxation, a soft-law instrument to assess tax measures causing ‘harmful tax competition’. The Code of Conduct Group assembles all Member States to oversee implementation and roll back ‘harmful measures’

280  Handbook on the politics of taxation while refraining from introducing new ones. The code, however, is not legally binding and can therefore be understood as the result of the EU failure to mitigate tax competition with formal rules (Genschel et al., 2008). The Monti report also consolidated the approach of the Commission to achieve partial measures to solve specific tax obstacles to market integration. This was further underlined by the Company Tax Study that the Commission presented in 2001 that decoupled ‘the necessity of targeted measures that could be implemented swiftly and on ad hoc basis’ from ‘the necessity of comprehensive proposals, which were more politically controversial and required a longer gestation period’ (Panayi, 2013, p. 25). The Interest and Royalty Directive was adopted in 2003 in line with this approach of targeted measures. Meanwhile, progress in the area of VAT continued to be limited. The Sixth Directive of 1977 remained the basis for any subsequent amendment in the next decades (Pîrvu, 2012). Proposed strategies by the Commission in 1996, 2000 and 2003 resulted in very few improvements of a system characterized by several problems in terms of administrative burdens, possibilities for evasion and fraud and national differences in exemptions and rates (Aujean, 2012). The Sixth Directive was finally replaced by a Directive on the common system of VAT (the VAT Directive) in 2006, as the main legal basis for the European VAT system. Although long overdue, the VAT Directive only entailed a few changes compared to the existing legislation, because it merely intended to present VAT provisions in a clear and logical form after the many substantial changes since 1977 (Pîrvu, 2012). 2.3

Combating Tax Evasion and Tax Avoidance

As other chapters have explained extensively, the past crisis-ridden decade has changed the scene of global tax governance in dramatic ways, and the EU is no exception. With respect to indirect taxation, the Commission has changed its approach in convincing Member States to move towards a single VAT system. It let go of a European perspective and appealed instead to national concerns over the mobilization of tax revenues in the wake of the financial and sovereign debt crisis, as reflected in the Commission’s Green Paper on the Future of VAT in 2010 (de la Feria, 2015). As a main objective of the green paper, a consultation process was launched with stakeholders on ‘the functioning of the current VAT system and how it should be reframed in the future’ (European Commission, 2010, p. 4). The ambition of a common VAT system is not entirely let go of, however, as demonstrated by the Commission’s latest Action Plan in 2016 setting out ‘the pathway to the creation of a single EU VAT’, which remains ‘a core element of Europe’s single market’ (European Commission, 2016, p. 3). Since then, the Commission has launched several legislative proposals, and the Council agreed on a few targeted measures with regard to administrative cooperation and e-commerce. Developments in direct taxation point to a substantial shift in EU corporate tax policy since the financial and Eurozone crises. As explained above, EU corporate tax provisions traditionally aimed at eliminating tax obstacles and double taxation to ensure the functioning of the single market. This changed in 2012, with the Commission’s ‘Action Plan for a more effective EU response to tax evasion and avoidance’ (European Commission, 2012). Addressing these issues, the EU’s approach to corporate taxation increasingly included market-correcting measures aimed at transparency and tax fairness (Panayi, 2019; Roland, 2020; Roland & Römgens, 2021). In terms of tax transparency, the introduction of public Country-by-Country Reporting (CBCR) for financial institutions (Fourth Capital Requirements Directive) and for firms in the extractive and forestry industry (Accounting and Transparency Directives) was a major step.

The politics of taxation in the European Union  281 The Commission also proposed to introduce public CBCR for all multinational corporations in 2016. After years of negotiation, this proposal was finally supported by a majority of Member States in the Council in February 2021, which is considered a major breakthrough in the fight against tax avoidance. Another innovation consisted in the introduction and expansion of automatic exchange of information between tax authorities since December 2014. After four amendments, the Directive on Administrative Cooperation now provides for the automatic exchange of financial account information, tax rulings and advanced pricing agreements, CBCR, beneficial ownership information and cross-border arrangements. The commitment to fair and efficient taxation materialized with the addition of anti-abuse rules to the Parent-Subsidiary Directive in January 2015 and the adoption of the Anti-Tax Avoidance Directives (ATAD I and II) in October 2016 and May 2017. ATAD I was derived from the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project and introduced six legally binding measures targeting common forms of aggressive tax planning. The Commission also proposed more comprehensive measures, such as the introduction of a Common Consolidated Corporate Tax Base (CCCTB), proposals regarding the taxation of the digital economy and a move towards qualified majority voting in tax matters. Those measures are facing strong resistance from several Member States and have therefore still not been agreed upon in the Council. However, in the context of the COVID-19 pandemic and revitalized international tax discussions, the CCCTB and digital taxation proposals are back on the EU’s agenda (see also Christensen & Lips, this volume). Beyond those legislative provisions, the Commission employed so-called state aid investigations to assess whether tax treatments granted to specific companies in certain Member States constitute a breach of EU competition rules. While those investigations traditionally aim at improving the functioning of the single market, the recent selection of very emblematic cases, such as Apple, Amazon or Starbucks, can be understood as a strategic decision by the Commission to address the issue of corporate tax avoidance in a pragmatic way (Roland & Römgens, 2021). This overview of developments regarding both indirect and direct taxation at the EU level shows a number of differences and similarities. The harmonization of indirect taxation has been an ambition since six European countries joined forces in the 1950s and its legal basis is explicitly enshrined in the Treaty of Rome in 1957. This was, and still is, not the case for direct taxation. However, initiatives for the coordination and harmonization of indirect and direct taxes have been proposed with similar aims: the establishment and functioning of the internal market. The historical overview further shows that the Commission was rarely able to follow ambitious expert recommendations. In both areas of indirect and direct taxation, compromises were sought in transitional regimes and targeted measures, instead of a comprehensive European tax system that would harmonize national tax systems. At the same time, such comprehensive approaches are not off the negotiating table yet, as illustrated by the review of recent initiatives. While the policy aim of improving the functioning of the internal market is still high on the EU’s tax agenda, it should also be noted that other issues, such as the extent of VAT fraud, harmful tax competition and, more recently, tax evasion and avoidance by the wealthy and multinationals have been added to this policy agenda. This historical overview shows that the role of the EU with regard to taxation is more complex than suggested by the no-taxation thesis, which brings us to the main question of this chapter: What determines the politics of taxation in the EU?

282  Handbook on the politics of taxation

3.

EXPLAINING THE POLITICS OF TAXATION IN THE EUROPEAN UNION

This section reviews contributions that offer diverging answers to this puzzle. Because analyses of developments in indirect policy are scarce, it will mainly focus on direct (corporate) taxation. Political scientists started to analyse the politics of EU taxation in the middle of the 1990s and the resulting literature built upon the concept of the joint-decision trap to explain both the difficulty to reach agreements on issues of taxation and the substantive content of EU tax policies. Originally a concept developed by Fritz Scharpf, the joint-decision trap describes a situation where ‘central government decisions are directly dependent upon the agreement of constituent governments’ and ‘the agreement of constituent governments must be unanimous or nearly unanimous’ (1988, p. 254). In the EU context, this means that ‘once a binding rule is agreed upon, individual action is no longer permitted, and the veto of one or few governments will prevent others from correcting or abolishing the rule in response to changed circumstances or preferences’ (Scharpf, 2006, p. 848). Such a situation is likely to result either in a stalemate or inadequate policy outcomes. As scholars started to make similar observations in the taxation area, a range of contributions focused on analysing the mechanisms leading to and reinforcing the joint-decision trap, while others attempted to identify the conditions under which the trap could be overcome. 3.1

The Joint-Decision Trap in Direct Taxation

The joint-decision trap in direct taxation emerges from the institutional framework enshrined in the various treaties since the end of the 1950s. As we have seen above, the tax provisions of the treaties are limited to indirect taxation without any explicit mention of direct taxes. The general consensus was that EU competences would not include direct taxes, ‘while in fact it only implied that they would be dealt with under the general provisions of the EC-Treaty, including, most importantly, the provisions on non-discrimination, the four freedoms, competition policy, and general policy harmonization’ (Genschel, 2011, pp. 55–56). Moreover, decisions on taxation are subject to the unanimity requirement as originally foreseen in the treaties and the implementation of decisions depends on Member States’ national authorities. As such, the problem-solving gap in direct taxation is a prime example of the joint-decision trap. A substantial change away from initial decisions shaped by the primacy of market integration and the acquis communautaire is hindered by the unanimity rule and heterogeneity of the Member States’ preferences. The joint-decision trap has been reinforced and further institutionalized, mostly through two mechanisms: market integration and judicialization (Genschel et al., 2011; Genschel & Jachtenfuchs, 2011; Kemmerling & Seils, 2009). The integration effect refers to the growth of secondary tax legislation ensuring the functioning of the single market, which has been covered extensively in the overview of the historical developments. It showed that market integration has been particularly pronounced in the area of corporate taxation because of the adoption of several directives that aimed specifically at removing tax barriers and abolishing double taxation: the Merger Directive, the Parent-Subsidiary Directive and the Interest and Royalty Directive. Both the Merger and Parent-Subsidiary Directives were adopted in 1990. The former ensured the creation of a common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies; the latter set up

The politics of taxation in the European Union  283 a common system of taxation applicable in the case of parent companies and subsidiaries of different Member States (Panayi, 2019). The Interest and Royalty Directive followed in 2003 with the aim of avoiding withholding taxes on interest and royalty payments made within a group of companies. The institutionalization of the joint-decision trap in direct taxation has also been strengthened by the judicialization effect, a dynamic that resulted from the increase of ECJ jurisprudence regarding the compatibility of national tax provisions with the treaties, the acquis communautaire and the four freedoms (Genschel et al., 2011). Although the ECJ acknowledges that direct taxation falls within the responsibility of the Member States, it also requires that they respect the fundamental treaty principles of free movement and non-discrimination. Accordingly, the ECJ was highly critical towards protective national measures and ‘began snipping them down in the name of the market freedoms’ in the 1980s (Genschel & Jachtenfuchs, 2011, p. 302). The number of direct tax cases decided upon by the ECJ increased from 20 between 1988 and 1997 to 101 between 1998 and 2007. Between 1986 and 2003 the Member States lost more than 80 per cent of the cases related to corporate taxation. The behaviour of the ECJ goes back to the constitutionalization of the treaty, which ‘distorts the balance between state and market’ and favours market-making principles and negative integration over market-correcting provisions and positive integration (Schmidt, 2018, p. 7). Through reinforcing the joint-decision trap in direct taxation, the combination of ECJ tax jurisprudence and EU tax legislation accelerated tax competition and the race to the bottom to a point that it became stronger within the EU than in the rest of the world (Davies & Voget, 2008; Genschel et al., 2011; Redoano, 2014). On the one hand, the various tax directives adopted since the 1990s fostered tax competition between the Member States as they facilitate cross-border movements of firms, capital owners and wealthy individuals (Kemmerling, 2010). On the other hand, Member States can no longer take unilateral measures to sufficiently protect their tax base from harmful competition since ‘the ECJ tends to accord higher priority to the protection of taxpayers’ Treaty-based rights of mobility than to Member States’ public policy requirements’ (Genschel et al., 2011, p. 600). Tax competition in the EU also has important redistributive consequences by limiting the progressivity of national tax systems, which raises critical questions regarding the democratic deficit commonly attributed to the EU (Ganghof & Genschel, 2008). In sum, there is a joint-decision trap in the area of direct taxation. Market-correcting initiatives would be needed to counter any harmful effects from market integration. However, as Scharpf points out ‘market-correcting positive integration depended on political legislation … where very high consensus requirements and the heterogeneity of Member State interests and preferences would make agreement difficult or impossible’ (2006, p. 854). A range of contributions has been concerned with explaining precisely why it is so difficult for the EU Member States to reach agreements on matters of taxation. Liberal intergovernmentalist scholars, who focus more on relations between states than on institutional constraints, argue that the main obstacle to cooperation lies with the conflicting preferences of the Member States bargaining in the Council. They do so by offering case studies of specific policies that have been proposed by the European Commission, but either rejected in the Council or only adopted after an extremely long and tedious process. Dehejia and Genschel (1998) looked for instance at the unsuccessful attempts of the European Community to develop a common approach to (capital) income taxation in the 1990s. The negotiations took nearly 10 years, but the Commission’s proposal was never

284  Handbook on the politics of taxation agreed upon. Dehejia and Genschel explained this outcome by looking into the interplay of two distributional conflicts. The first consists in a within-group distributive conflict between winners and losers of tax competition: small European states such as Ireland or Luxembourg resist tax cooperation because they benefit from tax competition. The second conflict is related to outside-world constraints, according to which even big states like Germany resist tax cooperation because they anticipate that cooperation within the European Community would be exploited by states from outside the Community. Building upon those findings, Holzinger (2005) analysed the lengthy process that resulted in the adoption of the Savings Tax Directive in 2003. The Directive aimed at coordinating (capital) income taxation in the EU through a system of automatic exchange of information between Member States on cross-border savings income payments made to EU resident individuals. Holzinger reconstructed the long and bumpy road to the 2003 agreement by analysing in detail the preference heterogeneity of the Member States in an asymmetric coordination dilemma. In addition to the size of the country in terms of tax revenues, she shows that the size of its financial market sector also plays a role: small countries with significant financial sectors are much more likely to oppose cooperation than big countries without significant financial sectors. She also identifies the outside-world conditionality as a major obstacle and traces it back to the nature of tax cooperation as a ‘weakest-link good, that is cooperation of all potential tax havens is needed’ (2005, p. 506). According to Holzinger, an agreement was only possible because the United States, Switzerland and other tax havens committed to the rules on information exchange upon request proposed by the OECD in 2002. Hakelberg (2014) confirmed those findings by showing that Luxembourg and Austria agreed to a later revision of the Savings Tax Directive only because of pressure exerted by the United States. These findings are in line with Wasserfallen’s research (2014) into the repeated failure to introduce qualified majority voting for tax decisions during all intergovernmental conferences since Maastricht. Because low-tax countries benefit from tax competition dynamics, they have ‘no material interest in supporting tax harmonization’ and are ‘therefore, more likely to oppose the pooling of tax authority’ (2014, p. 427). His findings further show that the idea of tax harmonization in the EU is becoming less and less popular since the accession of the Central and Eastern European countries: in the Maastricht and Nice conferences, half of the Member States were in favour of the introduction of qualified majority voting. In 2004, it was only a third of the Member States. Paradoxically, by resisting tax harmonization in order to protect their tax sovereignty, Member States are effectively giving it away: without any form of tax harmonization, Member States are trapped by EU legislation and jurisprudence that promote market integration, foster tax competition and prevent them from correcting it with protective measures. The literature reviewed so far identified the mechanisms leading to and reinforcing the joint-decision trap characteristic for the lack of harmonization or progress in direct taxation (in contrast to indirect taxation). From a rationalist perspective, policy or institutional changes needed to break this deadlock are hampered by the heterogeneity of the Member States’ preferences and their reluctance to transfer competences to EU-level institutions. This results in inefficient or suboptimal outcomes, such as acute tax competition, decreasing tax revenues and progressivity or a problematic democratic deficit.

The politics of taxation in the European Union  285 3.2

Overcoming the Joint-Decision Trap

As the overview of the historical developments made clear, there have been important moments of change in the 1990s and especially since the financial crisis. Aside from the necessity of an outside threat, a strict institutionalist or intergovernmentalist lens does not tell us much about the specific dynamics of the EU policy-making process, and why some EU tax policies were successfully adopted while others were not. Important aspects tend to be overlooked, such as the role of the Commission beyond being a legislative initiator, the importance of ideas and discourse, the meaning of soft-law instruments or the influence of non-state actors both at the national and EU level. We therefore turn to the few contributions that went beyond the institutional limitations or the material preferences of the Member States and carried out a detailed analysis of the conditions under which the joint-decision trap has been overcome. The central role of the Commission has been acknowledged by Genschel (2011), who identified the various strategies used by the EU institutions to exit the joint-decision trap. On a theoretical level, he argued that both the Commission and the ECJ can bypass the Council ‘by exercising their supranational decision-making power’ or by ‘manipulating the world-views, preferences, and opportunity structures of the Council members so as to increase their incentives for agreements’, a mechanism referred to as nudging (2011, p. 59). While the supranational bypass is primarily a prerogative of the ECJ, the Commission can also either directly bypass the Council because of its state aid powers, or indirectly by formulating soft-law guidelines for the interpretation of ECJ case law. In the past, the efficiency of this approach appears to have been rather limited. By comparison, the nudging strategy derived from the Commission’s agenda-setting powers and its ability ‘to establish a shared cognitive and normative understanding of the tax requirements of the single market’ has been much more successful (2011, p. 64). Those aspects have been at the centre of Radaelli’s work on the politics of corporate taxation in the EU (1995, 1997). To explain the 30 years’ long policy process that started in the 1960s and ended in the adoption of the Merger and Parent-Subsidiary Directives in 1990, Radaelli built upon three interrelated dynamics: a changing policy environment, the redefinition of policy problems and the new role of an emerging epistemic community. In a context characterized by far-reaching economic and monetary integration, discussions about taxation were connected to the overarching goal of market integration and the ‘commitment to remove barriers to the free movement of individuals, goods and capital’ (Radaelli, 1995, p. 165). Accordingly, the Commission changed its way to communicate about taxation and the redefinition of problems materialized through a shift from a focus on tax harmonization to a tax discourse emphasizing subsidiarity, neutrality and efficiency. In addition to this reframing of problems, a small epistemic community consisting of a few research institutes and policy fora has played a key role in transmitting knowledge into the policy process. Together with the Commission and business actors, this epistemic community built a supranational advocacy coalition that successfully ‘promoted the transmission of new shared beliefs and public policy paradigms into the European tax policy process’ (1995, p. 174). Eventually, the policy change occurred because the new framing of tax issues by the Commission aligned with the arguments and ideas supported by the epistemic community. While the Commission traditionally followed a technocratic approach that reduced ‘the political salience of tax coordination’ and increased ‘the role of technical arguments’ (Radaelli, 1999a, p. 97), this changed towards a broader and more political definition of tax

286  Handbook on the politics of taxation issues with the nomination of Mario Monti as new Commissioner in 1995. The Commission’s focus shifted from neutrality as a way of preserving the single market to the narrative of harmful tax competition. The new narrative was very effective because it ‘plays out a vivid dramatic scene of villains (avid capitalists who deprive their countries of revenue by investing in morally suspect tax havens), potential victims (the ordinary people who need the welfare state) and heroes (the European governments who decide to take action and protect the welfare state)’ (Radaelli, 1999b, p. 671). The narrative not only made the economic and political gains of tax cooperation in the EU explicit, it also helped to transform ‘a series of deadlocks in individual tax dossiers into a larger positive-sum game with compensations across policy issues’ (Radaelli, 1999b, p. 673). This process was reversed in the early 2000s, when the focus shifted back to corporate tax reforms and market integration. After progress was made with the Code of Conduct and the agreement on the Savings Tax Directive, the Commission felt that it needed to address the concerns of the business community with initiatives on a CCCTB, home state taxation or transfer pricing (Radaelli & Kraemer, 2008). The Commission gave up its political approach and insisted instead on the technical nature of its work, whose guiding principles consisted, again, in the elimination of tax obstacles and competitiveness in the single market. Eventually, those policy developments can be understood as the result of a deliberate strategy of the Commission to orchestrate ‘the creation of different governance arenas to balance the power relations between Brussels, the Member States and the business community’ (2008, p. 316). This strand of research explored policy developments that occurred 20 years ago and is in need of an empirical update. Additionally, an in-depth analysis of the origins of ideas and narratives is still lacking. While pointing out that specific frames such as ‘harmful tax competition’ gain so much traction that they acquire constitutive value, there is insufficient attention for the underlying mechanisms that could explain the emergence of such ideas. Recently, a range of contributions has built and expanded upon those findings to explain why the policy landscape has changed dramatically since the financial and sovereign debt crisis. They confirm that a multitude of actors is involved: supranational organizations, such as the Commission and the Parliament, as well as non-state actors, including non-governmental organizations (NGOs) and tax activists, play an increasingly important role. They also point to the importance of the global context and the need to take into consideration the interactions with international organizations, such as the OECD. Finally, they provide important insights into the ideational and discursive processes at stake, and why some tax ideas win over others. In his analysis of the processes leading to the adoption of CBCR by both the OECD and the EU, Christensen (2018) focuses on the role of NGOs and civil society activists, such as the Tax Justice Network. CBCR requires corporations to report their financial data (such as revenue, income, tax paid, etc.) for each jurisdiction in which they conduct operations, instead of consolidated accounts. As a measure supposed to improve corporate tax transparency, CBCR has been a request from civil society and tax activists for many years. Christensen explains that, since the global financial crisis, this increasingly influential network of NGOs started to address the EU institutions because of a lack of progress at the OECD. At the same time, the Commission and the Parliament were more open to the demands from NGOs and took advantage of their support to ‘strengthen the profile of popular new ideas’ and ‘counterbalance Member state authority’ (2018, p. 9). An interesting point raised by Christensen involves the Commission’s attempt to change the formal legal basis of the corresponding directive by proposing it as an accounting measure subject to qualified majority voting, instead of a tax

The politics of taxation in the European Union  287 measure that would require unanimity in the Council. This is a clear example of how the Commission is actively trying to overcome the joint-decision trap with a ‘Treaty base game’ (Genschel, 2011, p. 63). The entrepreneurship of the Commission also takes centre stage in Lips’ (2019) analysis of the current developments regarding the taxation of the digital economy. Because the international discussions coordinated by the OECD were not moving forward, the Commission reacted with two legislative proposals in March 2018. The first directive proposed a long-term and far-reaching reform of corporate tax rules to ensure that profits of corporations are taxed on the basis of their significant digital presence. The second directive consisted in an interim solution in the form of a digital service tax of 3 per cent on the revenue of certain digital transactions. Although both proposals stranded in the Council’s negotiations and were put on hold, Lips shows that the Commission had other purposes in mind: ‘avoid fragmentation on interim digital tax measures for single market reasons … and provide an impulse to the OECD negotiations’ (2019, p. 9). This is another example of the Commission’s strategic role, not only regarding EU-specific tax issues, but also on the international stage. While those contributions give important insights into the increasing influence of the EU as a global player in international tax negotiations, other authors focused instead on the specificities of the tax policy-making process within the EU. With their comparison of EU corporate tax policy before and after the financial crisis, Roland and Römgens (2021) provide an in-depth analysis of the policy change from a narrow focus on market-making measures to the inclusion of market-correcting provisions targeting tax evasion and tax avoidance since 2012. They explain that those developments did not happen in a vacuum, but were embedded in a very specific context of politicization. The financial crisis and the period thereafter provided fertile ground for tax reforms. Because of the bailout programmes, states were in acute need of tax revenues and sentiments of injustice started to emerge amongst regular citizens and taxpayers. Corporate taxation evolved from a depoliticized to a politicized issue. The salience of the issue has been further reinforced by a series of tax scandals carefully orchestrated by a global network of investigative journalists, such as LuxLeaks, the Panama Papers and Paradise Papers. In this era of politicization, new political opportunities arose and the range of actors involved in EU tax policy-making expanded and now includes NGOs and tax activists, such as the Tax Justice Network, Oxfam, Transparency International and Eurodad. At the same time, the engagement of these actors increased the polarization of views about corporate taxation. Their discourse emphasizing justice and tax fairness started to enjoy greater visibility and legitimacy, at the expense of the business community. Forces within the European Commission and Parliament then took advantage of this opportunity and addressed the newly politicized issues of tax avoidance and evasion to expand their influence. Regarding the Commission, the definition of problems to solve and goals to achieve shifted from a focus on ‘competitiveness and flexibility toward market-regulating narratives promoting transparency and fairness’ (Roland, 2020, p. 89). With this reframing strategy, the Commission responded to the demands from the civil society and presented its tax agenda as the solution to issues of tax evasion and tax avoidance. Another strategy consisted in using the politicization dynamics to pressure the Member States through naming and shaming. In that respect, the state aid powers of the Commission have been crucial. The state aid investigations conducted by DG Competition under Margrethe Vestager targeted well-known multinationals (Apple, Starbucks, Amazon, Ikea and Nike) as well as European tax havens (the Netherlands, Luxembourg, Ireland and Belgium). The selection of the cases was the result of a deliberate

288  Handbook on the politics of taxation political decision to reveal ‘to the general public the complicity of national governments and tax authorities in large-scale tax avoidance schemes’ and ‘put severe pressure on the Member States to change policies’ (Roland & Römgens, 2021, p. 20).The Parliament has been instrumental, too. Although it has only a consultative function in the legislative process, it played an important role mostly because of its increasing technical expertise and intensive committee work. Both supported the development of a different tax agenda and increased the pressure on the Member States in the Council. Here we can see that the Commission and recently the Parliament can take advantage of a politicized context and, at least partially, overcome the joint-decision trap by interacting with NGOs and civil society, adopting their tax ideas and using discursive strategies of framing and naming and shaming.

4. CONCLUSION While taxation remains a core competency of the state, changing political-economic circumstances increasingly required national governments to coordinate tax policies. In the EU, this need has been exacerbated by the push for an internal market without fiscal obstacles. Indirect taxation has been identified as an integral part of the single market since the early days of European integration, and the harmonization of indirect taxes has been faster and deeper than in the area of direct taxation. There, progress has been hampered by a problem-solving gap, commonly referred to as the joint-decision trap. The institutional setting – constituted by the treaties, ECJ case law and adopted legislation – constrains the Member States’ autonomy to set national tax policies. Simultaneously, the decision-making procedure requiring unanimity in the Council represents an institutional limitation to tax harmonization or any other form of coordination. Depending on the size of their economy or importance of certain sectors, the conflicting preferences of the Member States further reinforce the joint-decision trap. Those institutionalist and intergovernmentalist approaches are helpful to understand why decision making is a difficult process. However, while the unanimity requirement and diverging national interests are obstacles, there have been occasions where the joint-decision trap has been overcome. A different set of explanatory factors is needed to fully understand the politics of taxation in the EU. The context should not be overlooked, as international developments or processes of politicization had a substantial impact on policy and decision making in the EU. The literature also points to a variety of actors beyond the Member States: supranational institutions, experts building epistemic communities and non-governmental actors, either from the media, business community or civil society. Perhaps most importantly, rational preference formation is not the only mechanism influencing policy-making. Knowledge, ideas and discourse are equally important. As valuable as the political science literature on taxation in the EU is, it is also confronted with a number of gaps. Whereas the research on the politics of corporate taxation is expanding, this is not the case for indirect taxation. Subject to discussion among legal scholars, VAT and other indirect taxes have not been picked up on by political scientists or political economists to the same extent (an exception seems to be comparative political economy, see for instance Lierse & Seelkopf, 2016). Analyses of the politics of taxation in the EU would also benefit from a greater theoretical variety. There are only a few researchers who moved beyond the formal institutional constraints and dynamics of interstate bargaining, which results in a certain institutionalist or state-centric and rationalist bias. By ignoring to a large extent the influence

The politics of taxation in the European Union  289 of non-state actors, underlying power relations that transcend state boundaries and the role of ideational elements, certain changes can be easily overlooked or not sufficiently explained. More constructivist and critical integration approaches to the politics of EU taxation would therefore be a welcome contribution to this growing academic field. Moreover, the argument that the recent politicization of corporate taxation is key to explaining post-crisis changes shows that the global context should not be underestimated either. In light of the current international tax negotiations and the new impetus given by the Biden administration, research on the relation between the EU, the United States and the OECD would be particularly relevant. The role of the ECJ deserves additional analysis as well. Its latest state aid rulings are rather ambivalent. While the ECJ confirmed the Commission’s decision in the Fiat and Engie cases, it ruled against it in the Starbucks case and overturned the Apple and Amazon decisions, which has been largely considered a ‘big blow’ for the Commission (Van Dorpe & Oliver, 2020). A closer look at the recent rulings and the political dynamics behind them would improve our understanding of the ECJ behaviour in the field of taxation. Finally, the unprecedented economic recession and massive public debts that follow from the COVID-19 pandemic gave new impetus to fiscal integration in the EU. This is likely to have far-reaching implications for tax issues. Both the Commission and Parliament have highlighted the need to increase the EU’s own resources, for instance with a digital levy or a financial transaction tax. In May 2021, the Commission announced the relaunch of proposals to harmonize corporate taxes for the third time since 2011, as well as other anti-tax avoidance measures – reinforcing the political salience of corporate taxation in the EU. Indeed, questions of social justice and fair taxation are becoming more relevant than ever as experts and NGOs have repeatedly warned against the socio-economic consequences of the current health, economic and public debt crisis. In this context, political scientists are unlikely to lose interest in the politics of taxation in the EU any time soon.

REFERENCES Aujean, M. (2012). Harmonization of VAT in the EU: Back to the future. EC Tax Review, 21, 134­143. Christensen, R. C. (2018). The rise of the EU in international tax policy. https://​doi​.org/​10​.31235/​osf​.io/​ tn329 Davies, R. B., & Voget, J. (2008). Tax competition in an expanding European Union. WP 09 04; UCD Centre for Economic Research Working Paper Series. University College Dublin. de la Feria, R. (2009). The EU VAT system and the internal market. IBFD. de la Feria, R. (2015). Blueprint for reform of VAT rates in Europe. Intertax, 43(2), 155–172. Dehejia, V. H., & Genschel, P. (1998). Tax competition in the European Union. MPIfG Discussion Paper 98/03. Max-Planck-Institut für Gesellschaftsforschung. http://​hdl​.handle​.net/​10419/​43162 (accessed 21 May 2021). Easson, A. (1992). Harmonisation of direct taxation in the European Community, from Neumark to Ruding. Canadian Tax Journal, 400(3), 600–638. European Commission (1968). Tax harmonization in the European Community. European Community Information Service. http://​aei​.pitt​.edu/​34508/​1/​A677​.pdf (accessed 21 May 2021). European Commission (1985). Completing the Internal Market. White Paper from the Commission to the European Council, COM(85) 310. Office for Official Publications of the European Communities. European Commission (1990). Commission Communication to Parliament and Council. Guidelines on Company Taxation, SEC(90)601 Final. Commission of the European Communities. European Commission (1992). Report of the Committee of Independent Experts on Company Taxation. Office for Official Publications of the European Communities.

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The politics of taxation in the European Union  291 Radaelli, C. M. (1997). The Politics of Corporate Taxation in the European Union: Knowledge and International Policy Agendas. Routledge. Radaelli, C. M. (1999a). Technocracy in the European Union. Longman. Radaelli, C. M. (1999b). Harmful tax competition in the EU: Policy narratives and advocacy coalitions. Journal of Common Market Studies, 37(4), 661–682. Radaelli, C. M., & Kraemer, U. S. (2008). Governance areas in EU direct tax policy. Journal of Common Market Studies, 46(2), 315–336. Redoano, M. (2014). Tax competition among European countries. Does the EU matter? European Journal of Political Economy, 34, 353–371. Roland, A. (2020). Multiple streams, leaked opportunities, and entrepreneurship in the EU agenda against tax avoidance. European Policy Analysis, 6(1), 77–99. Roland, A., & Römgens, I. (2021). Policy change in times of politicisation: The case of corporate taxation in the European Union. Journal of Common Market Studies. Scharpf, F. W. (1988). The joint-decision trap: Lessons From German federalism and European integration. Public Administration, 66(3), 239–278. Scharpf, F. W. (2006). The joint-decision trap revisited. Journal of Common Market Studies, 44(4), 845–864. Schmidt, S. K. (2018). The European Court of Justice and the Policy Process, Vol. 1. Oxford University Press. Stone Sweet, A. (2004). The Judicial Construction of Europe. Oxford University Press. Uhl, S. (2006). Time for a tea party? Why tax regimes beyond the nation state matter, and why citizens should care. European Review, 14(4), 565–585. Van Dorpe, S., & Oliver, C. (2020). Defeat on €13B Apple tax bill delivers big blow to EU’s Vestager. Politico.Eu. www​.politico​.eu/​article/​defeat​-on​-13b​-apple​-tax​-bill​-delivers​-big​-blow​-to​-eu​-margrethe​ -vestager​-ireland/​(accessed 21 May 2021). Wasserfallen, F. (2014). Political and economic integration in the EU: The case of failed tax harmonization. Journal of Common Market Studies, 52(2), 420–435.

PART III INTERNATIONAL TAX POLITICS B: CURRENT DEBATES

19. Power and resistance in the global fight against tax evasion Loriana Crasnic and Lukas Hakelberg

1. INTRODUCTION National governments usually assert the right to tax the worldwide income of individuals who reside on their territory for at least 183 days a year. To this effect, they legally oblige residents to declare income earned in foreign accounts in their tax return, often treating underreporting as a criminal offense: tax evasion. While the norm of state sovereignty – usually traced back to the Treaty of Westphalia of 1648 – provides nation states with the right to tax their residents as they please, it also allows them to extend the protection of national law to foreigners conducting business under their jurisdiction. In fact, the principle of non-discrimination has become a key pillar of positive international law (Palan, 2002). When Switzerland became the first country to codify banking secrecy in 1934, extending protection from the dissemination of account information to domestic and foreign clients of Swiss banks, its legislature respected this principle (Guex, 2000). The dilemma becomes apparent: individuals who evade taxes act illegally, whereas states abetting tax evasion through the provision of secrecy do not. As a result, tax authorities had a hard time detecting tax evasion during the entire twentieth century (see Hearson & Rixen, this volume). This depressed tax revenue by substantial amounts and contributed to the increase in income inequality observed since the 1980s, given that wealthier people tend to evade more (Alstadsæter et al., 2019; Limberg, this volume). Against this background, social scientists long held that international cooperation against tax evasion was particularly hard to achieve. According to a constructivist narrative, the opponents of financial transparency mobilized shared regulative norms such as national sovereignty and free competition in their favor, arguing that moves against tax havens infringed upon the competences of national legislators and were equivalent to forming a tax cartel (Sharman, 2006a; Webb, 2004). At the same time, a liberal-institutionalist narrative suggested that an asymmetric prisoner’s dilemma coupled with a weakest-link problem stopped progress. Inside the European Union (EU), interest heterogeneity between small capital-importing and large capital-exporting member states combined with a unanimity requirement for decisions on taxation prevented an increase in financial transparency (Genschel & Plumper, 1997; Holzinger, 2005; Römgens & Roland, this volume). Outside the EU, the ability of tax evaders to shift hidden wealth from newly cooperative to recalcitrant secrecy jurisdictions supposedly undermined attempts at enlarging the coalition of cooperative countries. After all, the payoff to remaining a tax haven should increase with every market exit, making side payments more costly and enforcement more difficult (Dehejia & Genschel, 1999; Rixen, 2011). Accordingly, these approaches struggled to explain why secrecy jurisdictions eventually became more transparent, agreeing in 2014 to participate in multilateral automatic exchange of information (AEoI) from 2017. The AEoI – as codified by the Organisation for Economic Co-operation and Development (OECD) in its common reporting standard (CRS) – obliges 293

294  Handbook on the politics of taxation banks to report the account balances and capital income of non-resident clients to domestic tax authorities, which then pass the information on to the clients’ respective home countries. Banks have to look through interposed legal entities such as companies or trusts when identifying the beneficial owner of an account and promptly transmit the information, whether a request from a foreign government is pending or not (OECD, 2014). At the time of writing, all of the world’s major secrecy jurisdictions had committed to practicing the CRS, which often required the dismantling of banking secrecy laws against substantial political resistance at the domestic level (Eggenberger & Emmenegger, 2015; Hakelberg, 2020). As a result, the value of foreign deposits in traditional secrecy jurisdictions has declined relative to traditionally more transparent countries, since they announced their participation in multilateral AEoI (Ahrens & Bothner, 2019; Beer et al., 2019; Menkhoff & Miethe, 2019; O’Reilly et al., 2019). By reducing the risk of capital flight, the AEoI has thus enabled OECD countries to raise taxes on capital income in response to budgetary pressure (Ahrens et al., 2020a; Harding & Marten, 2018). How come that countries, which had successfully defended their secrecy provisions for decades, decided to dismantle them despite the associated political and economic costs? Analysts agree that a sanctions threat from the United States (US) embedded in the Obama administration’s Foreign Account Tax Compliance Act (FATCA) forced secrecy jurisdictions to make concessions (Eccleston & Gray, 2014; Emmenegger, 2015; Hakelberg, 2016; Palan & Wigan, 2014; Steinlin & Trampusch, 2012). The act passed by Congress in 2010 obliges all foreign financial institutions (FFIs) active in the US to report their US clients to the Internal Revenue Service (IRS) from 2014. In case of non-compliance, the act foresees a 30 percent withholding tax on all payments from the US, effectively shutting the affected bank out of the American financial market (Grinberg, 2012). Owing to their commercial and structural dependence on access to investment opportunities and clearing infrastructure in the US, FFIs responded by lobbying their home governments for the dismantling of secrecy provisions that prevented their compliance with the FATCA (Emmenegger, 2017; Hakelberg, 2020). While the importance of US coercion for the emergence of the multilateral AEoI regime is undisputed, analysts still debate the following questions. The first question concerns timing. Why did the US use its power against tax havens only from 2008, ten years after the OECD had launched its first major transparency campaign, and decades after similar discussions took place at the United Nations (Ylönen, 2017)? The second question concerns the mechanism through which pressure exerted by the US on secrecy jurisdictions enabled the emergence of a multilateral regime. Why did secrecy jurisdictions also begin to automatically exchange account information with third states, if only the US has the power to wrestle concessions from them? The third question concerns the room to maneuver that tax havens retain. To what extent have they been able to resist the increase in financial transparency through activities inside and outside the AEoI regime? This chapter reviews each of these discussions in turn.

2.

POWER IN GLOBAL TAX POLITICS

The US government’s ability to wrestle concessions from FFIs, including in secrecy jurisdictions, rests on a unique combination of market power, structural power, and regulatory capacity. The US is home to the world’s largest financial market, whether measured in terms of market capitalization of listed firms, interbank transactions, or securities trading. It is also

Power and resistance in the global fight against tax evasion  295 the most important destination for portfolio investment from secrecy jurisdictions (Hakelberg, 2020, pp. 28–29). This suggests that wealth managers, who attract foreign financial wealth with the promise of confidentiality and high returns, depend on investment opportunities in the US to satisfy the expectations of their clients. More fundamentally, the US dollar’s role as the world’s key currency – the default currency for international transactions – forces foreign banks to use clearing infrastructure controlled by the US Federal Reserve. Accordingly, international banks remain under the jurisdiction of US regulators even if they do not invest in the US (Emmenegger, 2015, pp. 478–480).1 In terms of regulatory capacity, the IRS can impose prohibitive withholding taxes on payments leaving the US, whereas the Federal Reserve can exclude foreign banks from its clearing system. The US government can thus make credible sanction threats linking non-compliance with transparency standards to a bank’s exclusion from the US financial market, or even the international financial system. 2.1

Preconditions for the Use of Power

If the US government holds these levers in hand, why did it not use its power to pierce banking secrecy before 2008? According to Emmenegger and Eggenberger (2018), the use of coercion against secrecy jurisdictions only became possible after a tax evasion scandal involving Union Bank of Switzerland (UBS) had enabled US law enforcement authorities to launch legal action against Swiss banks. The UBS scandal, which was based on testimony and data provided by a former employee, revealed that the bank had deliberately hidden its US clients behind shell companies to avoid having to report them under the Qualified Intermediary Program (QIP). The QIP obliged foreign banks to withhold taxes on returns to investment in US securities and report US recipients to the IRS (Government Accountability Office, 2007). Foreign banks could protect their US clients from the reporting by divesting their portfolios of US securities, which – owing to investors’ home bias – shrunk the pool of attractive investment opportunities.2 The evidence showed that to keep US clients, who insisted on investing in the US, wealth managers at UBS transferred formal account ownership to shell companies in other secrecy jurisdictions. Although they knew that the beneficial owners of these entities were US citizens, they did not report the corresponding accounts to the IRS. Against this background, US prosecutors accused UBS of defrauding the US (Levin & Coleman, 2008). Emmenegger and Eggenberger (2018) argue that the scandal enabled US law enforcement authorities to tackle Swiss banking secrecy in the judicial instead of the political arena. Prosecutors threatened UBS with criminal indictment, which implied the exclusion from clearing and interbank settlement systems in the US,3 if the bank did not cooperate with the investigations and submitted files on its US clients. Because of Swiss structural dependence on its largest bank, the Swiss financial market authority was swift to grant UBS an exception from banking secrecy to enable the bank’s compliance. But this move set an important precedent and produced information that enabled US law enforcement authorities to expand their investigations to most other Swiss banks. Owing to sustained pressure, amplified by the indictment and eventual bankruptcy of Wegelin bank, Swiss bankers ended up lobbying their government for the acceptance of AEoI. From the perspective of Emmenegger and Eggenberger, this outcome would not have been possible, if the US government had tried to pressure the Swiss government directly into the acceptance of AEoI. Instead, this would have enabled the Swiss government to fall back on its traditional defense strategy, invoking the shared norm of state

296  Handbook on the politics of taxation sovereignty, granting Switzerland the right to extend the protection of domestic law to foreigners (Palan, 2002; Sharman, 2006b). This account explains why US law enforcement authorities were able to pierce Swiss banking secrecy after 2008. It does not explain, however, why the US government followed up on successes in the judicial arena by targeting all secretive FFIs with new legislation: the FATCA. This is where party ideology, the financial crisis, and business power come into play. Drawing on Bartels (2009), Hakelberg (2016, 2020) shows that – in contrast to Republican governments – Democratic governments have traditionally implemented progressive tax reforms, increasing the tax burden on high incomes and income from capital. For such reforms to produce tax revenue instead of capital flight, however, the ability of taxpayers to evade has to be curbed. Accordingly, Barack Obama, who as a senator had regularly supported anti-tax haven bills, promised during Democratic primaries in 2007 that he would lead the world to new standards for information exchange (Obama, 2007). His proposal received tailwind from the UBS scandal and the financial crisis. Whereas bank bailouts and stimulus packages exacerbated budgetary pressure, the tax evasion scandal suggested that wealthy households, who had benefitted from bullish financial markets before the crisis, were shifting the costs of the clean-up towards the rest of society (Eccleston, 2012, pp. 83–85; Limberg, 2018). Given this combination of party ideology, budgetary pressure, and popular fairness concerns, the Obama administration was swift to present an anti-tax haven strategy, including measures against corporate tax avoidance and financial secrecy. These measures were supposed to reestablish tax fairness for the middle class and co-finance bailouts and recovery packages (Office of the Press Secretary, 2009). The FATCA became the main anti-secrecy measure from this strategy. It was supposed to close the loopholes identified by the UBS scandal in the Clinton administration’s QIP, thereby ensuring that all foreign capital income of US taxpayers was reported at regular intervals. Like previous legal action, the act targeted foreign banks instead of foreign governments, obliging them to report the account balances and capital income of their US clients directly to the IRS (Grinberg, 2012, pp. 23–25). Unlike a political initiative in a multilateral forum, this approach enabled the Obama administration to protect US banks from additional reporting requirements. The Treasury department considered that banks were already burdened enough with other post-crisis regulation. Applying the act exclusively to foreign banks prevented resistance from the financial industry and facilitated its adoption by Congress. This approach ensured that the only interest group directly affected by the FATCA were tax evaders themselves, who as criminal offenders had little sway over the legislative process (Hakelberg, 2020, pp. 100–105). It also implied, however, that the US government could not reciprocate the AEoI it requested from everyone else, thereby creating a competitive advantage for US banks in the attraction of hidden wealth. To this date, the US has not joined the multilateral AEoI regime and does not identify the beneficial owners of trusts for information exchange purposes under bilateral FATCA agreements (Hakelberg & Schaub, 2018). In sum, the literature suggests that sustained use of US power against secrecy jurisdictions after 2008 was due to three factors. First, a tax evasion scandal that gave law enforcement authorities a handle to make Swiss banks surrender client files in contravention of Swiss banking secrecy. Second, a Democratic administration that used the tailwind from the scandal and the financial crisis to develop far-reaching legislation applying to all foreign banks. Third, the deliberate exemption of US banks from additional reporting requirements, which ensured that the financial industry would not lobby Congress to oppose the measure.

Power and resistance in the global fight against tax evasion  297 2.2

From Unilateral Pressure to Multilateral Regime

Secrecy jurisdictions around the world succumbed to US power, removing legal obstacles to their banks’ compliance with the FATCA. Soon thereafter, the same jurisdictions also signed up to a multilateral regime developed by the OECD, providing at least 60 other governments with equivalent information on their taxpayers’ bank accounts (cf. OECD, 2020). Why would secrecy jurisdictions also lift banking secrecy for other countries, if only the US government has the power to exclude them from the international financial system? The EU, for instance, had not been able to pressure Switzerland into participating in its much more limited AEoI on interest payments under the Savings Tax Directive, because EU members Austria and Luxembourg also refused to comply. Whereas Switzerland could thus argue that it would not go beyond standards applied by all member states, Austria and Luxembourg could block corresponding negotiation mandates for the EU Commission in the Council of the European Union (Holzinger, 2005; Sharman, 2008). By 2014, however, Austria, Luxembourg, and Switzerland had all agreed to automatically report accounts held by EU citizens and were among the signatories of the multilateral agreement implementing the CRS (Hakelberg, 2015). How can we explain the spillover from a unilateral initiative by the US government to a multilateral regime involving over 100 jurisdictions across the world? The first reason can be found in the Obama administration’s preferences. Despite the structural dependence of foreign banks on the dollar, US policymakers were concerned about a residual risk of divestment from the US in response to the FATCA. Banks could try to invest elsewhere to avoid reporting requirements and the act’s withholding tax. They could also exclude US investors from their services, putting them at a disadvantage relative to foreign investors. Ensuring that governments overseeing other important financial markets requested equivalent reporting from foreign banks promised to alleviate these concerns by leveling the playing field (Foreign Bank Account Reporting and Tax Compliance, 2009, p. 58; Palan & Wigan, 2014, p. 340). Moreover, US regulators expected that embedding the FATCA in a multilateral regime would increase the act’s legitimacy with targeted banks and jurisdictions. Turning the FATCA into a global standard allowed the US government to pose as a leading implementer rather than a unilateral aggressor. After the act had passed Congress, the Obama administration thus began to offer foreign governments bilateral agreements for its implementation (Hakelberg, 2020, p. 91). Emmenegger (2017, p. 35) argues that the US government’s willingness to internationalize the FATCA provided other capital-exporting countries with a focal point around which they could coordinate their collective action. In a first step, the US Treasury approached France, Germany, Italy, Spain, and the United Kingdom to elaborate a common approach to FATCA implementation. The countries agreed on a template for intergovernmental agreements that allowed banks from signatory states to report data via their home governments instead of entering into a privity of contract with the IRS. In addition, the template contained two important pledges. The US government promised to reciprocate the reporting of some but not all of the requested account data (see above), and both signatories pledged to engage with the OECD in developing a multilateral regime based on the FATCA (Hakelberg, 2020, p. 92). In a second step, the US struck corresponding agreements with secrecy jurisdictions across the world. By entering into these agreements, secrecy jurisdictions set an important precedent. They demonstrated that domestic banks could provide account information to the state and identify the nationality of the accounts’ beneficial owners (Palan & Wigan, 2014, p. 340).

298  Handbook on the politics of taxation This made the traditional legal argument, according to which domestic law prevented such reporting, untenable, enabling European governments to request equivalent cooperation from the signatories of bilateral FATCA agreements. In their requests for more financial transparency the G20, OECD, and EU thus converged on the US model. After the US and the largest European countries had committed each other to the pursuit of multilateral AEoI, the G20 declared this approach the new global standard for administrative assistance in tax matters. For the group’s rising powers, the AEoI promised to provide a backstop against illicit capital outflows, which put pressure on their balance of payments. A multilateral regime in which they had ownership also was more acceptable to them than a unilateral request from the US (Lesage et al., 2020), just as the Obama administration had expected. Hence, the G20 mandated the OECD to develop a legal framework based on the FATCA, which became the CRS. To this end, the OECD invited the rising powers in the G20 along with 149 other non-members into the Global Forum on Transparency and Exchange of Information (Christensen & Hearson, 2019). The move was supposed to enhance the worldwide legitimacy of the OECD’s standard-setting effort, but also gave voice to secrecy jurisdictions, which lend additional support to some small but consequential amendments to the CRS (see Section 3.2). The EU then applied the CRS in a revision of its Directive on Administrative Cooperation (DAC), which also applied to Austria and Luxembourg and was extended to Switzerland via an analogous bilateral agreement. After they had signed bilateral FATCA agreements with the US, Austria and Luxembourg could no longer resist AEoI in the EU, because the DAC’s original version contained a most favored nation clause, obliging EU members to grant more extensive cooperation with third countries as well as to each other. Pressure from the US thus enabled EU member states to escape the joint-decision trap – the combination of interest heterogeneity and a unanimity requirement4 – in negotiations over administrative assistance in tax matters (also see Römgens & Roland, this volume). Ultimately, agreement inside the EU allowed the Commission to take the Swiss government by its word and request the adoption of the AEoI standard, which was now practiced by all member states (Hakelberg, 2015). Together these developments prepared the ground for the multilateral agreement on CRS implementation. Reminiscent of traditional US policy in financial market regulation, the Obama administration preferred a level regulatory playing field at the global level based on its domestic model (Simmons, 2001; Singer, 2007). Large EU member states converged on the US model because they saw the opportunity to obtain information on their taxpayers’ foreign accounts by requesting equivalent cooperation from secrecy jurisdictions. Similarly, rising powers hoped to curb illicit capital flight, putting their balance of payments under pressure. Secrecy jurisdictions within the OECD, including Austria, Luxembourg, and Switzerland, could not turn down requests for equivalent cooperation, because information reporting under FATCA had proven that the norm preventing the dissemination of client data did not universally apply, and activated previous (legal) commitments in unexpected ways. Secrecy jurisdictions outside the OECD were also bound by bilateral FATCA agreements and could no longer argue that the OECD applied double standards by exempting members from new reporting requirements. Accordingly, the multilateral agreement for CRS implementation was signed by more than 50 countries at an international conference in Berlin in October 2014, with another 50 joining soon thereafter. To the surprise of many observers, however, the US was eventually missing from the list of signatories, arguing that its network of bilateral FATCA agreements was equivalent to joining the multilateral AEoI agreement (Hakelberg & Schaub, 2018).

Power and resistance in the global fight against tax evasion  299

3.

RESISTANCE IN GLOBAL TAX POLITICS

The previous section demonstrated that a great power like the US can in principle enforce global financial transparency standards. The US government’s refusal to fully reciprocate the AEoI already shows, however, that the multilateral agreement on CRS implementation does not mark the end of tax evasion. Recent reports suggest that hidden wealth may have found a new home in secretive US states (Drucker, 2016; Scannell & Houlder, 2016). But smaller secrecy jurisdictions also seem to enjoy some room for resistance to the multilateral AEoI regime (Crasnic, 2020). After all, no hegemonic group has ever had the omniscience and necessary resources to exert full control over all counter-hegemonic groups at all times. Therefore, rules and regulations need to enjoy a minimum level of legitimacy with targeted actors in order to be followed. This requires some degree of ownership and a certain level of concessions on the part of the powerful (Barnett & Duvall, 2005; Finnemore, 2009). Accordingly, secrecy jurisdictions managed to make some amendments to the multilateral AEoI regime that protect parts of their business with wealthy foreign clients. They have also found new ways to extend the benefits of domestic tax law to non-residents that do not rely on banking secrecy. 3.1

Resistance against the Multilateral Automatic Exchange of Information Regime

While compliance with the FATCA was swift and secrecy jurisdictions made numerous concessions to the US, the story is not as straightforward with respect to the new OECD-sponsored multilateral AEoI regime, which secrecy jurisdictions tried to water down as much as possible. The tendency for secrecy jurisdictions to limit and delay change became immediately clear after the financial crisis, when the OECD initially required tax havens to sign tax information exchange agreements, preventing signatories from turning down requests for administrative assistance simply because they interfered with banking secrecy provisions. Secrecy jurisdictions resisted this new standard through a combination of signing treaties with inconsequential state partners, delaying the signing and implementation of treaties, and only partially or incorrectly transposing them. Both the inflation in treaty numbers, as well as the slow or inadequate transposition of standards into law and practice, indicate that considerable resistance in the form of ‘mock compliance’ took place immediately after the financial crisis (Woodward, 2016). Jurisdictions managed to inflate their levels of adherence to the standards of the new regime, while simultaneously offering potential tax evaders the opportunity to move investment around and avoid detection (Johannesen & Zucman, 2014). Similarly, resistance occurs under the newest regulations prescribing AEoI through the CRS. As detailed in the previous section, all major secrecy jurisdictions have committed to practicing the CRS. As such, multiple authors have found that since the introduction of CRS, household assets in secrecy jurisdictions decreased by a substantial amount, at least in secrecy jurisdictions other than the US (e.g. Ahrens & Bothner, 2019; Casi et al., 2020). Nonetheless, the CRS represents another treaty complex whereby jurisdictions have some leeway to decide which partners they will automatically send tax information to. The inability to abide by principles of specialty and reciprocity, as well as shortcomings with respect to the capacity to safeguard the legal and technical protection of data transferred, can for instance be invoked to refuse AEoI with CRS signatories. Most recently, Switzerland has refused to sign a treaty with Turkey, on account that the latter’s incursions into Syria do not enable it to guarantee

300  Handbook on the politics of taxation data protection.5 Perhaps unsurprisingly, Switzerland was also one of the countries fervently supporting the adoption of such clauses restricting the transference of tax data when the CRS agreements were devised at the OECD and the associated Global Forum. Secrecy jurisdictions can thus resist the multilateral AEoI regime by disrupting interpretations of new rules and regulations, through either arguing about the specific meaning of convention paragraphs or devising innovations to skirt the standards (Crasnic, 2020). By doing so, especially at the beginning of this new regime, secrecy jurisdictions managed to successfully keep many prominent relationships uncovered by AEoI (Jansky et al., 2018). As Figures 19.1 and 19.2 make clear, this was not just a trend when AEoI relationships first began to be activated. The majority of countries with which secrecy jurisdictions undertake exchange of information are still predominantly upper middle- and high-income countries. Most lower-income and lower middle-income countries, which are also important partner countries for secrecy jurisdictions, are excluded from the treaty complex, leading some observers to conclude that the multilateral AEoI regime is merely a club standard benefitting rich countries (Jansky et al., 2018). Speaking to this observation, a recent study has found that deposits in secrecy jurisdictions increase when aid-dependent countries receive international funds, suggestive of aid being diverted to private accounts in these jurisdictions (Andersen et al., 2020).

Figure 19.1

Automatic exchange of information treaties activated by secrecy jurisdictions (information sent)

Power and resistance in the global fight against tax evasion  301

Figure 19.2

Automatic exchange of information treaties activated by secrecy jurisdictions (information received)

Furthermore, a majority of secrecy jurisdictions have opted not to receive tax information on their citizens at all. For instance, as of 2020, the Bahamas has activated 63 bilateral exchange relationships, but none of them require the partner country to send tax information to the Bahamas on its own nationals. This could potentially indicate that the Bahamas, and other similar jurisdictions, want to make use of innovations such as ‘golden passport’ schemes, in another attempt at disrupting the new regime. By virtue of such legal arrangements, foreigners can receive the right of residence or citizenship in exchange for sizable investments. Because these foreigners would effectively be nationals, their tax information would not need to be exchanged, potentially enabling continued tax evasion at their normal place of residence. A recent study finds that golden passport schemes do not yet have a widespread impact on the composition of portfolio investment in major financial markets, but finds limited evidence for investments in the Eurozone, especially in more recent years (Ahrens et al., 2020b). These types of offers show how globalized, high net worth individuals may still take advantage of transnational networks composed of banks, shell companies, foreign real estate, and investor citizenship programs to shield their wealth from the state (Cooley & Sharman, 2017). As a response to changes at the international level, the secrecy industry might therefore be changing to cater only to a limited number of taxpayers, the small minority of the super-rich, further amplifying wealth concentration and inequality (Alstadsæter et al., 2019).

302  Handbook on the politics of taxation 3.2

Opportunities for Resistance

What explains the opportunities targeted states have for obfuscating international tax cooperation? First and most obviously, unequal power relations breed the possibility for resistance because no hegemonic group can ever exercise complete control over every counter-hegemonic group. While the coercive power of the US is considerable in international finance and banking (Emmenegger, 2015), great powers are not omniscient when it comes to controlling other states in the international system. The bureaucratic capacity of great powers as well as the international organizations through which they operate is bound by resource and informational limitations. As such, great powers must pick their battles and selectively target recalcitrant actors (Finnemore, 2009). States that are pressured into abiding by new regulations are therefore often the most egregious offenders, whose submission might set an example for the larger population of targeted countries. After the global financial crisis, the US government focused on Swiss banking secrecy, which had long been the crux of collective action against tax evasion (Emmenegger, 2017). While successful in weakening Swiss resistance to the exchange of information in tax matters, the strong focus on banking secrecy left jurisdictions specializing in other types of financial secrecy unattended. Although the CRS obliges banks to look through trusts when identifying account owners for information exchange purposes, for instance, many British crown dependencies and overseas territories do not register information on the parties involved in a trust. Even banks committed to the CRS may thus be unaware of the true beneficial owners of accounts opened with them (Harrington, 2016). Accordingly, calls for a global register of asset ownership have not lost their actuality since CRS adoption (Zucman, 2015). Given these resource and informational limitations, great powers and international organizations have often tried to instill rules and regulations with legitimacy. But achieving legitimacy of rules is equally as difficult as policing them. Within some socially constructed system of norms and beliefs, legitimacy is the perception that actions are desirable, proper, or appropriate. As such, in the absence of being able to coerce recalcitrant states and induce action through policing, legitimacy of rules can persuade targeted states to change behavior voluntarily (Finnemore, 2009). In tax cooperation, great powers learned this lesson the hard way after blacklists of secrecy jurisdictions drawn up by the OECD in the early 2000s were criticized for their hypocrisy and interference with national sovereignty, given that they did not include secretive OECD member states but attempted to impose standards on countries that had not participated in their elaboration (Eggenberger, 2018; Sharman, 2006b). Against this background, great powers forged consensus on the AEoI regime not only in the G7 but also in the G20, made sure all ordinary OECD members complied with the CRS, and invited all non-OECD members that so desired to participate in a Global Forum tasked with elaborating the details and the monitoring of CRS implementation (Christensen & Hearson, 2019). While this approach has proven effective on paper, seeing that even initially recalcitrant jurisdictions like Panama have become signatories of the CRS, the regime’s continued hypocrisy and the additional ownership granted to secrecy jurisdictions threaten to undermine multilateral AEoI in the mid- to long term. Small secrecy jurisdictions rightly point out that larger financial centers like the US do not abide by the same standards, effectively undermining the legitimacy the regime has gained so far (Hakelberg & Schaub, 2018). Relatedly, the regime’s inconsistent institutionalization even among great powers puts the credibility of commitments in question, obstructs enforcement, and threatens to increase backsliding among

Power and resistance in the global fight against tax evasion  303 treaty partners, as secrecy jurisdictions may model their behavior on the self-proclaimed ‘leading implementer’ (cf. Abbott et al., 2000; Chayes & Chayes, 1993; Kahler, 2000). Ironically, the OECD’s attempt at increasing the ownership of the CRS among non-OECD members has also bred its own variant of hypocrisy. While the expanded Global Forum enables non-OECD members from the Global South to contribute to the meaning and means through which the AEoI regime is to be implemented and monitored, secrecy jurisdictions grasped the opportunity to shape emerging institutions in their favor. Bermuda, Jersey, and the Cayman Islands, for instance, used their membership in the Global Forum Steering Group to voice strong support for the regime’s bilateral implementation, effectively excluding low- to middle-income countries from the AEoI.6 As such, the new inclusiveness of the OECD, while increasing the input legitimacy of its tax standards, may have come at the expense of the regulations’ output legitimacy (Clifton & Díaz-Fuentes, 2011; Crasnic, 2020). At the global level, the regime’s legitimation requires a certain degree of ownership among targeted jurisdictions, which opens the door to institutional adaptation. In addition, there is substantial recursivity between global norm making and national law making. Through domestic legislation, governments may try to strengthen or undermine global norms, prompting additional reform cycles at the global level (Halliday & Carruthers, 2009). This dynamic abounds in international tax and wealth management where financial and legal innovations are the bread and butter of the industry. As banking secrecy became incompatible with global standards, many financial centers abandoned the practice in favor of complex strategies of tax avoidance. What most offshore financial centers nowadays offer is substantial reductions in taxes on income, capital gains, bequests, or real property, and not necessarily the outright hiding of assets, which nevertheless goes against the intention of new regulations and further contributes to a widening wealth gap. To this effect, financial experts and wealth managers are engaged in a constant process of financial product innovation designed to be strictly in accordance with new laws and regulations, while simultaneously stretching the limits of what is acceptable (Cooley & Sharman, 2017; Seabrooke & Wigan, 2017). Examples include the constant adjustment of foundation and trust legislation to allow wealthy clients to manage and have access to their assets whilst avoiding high-income or inheritance taxes. Depending on the client’s needs, these structures can also be ‘stacked’ or ‘tiered’ in more complex legal arrangements that spread assets and control across a myriad of legal entities in different countries. Faced with this complexity, tax authorities find it increasingly hard to establish an asset’s or individual’s liability to tax (Harrington, 2016). Other investment vehicles are designed with specific markets in mind, expertly tailored to circumvent distinct national legislation. As developing markets are gaining prominence in the global economy, tax havens are increasingly attracting investment from non-OECD countries, which are less well integrated in the AEoI regime (Jansky et al., 2018; Sharman, 2012). The British Virgin Islands and the Cayman Islands have, for instance, experienced their fastest areas of growth in their ties with China, whereas the Bahamas legalized various financial products that cater specifically to Brazilian clients. While these examples point towards a high level of legal sophistication, innovations can also come in much simpler form. As previously mentioned, golden visa or passport schemes that have proliferated in recent years provide wealthy individuals with an easy way of documenting residence in a tax haven when opening a bank account, thereby diverting the flow of information away from tax authorities at their habitual residence (Transparency International, 2018).

304  Handbook on the politics of taxation Opportunities for resistance result from the limited focus of the enforcement effort pushed forward by great powers, the necessity to infuse global standards with a modicum of legitimacy, and the inventiveness of highly trained tax and financial experts, who constantly adapt tax haven legislation to a changing regulatory environment. But what determines whether political actors make use of these opportunities? Crasnic (2020) shows that there is considerable heterogeneity in how secrecy jurisdictions have responded to the OECD’s AEoI regime, even when their reliance on the offshore financial industry is on paper similar. Differences in the degree of resistance come from policymakers’ subjective stakes in the financial sector, for instance whether they believe that the industry is important for the nation state or positively contributes to national welfare. Relatedly, Binder (2019) draws attention to the fact that secrecy jurisdictions are used for offshore banking as well as tax evasion, some more than others. The nature of the offshore industry and the clients they cater to are therefore another important distinguishing factor in how and to what extent secrecy jurisdictions have decided to go against the AEoI. But while the current literature acknowledges that there are various ways for secrecy jurisdictions to engage in resistance, there is still little understanding of what advantages and risks these strategies come with, and ultimately what effects these have on the success of new standards and regulations (but see Ahrens et al., 2020b).

4. CONCLUSION The US government’s decision to use its commercial and structural power against secretive foreign banks paved the way for the emergence of the AEoI regime. Although the level of financial transparency provided by the regime is unprecedented, recent contributions have identified opportunities and strategies for resistance. More scholarship is needed, however, to explain variance in the response of targeted jurisdictions to opportunities for resistance and their strategic choice. For instance, why does a jurisdiction prefer financial product innovation to engagement in the Global Forum and how is this preference linked to the role it plays in the offshore system? Moreover, future research should attempt to establish the significance of resistance strategies for the effectiveness of the AEoI. Have investors re-routed their portfolio investment through jurisdictions offering particular legal or financial innovations? Is there a difference between the types of investors that potentially make use of such schemes? Has the share of low- to middle-income countries in portfolio investment routed through secrecy jurisdictions increased relative to high-income countries? And how has the tax revenue of different country groups responded to the establishment of the CRS? Finding answers to these questions would help the field determine who benefits from the AEoI regime and where the struggle for global financial transparency needs to continue.

NOTES 1. Scholars still debate whether the creation of Eurodollars by private banks outside the US enhances or reduces US monetary power. But even authors who see a reduction in US monetary power mainly associate this with the Federal Reserve Bank’s decreased autonomy in setting monetary policy. They do not consider the ‘efficacy of sanctions’ issued by the US government to be affected by the existence of the Eurodollar market (Hardie & Thompson, 2020, p. 7, in draft). 2. For a recent review of the literature on equity home bias see Ardalan (2019).

Power and resistance in the global fight against tax evasion  305 3.

For a detailed description of the link between criminal indictments and the exclusion from US dollar clearing see Emmenegger (2015, pp. 478–481). 4. The concept was developed by Scharpf (1988); for a general discussion of potential exits from the joint-decision trap see Falkner (2011); for an application of the concept to corporate taxation in the EU see Römgens and Roland, this volume. 5. www​.swissinfo​.ch/​eng/​automatic​-exchange​-​_switzerland​-grants​-18​-more​-countries​-access​-to​ -bank​-details/​45424544 (accessed 24 May 2021). 6. Of particular interest in this regard should be jurisdictions that can draw on different pools of expertise, as this can be a key resource of influence in global governance (Seabrooke, 2014). Eskelinen and Ylönen (2017) have shown for instance how Panama was able to resist attempts to sanction their secrecy structure due to their involvement and expertise in trade policy.

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Power and resistance in the global fight against tax evasion  307 Johannesen, N., & Zucman, G. (2014). The end of bank secrecy? An evaluation of the G20 tax haven crackdown. American Economic Journal: Economic Policy, 6(1), 65–91. Kahler, M. (2000). Conclusion: The causes and consequences of legalization. International Organization, 54(3), 661–683. Lesage, D., Lips, W., & Vermeiren, M. (2020). The BRICs and international tax governance: The case of automatic exchange of information. New Political Economy, 25(5), 715–733. Levin, C., & Coleman, N. (2008). Tax haven banks and US tax compliance. United States Senate. www​ .gpo​.gov/​fdsys/​pkg/​CHRG​-110shrg44127/​html/​CHRG​-110shrg44127​.htm (accessed 24 May 2021). Limberg, J. (2018). What’s fair? Preferences for tax progressivity in the wake of the financial crisis. Journal of Public Policy, 1–23. Menkhoff, L., & Miethe, J. (2019). Tax evasion in new disguise? Examining tax havens’ international bank deposits. Journal of Public Economics, 176, 53–78. O’Reilly, P., Ramirez, K. P., & Stemmer, M. A. (2019). Exchange of information and bank deposits in international financial centres. OECD Taxation Working Papers. Obama, B. (2007). Remarks in Washington, DC: ‘Tax Fairness for the Middle Class’. September 18. www​.presidency​.ucsb​.edu/​ws/​index​.php​?pid​=​77013 (accessed 24 May 2021). OECD (2014). Standard for Automatic Exchange of Financial Account Information in Tax Matters. OECD Publishing. www​.keepeek​.com/​Digital​-Asset​-Management/​oecd/​taxation/​standard​-for​ -automatic​-exchange​-of​-financial​-account​-information​-for​-tax​-matters​_9789264216525​-en​#page1 (accessed 24 May 2021). OECD (2020). Exchange relationships. Automatic Exchange Portal. www​.oecd​.org/​tax/​automatic​ -exchange/​international​-framework​-for​-the​-crs/​exchange​-relationships/​ (accessed 24 May 2021). Office of the Press Secretary (2009). Leveling the playing field: Curbing tax havens and removing tax incentives for shifting jobs overseas. The White House. www​.whitehouse​.gov/​node/​2739 (accessed 24 May 2021). Palan, R. (2002). Tax havens and the commercialization of state sovereignty. International Organization, 56(1), 151–176. Palan, R., & Wigan, D. (2014). Herding cats and taming tax havens: The US strategy of ‘not in my backyard’. Global Policy, 5(3), 334–343. Rixen, T. (2011). From double tax avoidance to tax competition: Explaining the institutional trajectory of international tax governance. Review of International Political Economy, 18(2), 197–227. Scannell, K., & Houlder, V. (2016). US tax havens – the new Switzerland. Financial Times, May 8. www​.ft​.com/​intl/​cms/​s/​0/​cc46c644​-12dd​-11e6​-839f​-2922947098f0​.html​#axzz48719fIAD (accessed 24 May 2021). Scharpf, F. W. (1988). The joint-decision trap: Lessons from German federalism and European integration. Public Administration, 66(3), 239–278. Seabrooke, L. (2014). Epistemic arbitrage: Transnational professional knowledge in action. Journals of Professions and Organizations, 1(1), 49–64. Seabrooke, L., & Wigan, D. (2017). The governance of global wealth chains. Review of International Political Economy, 24(1), 1–29. Sharman, J. C. (2006a). Havens in a Storm: The Struggle for Global Tax Regulation. Cornell University Press. Sharman, J. C. (2006b). Norms, coercion and contracting in the struggle against ‘harmful’ tax competition. Australian Journal of International Affairs, 60(1), 143–169. Sharman, J. C. (2008). Regional deals and the global imperative: The external dimension of the European Union savings tax directive. JCMS: Journal of Common Market Studies, 46(5), 1049–1069. Sharman, J. C. (2012). Canaries in the coal mine: Tax havens, the decline of the West and the rise of the rest. New Political Economy, 17(4), 493–513. Simmons, B. A. (2001). The international politics of harmonization: The case of capital market regulation. International Organization, 55(3), 589–620. Singer, D. A. (2007). Regulating Capital: Setting Standards for the International Financial System. Cornell University Press. Steinlin, S., & Trampusch, C. (2012). Institutional shrinkage: The deviant case of Swiss banking secrecy. Regulation and Governance, 6(2), 242–259.

308  Handbook on the politics of taxation Transparency International (2018). European Getaway: Inside the Murky World of Golden Visas. Transparency International and Global Witness. Webb, M. (2004). Defining the boundaries of legitimate state practice: Norms, transnational actors and the OECD’s project on harmful tax competition. Review of International Political Economy, 11(4), 787–827. Woodward, R. (2016). A strange revolution: Mock compliance and the failure of the OECD’s international tax transparency regime. In P. Dietsch & T. Rixen (eds), Global Tax Governance: What Is Wrong and How to Fix It, 103–122. ECPR Press. Ylönen, M. (2017). Back from oblivion? The rise and fall of the early initiatives against corporate tax avoidance from the 1960s to the 1980s. Transnational Corporations, 23(3), 33–65. Zucman, G. (2015). The Hidden Wealth of Nations: The Scourge of Tax Havens. University of Chicago Press.

20. The politics of taxing financial transactions in the EU Saliha Metinsoy

1. INTRODUCTION The global financial crisis that started in 2008 with the collapse of Lehman Brothers in the United States (US) triggered a worldwide and extensive search for policies that aimed at reducing financial volatility. Excessive risk taking by the financial industry in advanced countries is argued to be one of the main culprits of the global collapse and the recession in 2008 and the following years. In response, governments and international institutions alike started contemplating adequate policies for better regulation of the financial industry. Among the broader initiatives of regulating the financial sector and reducing volatility, the European Union (EU) made two attempts to introduce a financial transactions tax (FTT) first in 2011 and later in 2013 (the process of introducing the FTT is discussed in more detail in the next section). Despite broad public support for the initiative at the EU level, however, the EU FTT initiative has so far failed and is likely to remain so unless suddenly revived (Gabor, 2016; Hardiman & Metinsoy, 2019; Kalaitzake, 2017). Scholars often argue that the financial industry has won and managed to secure its interests by blocking this initiative to tax financial transactions at the EU level. There is, however, less agreement on the questions of ‘why’ and ‘how’. This chapter surveys the existing studies on the topic and explanations for the failure of the initiative and points to some further research areas. I identify four prominent actors in the politics of the EU FTT: (1) the European Commission, (2) EU member states (national governments), (3) the financial sector and market actors, and finally (4) civil society organizations. Each actor engaged prominently in the debate producing their own arguments and positions while attempting to refute the opposing view. In addition, I argue that at the core of the politics of the EU FTT there lies a profound debate on whether and, if so, in what degree market behaviour would change should the FTT be implemented (i.e. would there be a lower level of market activity and how much?). Tied to the debate on whether and how much reduction in the market activity can be expected, the potential yield of the FTT has also been fiercely debated. Logically, if the FTT reduced the market activity there would be less taxable activity, which would result in lower revenue yield from the EU FTT. Finally, there were various unknowns on whether a mass exodus of the financial services from the FTT zones to non-FTT countries was a real possibility or a largely empty threat from the financial sector. In addition, there has been a strong normative and ethical basis to the FTT, which is often mobilized by the proponents. All four actors mentioned above produced their own versions of prediction with regards to the possibility of changed market behaviour and potential yield of revenue. The proponents, the European Commission and civil societal actors, suggested that the reduction in the volume of transactions would be minimal and hence significant revenue can be raised; while the opponents, the financial sector and some member states, predicted a mass exodus of the financial 309

310  Handbook on the politics of taxation activity towards non-tax regions and envisaged minimal revenue and significant economic destruction for the countries that apply the EU FTT. In the end, the opposing camp won. This chapter documents the answers that have been proposed as to ‘why’ and ‘how’ they won. The chapter first delineates the arguments proposed in debates in two subsections: (1) the impact of FTT on the market and tax yields, and (2) social and normative desirability of the FTT. In the third section, it critically surveys the existing scholarly work on how and why the financial sector managed to secure its interests and side-lined the initiative (at least at the time of writing). Here the emphasis is on the lobbying and the structural and ideational power of the financial sector and how it affects the policy process. The chapter concludes by summarizing the debate and pointing to future research areas on the politics of FTT in Europe.

2.

THE EU FINANCIAL ACTIVITIES TAX INITIATIVE IN 2011 AND 2013

An FTT focuses on regulating market behaviour, more specifically reducing the speculative transactions in the financial market. It was originally proposed by an economist, James Tobin, in 1972 ‘to throw some sands in the wheels of speculation’. The proposal was later taken up by the International Monetary Fund (IMF) in 1995 and transformed into a suggestion for a financial activities tax. The IMF suggested that rather than taxing transactions in the market, all financial activities should be taxed in order to prevent dislocation of financial services. The proposal was revived when G20 countries asked the IMF to prepare a draft proposal for reducing financial volatility and potentially preventing a similar financial crisis to that of 2008 (IMF, 2010). While the Obama administration was originally open to the idea, it later dropped its support (Strezhneva, 2018). When the plans for a global FTT collapsed with the withdrawal of the US, the European Commission went ahead and prepared a draft proposal for a European FTT (European Commission, 2011). EU member governments were among the most adversely affected by the global financial crisis that started with the collapse of Lehman Brothers. Many witnessed significant shrinking of their gross domestic product due to the crisis. Furthermore, large bailout programmes for the failing banks, the bursting of housing bubbles and subsequent mortgage crisis brought the financial sector to the spotlight. The European Commission suggested that The financial sector has played a major role in causing the economic crisis whilst governments and European citizens at large have borne the cost. There is a strong consensus within Europe and internationally that the financial sector should contribute more fairly given the costs of dealing with the crisis and the current under-taxation of the sector. (European Commission, 2011)

The statement demonstrates a clear compensatory logic1 adopted by the European Commission in the proposal. In fact, the original 2011 EU FTT proposal lists ‘making sure the financial sector makes a fair contribution to the recovery’ as one of the main reasons for the legislation. It is worth noting that some actors in the financial sector then framed this logic as punitive and intended to deliberately harm the financial sector through initiatives such as the EU FTT.2 The other two reasons that the Commission gave for the legislation are unifying the fragmented practice regarding FTT in the internal market of the EU and regulating the financial sector and dampening down the inefficient transactions in the market and hence reducing the risks for a potential financial crisis in the future.

The politics of taxing financial transactions in the EU  311 The EU FTT proposal (perhaps to the surprise of many outside observers) drafted a plan broadly in line with the activists and social partners’ viewpoint rather than the industry interests. The proposal had a so-called ‘triple-A approach’: all actors, all instruments and all markets (both regulated and over-the-counter markets) (European Commission, 2011). It levied a tax of 0.1 per cent on securities and 0.01 per cent on derivatives. This is a much smaller amount compared to the 0.5 per cent stamp duty of the United Kingdom (UK). The purpose of a low tax rate and a broad coverage of market products and actors was to prevent a dislocation of financial services out of FTT countries to the non-FTT areas (European Commission, 2013). Despite overwhelming support from the European Parliament and broad social support from the European publics (Eurobarometer, 2012), however, the proposal failed at the European Council largely due to the objections of the UK and Sweden (Kalaitzake, 2017). It transpired that it would not be possible to implement an EU-wide FTT with the participation of all member states. It is perhaps an example of the ‘joint-decision trap’,3 where veto players can block the decision making at the EU level. Beyond the institutional necessities, the literature would benefit from a comparative analysis of relative positioning and veto exercises of EU governments on the EU FTT and looking at the preference formation for countries such as the UK and Sweden (Section 5 elaborates more on this point). The European Commission prepared a second draft proposal in February 2013 for the 11 EU states4 that decided to move ahead with the FTT through the instrument of ‘enhanced cooperation’.5 The new proposal preserved the overall structure and approach and has many aspects that are common with the original one. Both proposals have been subject to intense debate with the involvement of the four actors mentioned above. The debate focused on the merits of an EU FTT, particularly whether it would be market enhancing through better regulation, or market distorting by causing exodus and on the social and ethical desirability of an EU FTT. The next section looks at those debates in two subsections and delineates the position and arguments of the actors involved in the politics of the EU FTT.

3.

DEBATE ON THE EU FINANCIAL TRANSACTIONS TAX: PRO AND AGAINST ARGUMENTS

3.1

Merits of a European Financial Transactions Tax: Market Enhancing or Market Distorting?

The impact of the EU FTT, indeed an FTT in general, remains highly disputed. There have been several trials at national level such as the FTT introduced in Sweden in 1984 or the still existing stamp duties in the UK, in France since 2012 and Italy since 2013.6 However, the policy has never been introduced at a global or regional level. From one perspective, one can say that there is great uncertainty on the impact of a regional FTT in terms of how much the market activity would be reduced because of the tax and how much revenue can be raised as a result. From another perspective, it can be argued that the financial sector was successful in creating a perception of profound uncertainty and conveniently discredited positive experiences such as the UK’s stamp duty. It is, however, a fact that the anticipated impact at the EU level is highly contingent on the assumptions made by different actors such as the European Commission. Private financial sector actors and civil societal organizations came up with

312  Handbook on the politics of taxation highly divergent predictions with regards to how much the volume of transactions would decline and how much tax could be raised (cf. European Commission, 2011, 2013; Collins, 2016; PwC, 2012). Much of the contestation over the likely impact of FTT focuses on four issues that can be ranked based on the relative importance attributed to them in the discussions, starting from the most contested issue to the least: (1) the risk of losses due to evasive relocation of financial services (i.e. disinvestment); (2) its potential revenue yield judged against the risk of dislocation; (3) the potential of the FTT as a regulatory tool to dampen speculative attacks and volatility; and (4) its redistributive effect on customers of financial services such as pension funds. Each issue can be grouped into either market-distorting or market-enhancing impacts of FTT. In this section, I first summarize different positions and predictions made related to each issue by prominent economists and then contextualize the debate in terms of different assumptions made for the markets and behaviour of actors in each contradictory position taken. At the core of the debate on the EU FTT lies the question of dislocation of the financial services to non-tax countries. The FTT introduced in Sweden in the 1980s and subsequent relocation of finance mainly to London is often cited as a cautionary example (Kalaitzake, 2017). Schäfer (2012), on the other hand, gives the counter-example of the UK stamp duty (0.5 per cent), which is based on a registration principle in order to prevent geographical dislocation. It has been yielding around 4 billion euros of revenue annually. He underlines that it did not lead to a dislocation of services. Schulmeister (2012) argues that it is not possible to prevent relocation in today’s economy, and that many hedge funds already operate from offshore destinations that have a low-tax regime and an accommodating regulatory framework due to the absence of income tax in those places. He proposes an exit charge similar to the UK’s in order to reduce the scale of potential exodus. If applied, the exit charge means that financial institutions would be required to pay a tax several times higher than the FTT if they relocate. Second, scholars argue that it is hard to predict the scale of revenue that could be generated by the FTT. One common argument is that the tax rate would reduce financial activity and shrink credit in the economy, which would result in a lower overall tax yield and slower growth. Schäfer (2012) points out that with the comparatively low tax rates that the EU FTT envisages (0.1 per cent on securities and 0.01 per cent on derivatives), only companies engaging in high-frequency trading will find themselves liable to taxes of any real significance. Vella (2012), on the other hand, contends that taxation does not only fall on the companies engaging in high-frequency trading; because financial transactions cascade and each round of transaction is subject to tax even though it might only be a single transaction. Hence, he argues that almost all companies would be affected by the tax. Third, another prominent debate is on the issue of speculation, risk and volatility. The European Commission (2011, 2013) cites reducing harmful speculation and volatility as one of the main objectives of the EU FTT proposal. Schafer argues that the FTT would permanently reduce the attractiveness of speculation with derivatives, and that it would make shadow banking activities more visible (Schäfer, 2012). This would enable better control and oversight of outsourced, geographically dispersed hedge funds. Schulmeister (2012) makes a broader argument that points to the damage to the real economy caused by the scale of financialization itself, and the diversion of resources to the financial sector. He argues that the decline in economic growth can be linked to the growth of the financial sector since the 1970s. Conversely, Vella (2012) argues that reduced transactions may in fact encourage more speculation by reducing the frequency of trading contrary to the original purpose. If the number of

The politics of taxing financial transactions in the EU  313 transactions is reduced, speculation might yield greater gains, and this could encourage more actors to engage in speculative activity. Finally, the distributive effects of an FTT are also contested, with implications for regulatory effectiveness. Vella (2012) argues that the tax will inevitably be levied on real persons (and not on corporations), since the financial institutions can in principle pass the tax on to their employers and customers. Schäfer on the other hand suggests that ‘following the implementation of the FTT, savers for retirement should select the fund with the lowest total costs (sales charge plus management fee plus financial transaction tax) … Intense competition would require fund providers to carry the burden of the FTT’ (Schäfer, 2012, pp. 79–80). That is, the tax would simply reduce the fees charged by funds. Fund providers would then have a vested interest in keeping the turnover rate small, and hence speculation and high-frequency trading would be reduced. This discussion inevitably leads us to a more general debate on whether markets operate based on rational and accurate price signals or whether they require regulation. In fact, the debate on the EU FTT boils down to two opposing arguments. On the one hand, the financial industry and other opposing actors argue that an FTT would distort market activity and would harm economic growth and efficiency by restricting the number of transactions in the financial market. The supporters of the FTT, on the other hand, suggest that the FTT can bring more efficiency by regulating the markets that may not always make the most efficient individual or collective decisions. The positive or negative assessment on the impact of the FTT can be said to originate from two diametrically opposing views on the markets. Classical and neo-classical economics7 view free and unrestricted markets as welfare enhancing (Mügge, 2013). The famous ‘invisible hand’ ensures that most efficient outcomes are achieved when markets are left alone. The laissez-faire economists view the taxation as market distortion. Their opponents argue that large volumes of transactions in the financial market make sure that the ‘true’ price for each equity, bond and derivative is achieved. They argue that a single equity or bond might be overpriced or underpriced in a single transaction. As the transaction volume increases, however, such mistakes would be averaged out and the ‘true’ price in the long run would be determined. They suggest that a transaction tax would inevitably reduce the volume of transactions due to increased costs. This would result in greater inefficiency and speculation, since overpricing and underpricing would become more likely to be undetected (reported by financial sector representatives in Hardiman & Metinsoy, 2019). In other words, an FTT would lead to an opposite outcome than its intended results, i.e. increased speculation and distortion. The proponents of an FTT, on the other hand suggest that a regulatory tax on financial transactions might slow down speculative transactions in the market and reduce the diversion of scarce resources away from the real economy towards the financial sector. They suggest that the financial sector is welfare enhancing so long as it aids the real economy and investment. Shifting resources to unproductive and speculative transactions is welfare distorting for society as a whole (Keynes, 1936; Stiglitz, 1989; Tobin, 1978). The two approaches view the role and the place of the financial sector in the overall economy fundamentally differently, as well. While the opponents of the financial tax view the financial markets as more or less closed entities with their own rules of functioning, the proponents consider the financial sector not only as part of the overall economy but also essentially in service of the overall economy. This ties to the well-known Keynesian idea that finance should be the servant of the economy, not the master (Keynes, 1936).

314  Handbook on the politics of taxation Among the four actors that were described in the introduction that played a role in the debate and shaping the politics of the EU FTT, financial market actors have been particularly active in arguing that an EU FTT would be market distorting. Market actors published numerous reports on the likely adverse impact of the FTT triggering a mass dislocation of services and claimed that revenues generated by the tax would be negligible (Gabor, 2016; Kalaitzake, 2017; Hardiman & Metinsoy, 2019). They formulated this adverse impact as an overall negative effect on societal welfare rather than their narrow special interests (Gabor, 2016). Pro-FTT actors, namely civil society actors and the European Commission, can be argued to be on the defensive regarding the impact of an FTT on the market. The European Commission published its own impact assessment suggesting that an FTT would inevitably result in some reduced market activity but would still yield between 30 to 35 billion euros for countries participating in the enhanced cooperation (11 EU member states) (European Commission, 2013). The original prediction was 57 billion euros for the whole EU area (27 EU member states) (European Commission, 2011). Some pro-FTT think tanks such as the NERI Institute in Ireland similarly published reports that predicted a significant revenue to be generated by the FTT (Collins, 2016). Either positive or negative predictions regarding revenue yield of an FTT are highly sensitive to the assumptions made on how much reduction in the market activity can be expected and how likely the financial services are to flee to non-FTT countries. While the opponents of the FTT underline that the financial services are highly mobile, the proponents would argue that the financial sector may not be as mobile as they want the policymakers to believe. Auxiliary services such as accounting and legal services and other regulatory and tax provisions as well as the availability of an educated workforce and high-skilled employees required for the financial services might make finance less mobile than it is theoretically assumed to be, at least in the short run (Hardiman & Metinsoy, 2019). In addition to attempts for an objective analysis on the merits of an EU FTT, i.e. whether it would be market enhancing or market distorting, the proponents would often point to the normative desirability of an EU FTT. Such arguments often centre on making sure that the financial sector, as one of the main culprits of the global financial crisis, makes a contribution to the recovery. The next section discusses the normative arguments that play an important role in analysing the politics of the EU FTT. 3.2

Social and Normative Desirability of the Financial Transactions Tax

There is a strong normative angle to the debate on the FTT. The debate is strongly tied to the re-evaluation of the financial sector and its role in the global financial crisis that started in 2008. If the market actors and opponents of the EU FTT were highly active in making the argument that an EU FTT would be market distorting and welfare reducing, proponents such as the European Commission and civil society actors were highly active in underlining social and ethical desirability. The same rationale was repeated in the revised 2013 proposal. The argument of ‘fairness’ in crisis recovery and making an ‘equal’ contribution to it as well as responsibility in causing the crisis underpin the Commission’s position. In the politics of the EU FTT, perhaps civil society organizations played an equally important role in terms of proposing moral arguments in favour of the EU FTT. In fact, some pro-EU FTT groups in the UK, the Netherlands and Ireland, organized globally under the name ‘Robin Hood tax’, argue that the revenue that can be generated via the tax can be used for fighting

The politics of taxing financial transactions in the EU  315 global poverty and tackling climate change.8 Like the European Commission, they underline that the reckless exchanges by the financial sector and excessive risk taking contributed to causing the crisis in 2008 (Robin Hood Tax UK, n.d.). Later, within the context of the campaign, 1,000 economists signed a letter to G20 leaders in April 2011 urging them to implement the FTT. They argued that the FTT was ‘morally right’ (Guardian, 2011). They backed claims that a small tax rate would not affect competitiveness or financial activity while calming excessive speculation. As a moral justification, they argued that ‘The financial crisis has shown us the dangers of unregulated finance, and the link between the financial sector and society has been broken. It is time to fix this link and for the financial sector to give something back to society’ (Guardian, 2011). This echoes the compensatory logic of the European Commission with respect to the role of the financial industry in the 2008 global financial crisis. Indeed, there was very large public support for the FTT at the EU level. Sixty-six per cent of the EU population was in favour of an EU FTT in 2012 according to the Eurobarometer results (Kalaitzake, 2017). Many staunchly opposing governments such as the UK and Ireland had to clarify that they were not against the initiative per se but its implementation (Strezhneva, 2018; Hardiman & Metinsoy, 2019). The financial sector countered the ethical and normative desirability arguments by arguing that they are ‘political’ claims rather than relying on market fundamentals (Hardiman & Metinsoy, 2019). They branded the pro-FTT arguments as ‘irrational’ and ‘implausible’ while emphasizing the market ‘fundamentals’. The politics of the EU FTT showcased the clash of competing ideas at the EU level. The normative and social desirability of an EU FTT might have motivated the European Commission to propose the legislation in the first place. Gabor (2016) argues that the EU FTT is an attempt by the European Commission to secure legitimacy in the wake of the crisis. The EU FTT would indeed serve the purpose of the Commission to distance itself from the financial sector, which was heavily blamed in the aftermath of the 2008 financial crisis for the economic collapse. Furthermore, it would provide a tool for the Commission for tackling the cause of the crisis and ensuring stability (Gabor, 2016). Indeed, the European FTT is part of the broader EU initiative of regulating finance to prevent a similar crisis in the future in the EU (Kalaitzake, 2017). Strezhneva (2018, p. 705) argues that a successful implementation of the EU FTT would foster European integration. As stated by the Commission proposal, part of the revenue would be used to finance the EU budget (European Commission, 2011, 2013). It is indeed highly plausible that this would be a step further towards a supranational EU with its own budgetary revenue independent of member state contributions. In a twin purpose, Strezhneva (2018) argues that the EU FTT was an initiative by the European Commission to project its normative power in forming and disseminating global norms. In proposing the EU FTT and promoting it within the global society, the Commission hoped to mobilize its normative power. According to Strezhneva (2018), this initiative failed due to the EU’s own weakness and ongoing Eurozone crisis, which reduced the desirability of the European model, and support for the FTT faded away as more time passed after the global financial crisis. The inability of the EU to mobilize its normative power is one possible explanation for the failure of the FTT at the global level. At the nation state level, scholars often contend that the structural and instrumental power (i.e. lobbying) of finance blocked the initiative and ensured

316  Handbook on the politics of taxation its ‘death by thousand cuts’ (Kalaitzake, 2017). The next section discusses the power of finance and its potential impact on blocking the proposal on the EU FTT.

4.

THE POWER OF THE FINANCIAL INDUSTRY AND THE POLITICS OF BLOCKING

Among the actors involved in the politics of the EU FTT, national governments perhaps have had the most pivotal role. Among the four actors mentioned above, i.e. the European Commission, civil societal organizations and the financial industry, the national governments are the main decision makers in the intergovernmental decision-making mode necessary for implementing the FTT (Scharpf, 2006). While the legislation was initiated by the European Commission, and market actors and civil society organizations proposed respective arguments and countered the claims of the opposing camps, in the end some member governments in the European Council such as the UK, Sweden, Denmark and the Netherlands decided not to proceed further with the initiative. Eleven member states such as Germany, France, Italy, Spain, Greece, Slovenia and Slovakia on the other hand decided to proceed with enhanced cooperation. Later, the enhanced cooperation initiative became largely inactive as well. Why did the governments decide to abandon the EU FTT despite significant support for the proposal at public level and a strong moral justification for taxing the financial sector in the aftermath of sizeable bailout packages in the European countries? There is near consensus in the literature that finance won the debate. Why and how is, however, still subject to contestation. Three groups of explanations can be listed: structural power of finance (i.e. threat of dislocation), instrumental power of finance (i.e. lobbying behind closed doors) and, finally, ideational power of finance in crowding out competing ideas and its significant power in determining the terms of the debate. In this section I review each set of explanations, i.e. the structural, instrumental and ideational power theses, respectively. The structural power of the financial sector is well researched in the literature (Culpepper, 2010, 2015; Culpepper & Reinke, 2014; Epstein, 2017; Grossman & Woll, 2014; Moschella, 2017; Woll, 2014a, 2014b, 2016). The literature has long discussed the crucial role and significance of the financial sector in capitalist societies as a gate-keeper to investment and therefore occupying a privileged position in policy formation (Epstein, 2017). Culpepper defines structural power as ‘the ways in which large companies and capital holders – in practice very often the same thing – gain influence over politics without necessarily trying to, because of the way they are built into the process of economic growth’ (Culpepper, 2015, p. 405). In this framework, the availability of exit options (disinvestment) and the dependence of the policymakers on capital holders are the main components of structural power (Culpepper & Reinke, 2014). For instance, Culpepper and Reinke argue that the reliance of the US banks on the domestic market rendered them weaker vis-à-vis the policymakers in the case of bank bailouts after the crisis, compared to the UK banks, which had more varied outside options. As a result, the US banks had limited capacity to challenge the regulatory initiatives (Culpepper & Reinke, 2014). Therefore, finance is also reliant on the government for functioning, or to put it differently, there is a mutual dependence between the two (Culpepper, 2015). Arguably, studies on the lobbying and structural power of finance are the most developed among the written work on the EU FTT. Among these studies, Lisa Kastner (2018) focuses on the changes in the two proposals (2011 and 2013) by the Commission for an EU FTT.

The politics of taxing financial transactions in the EU  317 Analysing the relevant edits and changes, she particularly focuses on the financial industry’s instrumental power under high salience and strong public scrutiny. She argues that in such cases the financial industry would be unlikely to secure favourable outcomes mainly due to electoral concerns for governments. Governments that want to be re-elected are more likely to tune in to public demands regarding the FTT than the narrow special interests of finance. This explains why the EU FTT was proposed as a legislation in the first place. She does however argue that once the negotiations moved to the specificities of the design of the tax, the financial sector was once again successful in watering down the agreement, securing various exceptions for some particular forms of transactions and products such as repos. It is fair to argue that civil society organizations do not have equal access to policymakers compared to the financial sector, and the general public is not as organized as the financial sector representatives. Specifically on the issue of repos, Daniela Gabor (2016) argues that repos were considered ‘a step too far’ in the negotiations and were exempted from the tax. She argues that this was because of the complex ‘entanglement’ of the regulators and policymakers in the repo market. Similar to Kastner (2018), she demonstrates that the financial industry was successful in framing the repo market as a necessary component of the liquidity in the market and serving socially desirable goals such as investment and growth. Among the few works on the impact of majority opinion and FTT, Masciandaro and Passarelli (2012, p. 98) argue that intervention in the financial sector is a general interest issue. They expect a political intervention in the financial sector to reflect the majority opinion in a democracy, since ‘every citizen is a potential portfolio owner’. Otherwise, policymaking would be susceptible to the lobbying of banks and the vested interests of other financial institutions. Since the 2008 financial crisis, in their view, political intervention in the financial sector is a general rather than a special issue due to increased saliency of the topic. They argue that ‘regulation is more likely to be preferred to taxation in a direct democracy, in which citizens/ voters are heterogeneous in their portfolio toxicity’. That is, if there is a clear majority investing mainly in non-speculative activities, we would expect a popular preference for taxation. Where the opposite is true (and a majority invests in speculative activities), we would expect regulation to be the favoured option in democratic debate. We might expect that this would be associated not only with the sophistication of voters as investors, but with the degree to which investment vehicles are based on long-term bond holding or on managed funds that invest in shares and equities on the stock market. This might also bring us back to differences in varieties of capitalism (and bank-based versus market-based systems). Kalaitzake (2017), in contrast, provides evidence that FTT commands widespread popular support among voters right across the EU in the wake of the financial crisis, which does not seem to vary in relation to the investment behaviour of voters in general. One can argue that the normative desirability of the tax gained enough traction among the general public. But, perhaps, the general public was not organized enough, unlike the financial sector, to pursue their interests with the policymakers and this is why their preferences were not as effective in influencing the policy process. In fact, there is near consensus in the literature that the success of finance in watering down various aspects of the original EU FTT proposal and delaying its implementation can be attributed to its ability to frame the potential adverse consequences of the taxation not in terms of its own special interests but in terms of broader public and societal good. More specifically, existing studies argue that finance was successful in framing the tax as detrimental to liquidity in the market and hence to investment and growth.

318  Handbook on the politics of taxation There is however less consensus on what made the policymakers receptive to such arguments. It is clear that the success of the financial industry in watering down the EU FTT proposal depends on a reciprocal relationship between the industry and policymakers. Unless listened to and attended to by the policymakers, the industry’s lobbying attempts would not be productive. There are two main explanations as to why policymakers would listen to the arguments of the industry and might be susceptible to attending to their interests. One strand argues that the financial industry successfully mobilized the structural dependency of the capitalist economies on the financial sector (Gabor, 2016; Kalaitzake, 2017; Kastner, 2018). All capitalist economies rely on the financial industry providing the necessary capital for investment and economic growth. As re-election of democratic governments is largely reliant on economically delivering, we can expect that the governments are receptive to industry demands. It can do this either through lobbying (instrumental power of the financial industry) or through threatening to exit and relocate to other non-tax locations (structural power of the financial industry). In addition to the instrumental and structural power of the financial industry, Hardiman and Metinsoy (2019) turn their focus to the role of ideas in explaining when and why policymakers would be receptive to framing by the industry. They propose that finance commands not only lobbying and structural power due to the dependence of the economies on investment but also that it has significant power over ideas. It is successful in framing what is considered ‘rational’, ‘reasonable’ and ‘plausible’ while crowding out competing ideas that contradict their interests (Hardiman & Metinsoy, 2019). They argue that the financial sector was successful in branding the EU FTT ‘non-plausible’ and economically harmful. They depart from the existing studies in emphasizing the ‘power in ideas’ and ‘power through ideas’. They argue that finance controlled the broad contours of the debate and which ideas found their ways to policymakers or were considered reasonable by them. The politics of the EU FTT has been discussed by scholars among other financial regulatory initiatives in the aftermath of the 2008 financial crisis. However, there are still some unanswered questions and room for bringing in further nuance and specification to the studies. The next section summarizes the chapter and points to some plausible research directions.

5.

CONCLUSION AND FUTURE RESEARCH

This chapter discussed the politics of the EU FTT, a proposal originally tabled by the European Commission in 2011 for 27 member states and later revised in 2013 for enhanced cooperation of 11 members. At the time of writing, the proposal is largely inactive. In the chapter I argued that four sets of actors, namely the European Commission, member governments, the financial industry and the pro-FTT civil society organizations have been active in the politics of the EU FTT. In a war of ideas, pro and against camps formulated different sets of arguments. The financial industry mainly argued that an FTT would be market distorting, triggering a mass exodus of the financial services away from tax zones to non-tax countries, would increase speculation and volatility as opposed to its original intent and would not yield the significant revenues that were proposed by the European Commission. The European Commission and the civil society actors on the other hand emphasized the moral and social desirability of the tax that could be used to finance the EU budget as well as the fight against climate change and global poverty. Furthermore, they argued that the tax would be market enhancing by reducing excessive speculation and by providing better regulation for the finance sector. The financial

The politics of taxing financial transactions in the EU  319 sector actors countered the ethical and social desirability arguments of the pro-FTT actors by branding their arguments at odds with market ‘realities’ and lofty, political ideas that are unrealistic and implausible. When all is said and done, member governments, the key decision makers in a proposal like the EU FTT, were against the proposal or largely failed to enact on it. The dominant explanation in the literature for the failure of the initiative is the power of the financial sector in securing its interests. There is however less agreement with regards to how this power played out. While some scholars point to the use of structural dependence of capitalist economies on investment and finance and lobbying by the financial representatives, others point to the power of ideas and the significant power finance commands on ‘acceptable’ market ideas. One fruitful research area, drawing on the existing studies, is a comparative study that analyses why some countries had positive preferences vis-à-vis the EU FTT while others opted out of the initiative. Most of the existing work offers an analysis at the EU level and looks at the lobbying activity of the financial industry in the Commission and the European Parliament. Such studies constitute finance and the EU institutions as two sides of different interests. However, the original proposal was in fact blocked in the European Council, which is an intergovernmental arena where national interests are aired and can be observed at their best. Future studies can focus on the national level and ask the question: why did 11 states press ahead with the EU FTT (enhanced cooperation) while the remaining 16 opted out? What determines the national preference with respect to the EU FTT? Such studies can refine the arguments regarding successful mobilization of public and private entanglements in the field of finance as well as lobbying and structural power of finance. They would propose more fine-tuned arguments with respect to the processes at play in the engagement of finance and governments. They would also refine the existing perception that the financial industry’s interests are bypassed under high saliency and public attention (Kastner, 2018). It is an empirical puzzle as to why such interests were ignored in 11 EU countries, which decided to move ahead with enhanced cooperation. One potential reason for countries moving ahead with the EU FTT might be structural weakness of finance in such economies and relatively weaker dependence of the economy on the financial industry. A juxtaposition between the UK and Germany is useful in this respect. While the UK government heavily lobbied against the EU FTT in the Council and sued the Commission in order to prevent enhanced cooperation in the case of the EU FTT, Germany has been a keen supporter of the initiative from the start. A comparative analysis between such positive and negative cases can also identify scope conditions for successful lobbying by the finance industry and the context for its ability to mobilize its interests. In addition to structural dependence arguments, one can think of the depth and type of the economic crisis in a country as well as the degree of public support for initiatives of applying taxes on financial activity. Such arguments can be put to the test only through a comparative analysis between pro-FTT EU member states and those who opted out of the enhanced cooperation initiative. From a theoretical perspective, almost all of the existing studies propose a constructivist argument. There is not much written from the institutionalist and perhaps realist and materialist perspectives. Especially in uncovering state preferences and studying the different positions taken by member states, intergovernmentalist accounts specifically looking at domestic interests in the formulation of state preferences can provide a useful framework of analysis. Similarly, future studies can look at the number and prominence of especially financial actors that have the most to gain from speculative transactions in the market such as hedge funds and

320  Handbook on the politics of taxation delve into a potential link between the presence and prominence of hedge funds in a country and the respective preferences of member states. In this case, realist and materialist accounts looking at economic competition between member states and actors in the EU can provide some answers. Finally, existing studies invariably treat the degree of saliency as a background condition that determines the industry’s relevant strategy such as playing ‘quiet’ or ‘noisy’ politics. There are not many studies that look at the interaction between both, i.e. between the degree of saliency and finance’s strategies. One fruitful research area in the field of politics of the EU FTT would uncover this dynamic process in clearer terms. How does finance pursue its interests in the case of taxation proposals when there is low or high saliency? How and why does the sector adopt its lobbying activities? Future studies can look into this relationship.

NOTES 1. Scheve and Stasavage (2010) discuss ‘compensatory logic’ in relation to war mobilization and redistribution. It is an intuitive concept that requires the beneficiaries of the war pay back to the lower-income groups in society, which were conscripted during war mobilization. 2. Author’s interview data collected for Hardiman and Metinsoy (2019) but not cited in the article. 3. For a discussion on the intergovernmental mode of decision making and the ‘joint-decision trap’, see Scharpf (2006). 4. Those states are France, Germany, Belgium, Austria, Slovenia, Portugal, Greece, Slovakia, Italy, Spain and Estonia (European Commission, 2013). 5. The enhanced cooperation is a procedure in the EU institutional design that allows at least nine EU countries to cooperate in a particular area of EU jurisdiction and deepen their integration. It has been used in the case of divorce law and is approved for the FTT (Eur-Lex, 2013). In other words, the FTT is one of the first areas where an enhanced cooperation procedure might be implemented. 6. For a survey of national experiences with stamp duty, see Froot and Campbell (1994). 7. For an accessible review of classical and neo-classical economics, see Watson (2017); for a more in-depth discussion, see Backhouse (2002); and for a critical review see Chang (2014). 8. Originally, the FTT was envisaged to be used to compensate the losers of globalization and make sure that finance equally contributes as the main beneficiary of globalization (Begg, 2011).

REFERENCES Backhouse, Roger (2002). The Penguin History of Economics. Penguin. Begg, Iain (2011). An EU Tax: Overdue Reform or a Federalist Fantasy? Friedrich-Ebert-Stiftung. Chang, Ha-Joon (2014). Economics: The User’s Guide. Penguin. Collins, Micheál (2016). Estimating the revenue yield from a FTT for the Republic of Ireland. Nevin Economic Research Institute. www​.nerinstitute​.net/​research/​estimating​-the​-revenue​-yield​-from​-a​-ftt/​ (accessed 24 May 2021). Culpepper, Pepper D. (2010). Quiet Politics and Business Power: Corporate Control in Europe and Japan. Cambridge University Press. Culpepper, Pepper D. (2015). Structural power and political science in the post-crisis era. Business and Politics, 17(3), 391–409. Culpepper, Pepper D., & Reinke, Raphael (2014). Structural power and bank bailouts in the United Kingdom and the United States. Politics and Society, 42(4), 427–454.  Epstein, Rachel (2017). Banking on Markets: The Transformation of Bank-State Ties in Europe and Beyond. Oxford University Press.

The politics of taxing financial transactions in the EU  321 Eur-Lex (2013). Council decision of 22 January 2013 authorising enhanced cooperation in the area of financial transaction tax. https://​eur​-lex​.europa​.eu/​legal​-content/​EN/​TXT/​?uri​=​CELEX​ %3A32013D0052​&​qid​=​1622036629398 (accessed 26 May 2021). Eurobarometer (2012). Crisis and economic governance. Eurobarometer, EBEB 77.2. www​.europarl​ .europa​.eu/​poland/​resource/​static/​files/​Eurobarometry/​v​.​-ebeb​-77​.2​-crisis​-and​-economic​-governance​ -pl​-​-en​-​.pdf (accessed 24 May 2021). European Commission (2011). The Commission proposal for a Council Directive on a common system of FTT. COM (2011) 594, 28 September. Commission of the European Communities. http://​ ec​.europa​.eu/​taxation​_customs/​ resources/documents/taxation/other_taxes/financial_sector/ftt_proposal_en.pdf (accessed 24 May 2021). European Commission (2013). Proposal for a council directive implementing enhanced cooperation in the area of Financial Transaction Tax. COM (2013) 71 final. Commission of the European Communities. http://​ec​.europa​.eu/​taxation​_customs/​resources/​documents/​taxation/​com​_2013​_71​_en​ .pdf (accessed 24 May 2021). Froot, Kenneth A., & Campbell, John Y. (1994). International experiences with securities transaction taxes. In J. Frankel (ed.), The Internationalization of Equity Markets, 277–308. University of Chicago Press. Gabor, Daniela (2016). A step too far? The European financial transactions tax on shadow banking. Journal of European Public Policy, 23(6), 925–945. Grossman, Emiliano, & Woll, Cornelia (2014). Saving the banks: The political economy of bailouts. Comparative Political Studies, 47(4), 574–600. Guardian (2011). Robin Hood tax: 1,000 economists urge G20 to accept Tobin tax. 13 April. www​ .theguardian​.com/​business/​2011/​apr/​13/​robin​-hood​-tax​-economists​-letter (accessed 24 May 2021). Hardiman, Niamnh, & Metinsoy, Saliha (2019). Power, ideas, and national preferences: Ireland and the FTT. Journal of European Public Policy, 26(11), 1600–1619. IMF (2010). Global financial stability report: Sovereigns, funding and systemic liquidity. www​.imf​.org/​ external/​pubs/​ft/​gfsr/​2010/​02/​pdf/​text​.pdf (accessed 24 May 2021). Kalaitzake, Manolis (2017). Death by a thousand cuts? Financial political power and the case of the European financial transaction tax. New Political Economy, 1–18. Kastner, Lisa (2018). Business lobbying under salience: Financial industry mobilization against the European financial transaction tax. Journal of European Public Policy, 25(11), 1648–1666. Keynes, John M. (1936). The General Theory of Employment, Interest, and Money. Macmillan. Masciandaro, Donato, & Passarelli, Francesco (2012). The financial transaction tax: A political economy view. Intereconomics – Forum on Financial Transaction Tax, 47(2), 96–99. Moschella, Manuela (2017). When some are more equal than others: National parliaments and intergovernmental bailout negotiations in the Eurozone. Government and Opposition, 52(2), 239–265. Mügge, Daniel (2013). Resilient neo-liberalism in European financial regulation. In A. Vivien Schmidt & Mark Thatcher (eds), Resilient Liberalism in Europe’s Political Economy, 201–225. Cambridge University Press. PwC (2012). The EU financial transactions tax latest developments. www​.pwc​.com/​sg/​en/​tax​-newsflash/​ assets/​taxnewsflash​-201202​.pdf (accessed 26 May 2021). Robin Hood Tax (n.d.). Robin Hood Tax: A campaign in Ireland by claiming our future. www​ .robinhoodtax​.ie (accessed 24 May 2021). Schäfer, Dorothea (2012). Financial transaction tax contributes to more sustainability in financial markets. Intereconomics – Forum on Financial Transaction Tax, 47(2), 76–83. Scharpf, Fritz W. (2006). The joint-decision trap revisited. Journal of Common Market Studies, 44(4), 845–864. Scheve, Kenneth, & Stasavage, David (2010). The conscription of wealth: Mass warfare and the demand for progressive taxation. International Organization, 64(4), 529–561. Schulmeister, Stephan (2012). A general financial transactions tax: Strong pros, weak cons. Intereconomics, 47(2), 84–89. Stiglitz, Joseph (1989). Using tax policy to curb speculative short-term trading. Journal of Financial Services Research, 3, 101–115. Strezhneva, Marina (2018). The European Union as a global actor: The case of the financial transaction tax. European Review, 26(4), 704–720.

322  Handbook on the politics of taxation Tobin, James (1978). A proposal for international monetary reform. Eastern Economic Journal, 4, 153–159. Vella, John (2012). The financial transaction tax debate: Some questionable claims. Intereconomics, 47(2), 90–95. Watson, Matthew (2017). The nineteenth-century roots of theoretical traditions in global political economy. In John Ravenhill (ed.), Global Political Economy, 26–51. Oxford University Press. Woll, Cornelia (2014a). The Power of Inaction: Bank Bailouts in Comparison. Cornell University Press. Woll, Cornelia (2014b). Bank rescue schemes in continental Europe: The power of collective inaction. Government and Opposition, 49(3), 426–451. Woll, Cornelia (2016). Politics in the interest of capital: A not-so-organized combat. Politics and Society, 44(3), 373–391.

21. Revenue challenges in developing countries: can international assistance help? Ida Bastiaens

1. INTRODUCTION Raising domestic revenue is vital for many developing countries to meet their development needs. For example, the United Nations Conference on Trade and Development estimates that achieving the Sustainable Development Goals (SDGs) requires low-income countries to raise their current tax-to-gross domestic product (GDP) ratios by close to four percentage points (UNCTAD, 2016). In fact, over 75 per cent of the financing for the SDGs must come from domestic sources (Lundstøl, 2018). Yet, collecting taxes faces tremendous challenges, as this handbook illuminates. Exemptions, avoidance, large informal sectors, complex and obscure laws, and weak bureaucratic administrative capacity are just some of the obstacles these countries face (Fjeldstad, 2013; Cottarelli, 2011; Besley & Persson, 2014). Developing countries have lost 100 billion dollars to tax evasion and avoidance and 138 billion dollars to tax incentives (United Nations, 2015a). In fact, tax revenue of low-income countries is typically under 20 per cent of GDP, while it reaches 40 per cent in high-income countries (Besley & Persson, 2014). The consequences of this low revenue are dire: ‘African countries will both need to grow their economies and increase the ratio of taxes to GDP to 25 percent, up from 19.2 percent today, to finance Africa’s infrastructure and human development needs’ (Drummond & Their, 2018). Such low tax-to-GDP ratios may also have major consequences for democracy as taxes can incentivize citizens to demand representation from their government (Ross, 2004; Eubank, 2012). This chapter reviews the existing research on revenue generation in developing countries from the mid-1900s through today.1 I start by examining the trends and composition of tax and nontax revenue in developing countries. I then narrow in on tax revenue and review the major challenges developing countries face in building stronger, more reliable bases of such revenue. I analyse how internal factors, such as willingness and ability, and external factors, including colonial powers and international organizations, affect taxation in developing countries. Building on this, I conduct an assessment of a new line of research on aid targeted specifically for taxation, or tax aid. Across a large sample of developing countries over the past few decades, tax aid has been shown to be effective in generating domestic tax revenue, but through a reliance on indirect taxation, such as the value-added tax (VAT) (Seelkopf & Bastiaens, 2020). Confounding factors such as regime type, international market integration, and the income level of the recipient moderate this relationship (Bastiaens & Rudra, 2016; Seelkopf & Bastiaens, 2020). I conclude by highlighting that despite the recent international attention on and increased assistance for domestic revenue generation, developing countries are still struggling to meet their revenue needs. Moving forward, policymakers are calling for international tax aid programmes to prioritize enforcement, transparency, reduce informality, and enhance engage323

324  Handbook on the politics of taxation ment between civil society, government, citizens, and donors (Fjeldstad, 2013; Prichard et al., 2012). Future academic work could employ innovative qualitative and quantitative methods to systematically uncover the heterogenous, nuanced effects of all varieties of tax aid and advice on revenue generation, taxpayer behaviour, policy and administrative reform, equality, and democracy.

2.

TAX AND NONTAX REVENUE IN DEVELOPING COUNTRIES

Developing countries rely on various sources of tax and nontax revenue to fund government activities and expenditures. Figure 21.1 presents the average of various sources of revenue as a percentage of GDP across developing countries since the 1970s.2 Bonds consistently remain the lowest source of revenue. In the 1970s and 1980s, developing countries relied on commercial bank loans for financing, but then with the extensive and widespread financial crises across the developing world in the 1990s, such loans became associated with capital flight, vulnerability, and economic distress (Balima et al., 2016). In the 1990s, therefore, these governments started to place more emphasis on the sovereign bond market as a source of long-term government financing. Figure 21.1 indicates this slight and continued increase in bond revenue since the 1990s. It is important to note, however, that developing and raising revenue through bond markets is not cost-free – it involves extensive market infrastructure, risks of default, and government stability and regulation (Balima et al., 2016). The three sources of revenue in the middle of Figure 21.1 are also nontax sources: foreign aid, remittances, and natural resource rents. An important distinction across these flows is that natural resource rents and foreign aid often accrue directly to the government (and can therefore directly substitute for other forms of revenue, like taxes), while remittances are received

Source: World Bank (2020).

Figure 21.1

Pattern of various sources of revenue across developing countries, 1970–2018

Revenue challenges in developing countries  325 by the people. For governments to access remittance monies, they must incentivize their citizens to participate in the formal economy and impose taxes (Bastiaens & Tirone, 2019). The amount of remittances sent globally has increased greatly over time, reaching over 600 billion dollars in 2015, with 441 billion dollars entering developing economies (World Bank, 2016). Unlike other revenues, remittances are typically counter-cyclical as migrants send more money in times of economic downturns and crises (Kapur, 2004). The flow of aid to developing countries has varied over time, often depending on the international development paradigm. For example, between 1945 and 1970 aid focused on Cold War geopolitics, but with the relaxation of such rivalries in the 1970s and 1980s, aid concentrated on supporting humanitarian projects such as international food crises. During the late 1980s and 1990s, donor fatigue was strong and a market-based approach to development was predominant. In the 2000s, beginning with the Millennium Development Goal commitments and later the SDGs, aid for development was revitalized and flows increased. Countries throughout the developing world vary in their dependence on and access to natural resource rents. Just as with aid, the price of oil has fluctuated greatly over time (for example spiking in the 1970s with the global oil crises, declining with reduced demand in the 1980s, surging after the Iraq War in 2003 and in 2008 with continued instability in the Middle East and increased Chinese demand, and declining in 2014). Tax revenue consistently remains, on average, the largest source of financing for governments, yet the type of tax collected has varied over time. In general, developing countries rely on taxes from both indirect (goods and service taxes and trade taxes) and direct (personal and corporate income taxes) sources, with less revenue from social security contributions and very limited revenue from property taxes (Keen & Simone, 2004). Yet, the ratio of these various tax revenues has shifted over time. Since the 1980s, developing countries have continued to increase their revenue from the VAT (Cottarelli, 2011). Also, since the 1980s, corporate income taxes and personal income tax revenue has remained flat and low, while trade tax revenue declined steadily with the advance of trade liberalization (Cottarelli, 2011). In 2017, on average, developing countries collected 33 per cent of their revenue from goods and service taxes and 22 per cent of their revenue from personal and corporate income taxes (World Bank, 2020). Trade taxes were less than 10 per cent of revenue in 2017, but over 22 per cent in 1990 (World Bank, 2020). The historical reliance on trade taxes was because they are relatively ‘easy to collect’ due to their collection at a centralized location and requirement of less complex administrative apparatus (Bastiaens & Rudra, 2018). Since adopting trade liberalization policies, developing countries must now implement tax reforms to collect ‘hard-to-collect’ taxes on their citizens (Bastiaens & Rudra, 2018). As discussed in the next sections, this domestic tax revenue collection requires extensive bureaucratic capacity, political will, and public confidence and can therefore be quite challenging to achieve.

3.

INTERNAL CHALLENGES TO RAISING TAX REVENUES IN DEVELOPING COUNTRIES

While taxes are a large source of revenue for developing country governments (Figure 21.1), tax levels remain quite low compared to the rich, industrialized world and are often inadequate to meet development priorities, as the introduction explained. I now analyse some of the major internal challenges to raising taxes in the developing world. In the mid-1900s, much of the

326  Handbook on the politics of taxation research and policymaking on taxation in developing countries focused on the experience of the rich, industrialized world. Essentially, explanations of developing world outcomes were explained through the past experience of the West. Linking the occurrence of war to increased taxation and tax administrative capacity is one such example (see Emmenegger & Walter, this volume; Besley & Persson, 2014). More recently, however, scholars and policymakers have begun to identify some of the unique and persistent challenges facing developing countries’ tax revenue collection. First, the structure of developing countries’ economies affects the level and composition of taxes. A strong and persistent link exists between tax revenue and GDP per capita: lower income and production in developing countries is associated with lower tax revenues (Tanzi, 1992; Besley & Persson, 2014). Additionally, the large informal sector is costly and difficult to tax (Besley & Persson, 2014). Variation in reliance on imports and agriculture also affects the taxes collected (Tanzi, 1992). Second, a weak state capacity in developing countries is often associated with low tax revenues (Besley & Persson, 2014). Tax administrations often lack needed information technology, skilled personnel, or interagency coordination (Keen & Simone, 2004). An effective, efficient, capable tax administration is especially vital after countries liberalize and can no longer rely on ‘easy-to-collect’ trade taxes (Bastiaens & Rudra, 2018; Besley & Persson, 2014). Third, in addition to a low capacity or ability to collect taxes, a low willingness to collect taxes is associated with low tax revenues in developing countries (Cottarelli, 2011). Political challenges as well as alternative sources of revenue (i.e., nontax sources) affect the incentives of governments to adopt tax reforms or enforce existing tax policies. Politics and political institutions influence the willingness of governments to collect taxes (see Andersson, this volume). Taxation requires governments to ‘strike a bargain’ with their constituents – the former levies taxes and the latter demands representation, public goods, and/or broader enforcement of the law in return (Levi, 1988; Bastiaens & Rudra, 2018; Ross, 2004; Timmons, 2010; Berens & Gelepithis, this volume). Levi’s (1988) seminal work on quasi-voluntary compliance explains that citizens will pay taxes when there is a fiscal bargain (i.e., they receive benefits in exchange for the cost of payment) and assurance of broad compliance across the populace (Guerra & Harrington, this volume). Following this, many scholars link democracy and taxation. Bird et al. (2008), for example, discuss how fostering political will for citizens to pay their taxes depends on the people having a voice and being confident that their monies will not be used to further corruption. They find an association between voice and accountability and increased tax collection (see also Besley & Persson, 2014; Kenny & Winer, 2006; Kemmerling & Truchlewski, this volume; von Haldenwang, this volume). Other scholars, such as Bastiaens and Rudra (2018), discuss the challenges developing country democracies (especially liberalizing ones) face collecting taxes. Developing country democracies struggle to build confidence among the masses, while authoritarian states can rely on coercion to enact and enforce tax reform (Bastiaens & Rudra, 2018; Cheibub, 1998). Additionally, recent work now examines tax policy around an election. Ehrhart (2013), for example, presents evidence from 56 developing countries between 1980 and 2006 that incumbent governments reduce indirect taxes before an election to gain votes. Such a cycle can be attributed to an undeveloped media, weak political institutions, and inexperience with competitive elections in developing countries (Brender & Drazen, 2005; Shi & Svensson, 2006). Much scholarship also focuses on the role nontax revenue can play in possibly perpetuating a ‘tax curse’ (Tijerina-Guajardo & Pagan, 2003; Ross, 2012; Moore et al., 2018). Essentially,

Revenue challenges in developing countries  327 inflows of nontax revenue like foreign aid or natural resource rents reduce the incentives of (recipient) governments to adopt tax reforms. The logic is that nontax revenue is substituting for or crowding out taxation. Scholars also point to an indirect, negative effect of nontax revenue on taxation: as nontax revenue weakens domestic institutions (by reducing accountability of leaders to their people and fostering dependency), tax collection is also weakened (leaders are less incentivized to respond to citizen demands, which in turn reduces taxpayer morale and compliance). Nontax revenue can be viewed as a less politically costly source of revenue than taxation because it does not require democratic bargaining (Mascagni, 2016).3 Classic research did find evidence of an aid curse: aid inflows were associated with lower domestic taxes (Benedek et al., 2012; Crivelli & Gupta, 2017; Prichard et al., 2012). Recent work, however, adds nuance to when and why an aid curse may occur (Mascagni, 2016; Alonso & Garcimartín, 2019). First, scholars using novel empirical methods and datasets tend to find either no relationship between aid and taxation (Carter, 2013; Morrissey et al., 2014; Morrissey & Torrance, 2015) or a modest, positive effect (Clist, 2016). Second, moderating factors such as government conditions (Yohou et al., 2015; Prichard et al., 2012), the wealth of individuals (Dolan, 2019), or income distribution (Alonso & Garcimartín, 2019) affect the aid–tax relationship. Third, aid can have an indirect positive impact on revenue (Morrissey, 2015). Aid may influence the macroeconomy, institutional capacity, the budget, and public good commitments, which in turn influence revenue generation and tax collection. Finally, the type of aid differentially impacts revenue generation (Gupta et al., 2003; Khan & Hoshino, 1992; Mascagni, 2016; Mascagni & Timmis, 2017). Aid for service provision, for example, ‘may similarly generate substantial long-term expenditure and revenue commitments for recipient governments’ and contribute positively to tax collection (Prichard et al., 2012, p. 14). Yet, aid conditionality terms, such as trade liberalization, could ‘undermine tax collection in low-income countries at least in the short-term by replacing “easy to collect” trade taxes with “hard to collect” taxes, such as the VAT or income taxes’ (Prichard et al., 2012, p. 14). Thus, overall, while the aid curse may not be as drastically problematic as classic scholarship posited, recent research does not provide robust evidence that aid is helping to increase taxes. Further, the type of aid and local context are critical for understanding if and when an aid curse is likely to occur. While research does show a substitution effect between oil rents and taxation (Tijerina-Guajardo & Pagan, 2003), much of the resource curse literature focuses on how such rents may (or may not) foster authoritarianism, repression, distorted development, and currency appreciation (Ross, 2012; Morrison, 2009; Dunning, 2008).4 Similarly, the remittance scholarship focuses on how remittances change the fiscal contract between the government and its people, resulting in some of the various scenarios: (1) less citizen demand for public goods (Doyle, 2015) and therefore the empowerment of autocratic regimes with more fiscal space (Ahmed, 2012); (2) more citizen demand for democracy because of the empowerment from remittance monies (Tyburski, 2012); or (3) less citizen responsiveness to patronage spending thereby reducing the source of power for institutionalized autocrats (Escribà-Folch et al., 2015). Finally, a sovereign bond market could hypothetically increase or decrease the incentives to raise taxes. On one hand, just as with aid and oil, bonds could be considered a substitute for tax revenue. Yet, Balima et al. (2016) find that bonds are associated with increased tax collection. Financing from bonds allows governments to invest in compliance and capacity thereby increasing the confidence and morale of their taxpayers. Taxes are also a strong indicator of

328  Handbook on the politics of taxation a government’s credibility to pay back its long-run obligations on a bond and so governments have a strong incentive to complement a sovereign bond market with tax collection (Balima et al., 2016).

4.

ADDITIONAL DETERMINANTS OF TAXATION IN DEVELOPING COUNTRIES: A FOCUS ON EXTERNAL FACTORS

Historically, in some developing countries, taxes and tax systems were introduced or shaped by colonial powers (Stewart, 2003). First, colonialism influenced short- and long-run institutions, development models, informality, and inequality in developing countries (Feger & Asafu-Adjaye, 2014). Colonial powers also directly imposed or implemented tax regimes. For example, the Shoup Mission, requested by General Douglas MacArthur and involving a team of economists from the United States, helped to create a ‘modern’ tax system in Japan after the Second World War (Johnson, 2000). During the Shoup Mission and other such international efforts at this time, the emphasis was on personal and corporate income taxes (Sundelson, 1950; Bronfenbrenner & Kogiku, 1957). Extrapolating from the experiences of the industrialized countries, specific policy recommendations included adopting a broad-based, progressive income tax with a simplified rate structure and limited exemptions (Kaldor, 1963). The goal was to boost revenue and minimize evasion and avoidance (Sundelson, 1950; Kaldor, 1963). For example, Kaldor, writes that ‘The shortfall in revenue is thus largely a reflection of failure to tax the wealthier sectors of the community effectively’ (1963, p. 412). At this time, economists did not emphasize capacity building as the perception was that ‘even the poorest country had sufficient “capacity” in both economic and administrative terms to tax more’ (Bird et al., 2008, p. 56). In more recent history, many multilateral forums and institutions – such as the International Monetary Fund (IMF), World Bank, United Nations, G20, European Commission, Organisation for Economic Co-operation and Development, and regional development banks – have promised to provide assistance or raise awareness of the need for revenue generation across the developing world (Fjeldstad, 2013; Michielse & Thuronyi, 2010; Cottarelli, 2011; Stewart, 2003; Eccleston and Johnson, this volume).5 In fact, over time, the scope of the reform agenda and number of donors of aid for taxation efforts have expanded (Prichard et al., 2012). First-generation tax aid reforms in the late 1980s and 1990s promoted by international financial institutions, primarily the IMF and World Bank, included lowering trade taxes (i.e., abolishing export taxes and reducing import tariffs) and balancing the budget (Fjeldstad, 2013). Such reforms were influenced by the Washington Consensus development model in vogue at the time. By the early to mid-1990s, the international community realized that revenue concerns were not being effectively addressed (Rajaram, 1992; Fjeldstad, 2013). Second-generation reforms therefore prioritized reforming and raising domestic taxes. Replacing lost trade tax revenue (from liberalization) was emphasized. However, unlike in the past, the emphasis was on raising such revenue through the VAT, not personal income taxes. Income taxes were now viewed as less effective in raising revenue in developing countries (Keen & Simone, 2004). Bird and Zolt (2005), for example, discuss the high administrative capacity and costs required to implement a progressive income tax system. Further, corporate income taxes are susceptible to business group and global competitive pressures (Keen & Simone, 2004; Castañeda,

Revenue challenges in developing countries  329 this volume). The mobility of capital and its ability to shift profits across jurisdictions further complicate the ability of developing countries to tax corporations (Lierse, this volume; Moore et al., 2018). Today, the IMF and World Bank are still the major donors of tax assistance (Seelkopf & Bastiaens, 2020), but many other multilateral and bilateral organizations are also engaging in such policy work and aid. All these donors typically advise: (1) designing and simplifying the tax code; (2) implementing VAT; and (3) strengthening tax administration and enforcement systems (Arnold, 2012; Bastiaens & Rudra, 2016; Bogetic & Hassan, 1993; Cottarelli, 2011; International Monetary Fund, 2011; Stotsky, 1995). The first agenda – designing and simplifying the tax code – involves increasing payment thresholds to focus on wealthier taxpayers (Seelkopf & Bastiaens, 2020), considered a cost-effective way to generate revenue. Simplifying the tax structures often involves implementing a dual income, progressive tax system, and a flat, low corporate tax that is competitive internationally (Fjeldstad, 2013; Cottarelli, 2011). Such a simple, coherent tax code is intended to reduce noncompliance (Cottarelli, 2011). Other advice includes enhancing transparency, reducing tariffs, eliminating export taxes, removing minor taxes and fees (that are costly to administer), and reducing exemptions (Prichard et al., 2012; Bastiaens & Rudra, 2016; Cottarelli, 2011). The second item – implementing VAT on a broad base – is considered a cost-effective, efficient taxation method (Barbone et al., 1999; Seelkopf & Bastiaens, 2020; Damme et al., 2008; Keen & Lockwood, 2010). Income tax receipts have remained low due to noncompliance, evasion, and difficulty in implementing and enforcement and, so, indirect taxation is seen as a more effective means of raising funds (Cottarelli, 2011; Seelkopf & Bastiaens, 2020). International donors, such as the IMF, prioritize the VAT because it generates ‘significant amounts of revenue in a way that does less damage to economic activity than alternatives, supports equity objectives, and is relatively simple to administer and comply with’ (Cottarelli, 2011, p. 24). Some critiques of the VAT include vulnerability to fraud and difficulty administering it with small businesses (Keen & Simone, 2004). Finally, the goal of strengthening the tax administration often requires extensive technical support (Damme et al., 2008; Prichard et al., 2012). Computerization, information technology resources, and training platforms for staff are intended to increase efficiency and automation as well as technological capacities (Bastiaens & Rudra, 2016; Barbone et al., 1999; Cottarelli, 2011). For example, Fjeldstad (2013) describes common administrative reforms to include new technologies, unique taxpayer identification numbers, ‘user-friendly’ collection processes, audits, and the creation of revenue authorities. Policy, administration, and state– society engagement are three common pillars of the assistance (Fjeldstad, 2013). Compliance and accountability goals are increasingly included (Fjeldstad, 2013; Prichard et al., 2012). Taxpayer education and services are therefore another component of these administrative reforms (Barbone et al., 1999). Cottarelli (2011) explains that revenue administrations are critical to expanding the tax base, increasing compliance, and reducing corruption. Since the 2000s, the United Nations has played a significant role in spearheading international efforts to support developing countries in raising revenue, especially for development goals. One of the first such efforts occurred in Monterrey, Mexico in 2002 at the International Conference on Financing for Development. This United Nations-sponsored conference included government leaders and ministers, civil society, the business community, and cooperation from the World Bank, IMF, and World Trade Organization. It had the goal of addressing the ‘dramatic shortfalls in resources’ required to achieve the Millennium Development Goals

330  Handbook on the politics of taxation (United Nations, 2002, p. 2; International Monetary Fund, 2002). Major consequences of this conference included creating international awareness and multifaceted policies to address revenue and development concerns. In 2015, the Addis Ababa Action Agenda’s Addis Tax Initiative was signed in Ethiopia as another political commitment by the global community to further such efforts. Relatedly, the United Nations General Assembly put forth the following resolution in 2015: We recognize that significant additional domestic public resources, supplemented by international assistance as appropriate, will be critical to realizing sustainable development and achieving the sustainable development goals. We commit to enhancing revenue administration through modernized, progressive tax systems, improved tax policy and more efficient tax collection. We will work to improve the fairness, transparency, efficiency and effectiveness of our tax systems, including by broadening the tax base and continuing efforts to integrate the informal sector into the formal economy in line with country circumstances. In this regard, we will strengthen international cooperation to support efforts to build capacity in developing countries, including through enhanced official development assistance. (United Nations General Assembly, 2015, p. 8/37)

Similar to Monterrey, this resolution focuses on supporting domestic resource mobilization to finance the SDGs (Coplin, 2018; Lundstøl, 2018; World Bank, 2013). Unfortunately, however, the Addis Tax Initiative is not on track to meet its increased aid goals: ‘ATI donors have self-reported an increase of 61 percent, but two large loans from France drive most of this change … at the same time, aid for fiscal transparency decreased by more than this’ (Drummond & Their, 2018). Further, the Addis Tax Initiative aid efforts to date have been concentrated among the donors of the United Kingdom, United States, and Germany and the recipients of Afghanistan, Tanzania, and Mozambique (Lundstøl, 2018). Ultimately, the focus of such recent tax aid efforts is generating revenue, not just replacing lost revenue. Further, these initiatives place revenue generation within the development context – raising revenue is imperative for developing countries to achieve their critical poverty reduction goals. Many scholars, however, criticize the international community’s policy and discourse on tax reform. Stewart, for example, discusses how current tax reform discourse has continually ‘side-lined the problems of inequality, poverty, and redistribution’ (2003, p. 143) and relies on an ‘explicit vision of the developed, market-oriented state’ (2003, p. 167) with a neglect of the unique experience of developing countries (Keen, 2012; Moore et al., 2018; Limberg, this volume). Tax policy undoubtedly involves normative decisions and consequences for the public more broadly as well as various classes and genders (Philipps, 1996; Seelkopf, Chapter 13, this volume). Yet the current international discourse focuses on the technical aspects of taxation, neglecting such normative and power dynamics (Christians, 2009; Moore et al., 2018).

5.

A FOCUS ON TAX AID: IS IT EFFECTIVE?

Building on this aforementioned research, a nascent line of scholarship has started to focus on examining the impact of tax aid. Scholars in this field, such as Bastiaens and Rudra (2016) and Seelkopf and Bastiaens (2020), define tax aid as foreign assistance targeted to enhance the revenue-raising capacity of the recipient. Empirically, they operationalize tax aid as aid with a ‘tax assessment procedures’ activity code in Tierney et al. (2011). Fiscal aid is an alternative measure which has the following activity codes in Tierney et al.’s (2011) dataset:

Revenue challenges in developing countries  331

Source: Data from Tierney et al. (2011).

Figure 21.2

Tax and fiscal aid trends

‘Macro-economic, fiscal and monetary policy and planning’, ‘Institutional capacity building, Government’, ‘Public sector financial management’, ‘Improving financial management systems’, ‘Tax assessment procedures’, ‘Measures against waste, fraud and corruption’, and ‘Tariff reforms’.6 Using these data, Figure 21.2 details averages of tax and fiscal aid as a percentage of total aid and GDP per capita and in United States dollars over time. Fiscal aid is more prevalent than tax aid – primarily because it encompasses a wider variety of priorities and activities.7 While tax and fiscal aid have increased since the 1980s, they remain only a small part of total aid given (Prichard et al., 2012; Seelkopf & Bastiaens, 2020). How does tax aid impact revenue generation? Could it be different from general aid and the aforementioned aid curse? On one hand, Prichard et al. (2012) focus on the conditionality of aid and how the ‘crude’ conditions are likely to be ineffective in spurring effective tax reform or collection. For example, ‘They have often reflected changes in formal policy and administrative rules, but significantly less meaningful reform of actual practices and outcomes’ (Prichard et al., 2012, p. 7). The limited increase in tax revenue broadly across the developing world supports this argument. On the other hand, Seelkopf and Bastiaens (2020) present an argument that tax aid is unique from general aid. They explain that at the micro level, given the newness of tax aid, the associated monitoring and technology enhance its capability and effectiveness. Additionally, at the macro level, the multilateral nature of tax aid (as opposed to the bilateral nature of ‘general’ aid) ensures greater harmonization. Therefore, they expect tax aid to be more effective than general aid in raising revenue in the recipient.

332  Handbook on the politics of taxation

Source: Data from Seelkopf and Bastiaens (2020).

Figure 21.3

Average tax revenues among tax aid recipients

Seelkopf and Bastiaens’s (2020) statistical regressions indicate that tax aid is effective in generating domestic tax revenue, but it shifts the structure away from direct taxation towards a stronger reliance on indirect taxes. Figure 21.3 uses the data from Seelkopf and Bastiaens (2020) to present the average tax revenue of tax aid recipients between 1990 and 2010. Overall, goods and service tax revenue increases and tariff revenue decreases. Income tax revenue remains quite stagnant over the time period, with a slight dip in the early 2000s and an increase at the end of the time period. Bastiaens and Rudra (2016) highlight two confounding factors to consider in the tax aid– revenue relationship: regime type and globalization. Their analysis indicates that domestic politics intervene in the tax reform process, especially for liberalizing countries. As developing countries reduce trade taxes and enter into the global economy, nondemocracies are better able to implement domestic tax reform (Bastiaens & Rudra, 2018). Liberalizing democracies – even upon receiving international assistance – are less effective at replacing lost trade tax revenue. The political pressure to appease wealthy voters makes democratic leaders less likely to tax them.8 Bastiaens and Rudra’s (2016) empirics confirm this argument and show that autocracies receiving tax aid are more effective in raising domestic tax revenue, in particular, income taxes. Another confounding factor in the tax aid–revenue relationship is the income level of the recipient (Bastiaens & Seelkopf, 2020; Seelkopf & Bastiaens, 2020). Seelkopf and Bastiaens (2020) provide evidence that middle-income countries – upon receiving tax aid – are effective in increasing the VAT, while poor countries see no increased revenues after receiving tax aid. Brazil, Russia, India, and China also see increased income tax revenues after receiving tax aid (Bastiaens & Seelkopf, 2020). Ultimately, the varied impact and effectiveness of tax aid

Revenue challenges in developing countries  333 across the developing world further substantiates the previous scholarship that points to the moderating effect of institutions on the aid curse (Yohou et al., 2015). Questions, however, remain. Specifically, is tax aid ineffective in improving tax administrative capacity? Or are recipients failing to implement policy reforms? Stewart (2003) and others critique global tax assistance efforts for their failure to effectively reform taxes in developing countries in a sustainable, participatory manner (Schaffer, this volume). For example, the one-size-fits-all approach of many multilateral organizations inhibits the ability of countries to meet their tax and development objectives (Marshall, 2009; Keen, 2012; Damme et al., 2008). In essence, unlike Seelkopf and Bastiaens (2020), these scholars highlight how the broad consensus across tax aid donors could be adversely affecting revenue generation and poverty goals in developing countries.

6.

CONTINUED CHALLENGES AND STEPS FORWARD

Despite the findings that tax aid programmes are broadly reaching their goals of raising indirect tax revenue, this success is not universal or complete. Both the donors and recipients of tax aid face continued challenges. Prichard et al. (2012), for example, explain that despite reforms in tax codes and administrations, revenues have not increased substantially in recent decades (Bastiaens & Rudra, 2018). Moving forward, scholars and policymakers are calling for more engagement between government and citizens on tax issues (Fjeldstad, 2013). Such engagement is considered critical to ensure aid is specialized and context-specific to each recipient. Information sharing can also promote greater transparency and compliance (Prichard et al., 2014). Some other challenges facing global efforts to helping developing countries raise revenue are donor coordination and funding (Cottarelli, 2011; Michielse & Thuronyi, 2010). For example, while the Addis Ababa Action Agenda provides a platform for such donor discussions, the funding goals are yet to be met. In the end, the persistence of these challenges has major implications for the revenue raised and the corresponding level of democracy and development across the developing world (Eubank, 2012; Mascagni, 2016). Moving forward, there are several key areas for future research. Rigorous, nuanced testing of the effect of tax aid on the goals of this assistance – broadening of the taxpayer base, enhancing tax administrative capacity, tax rate reform – is needed. Measures that directly and clearly capture these goals is currently underdeveloped in the existing literature. Innovative uses of data and modelling are also apt for studying the impacts of tax aid. Future work could explore the effect of tax aid before and after an exogenous, system-wide shock. For example, with a financial crisis and severe economic downturn in a major trading partner (i.e., a major loss in trade tax revenue), how do countries with and without tax aid compare in weathering this shock? In addition to such quantitative examinations, more case studies on the composition of tax aid and its impacts would be quite illuminating. Such qualitative work is imperative to better understand the nuances of tax aid and the potential aid curse. Mascagni (2016), for example, discusses how case studies would be valuable to better understand the heterogeneous effects of aid across countries. To date, case studies are infrequently employed in aid taxation research.

334  Handbook on the politics of taxation

NOTES 1. I operationalize developing countries as countries who are not Organisation on Economic Co-operation and Development members. Employing an alternative definition, such as one based on income, would not change the core findings of this chapter. Also note that the focus is national government revenue. See United Nations (2015b) for information on the scope and challenges of local financing as well as the chapter by Garmendia Madariaga in this volume on fiscal decentralization. 2. Figure 21.1 presents some of the major sources of revenue but is not meant to be wholly comprehensive. Revenue from state-owned enterprises, for example, is omitted. 3. The conventional logic is that governments provide services, which then increase their legitimacy, and then increase compliance to government policies, such as paying taxes. Aid decreases this legitimacy by disrupting this fiscal contract. Dolan (2019), however, presents micro-level evidence that citizens believe government should receive and distribute aid and so aid is neither a signal of a government deficit nor associated with perceptions of ‘less right to tax’. 4. Moore et al. (2018) discuss how Africa undertaxes its mineral sector. 5. International tax treaties are another external factor affecting taxation in developing countries (Stewart, 2003). 6. As a cautionary note, it is important to recognize that these data could be criticized for being either too narrow (e.g., tax aid) or too broad (e.g., fiscal aid). They also capture assistance for tax administrative reforms but do not directly address policy advice and assistance. Other data sources for tax aid include World Bank project data and Organisation for Economic Co-operation and Development statistics. 7. The large increase in assistance in 2010 is driven by a two-year increase in 2009 and 2010. Levels dropped in 2011–2013 closer to averages in the 2005 period. 8. Brender and Drazen (2005) also point to large political deficit cycles in ‘new democracies’ whereby leaders use pre-election spending to manipulate voters.

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Revenue challenges in developing countries  335 Bird, R. M., Martinez-Vazquez, J., & Torgler, B. (2008). Tax effort in developing countries and high income countries: The impact of corruption, voice and accountability. Economic Analysis and Policy, 38(1), 55–71. Bird, R. M., & Zolt, E. M. (2005). The limited role of personal income tax in developing countries. Journal of Asian Economics, 16, 928–946. Bogetic, Z., & Hassan, F. (1993). Determinants of value-added tax revenue. World Bank Working Paper, No. 1203. Brender, A., & Drazen, A. (2005). Political budget cycles in new versus established democracies. Journal of Monetary Economics, 52, 1271–1295. Bronfenbrenner, M., & Kogiku, K. (1957). The aftermath of the Shoup tax reforms. National Tax Journal, 10(3), 236–254. Carter, P. (2013). Does foreign aid displace domestic taxation? Journal of Globalization and Development, 4(1), 1–47. Cheibub, J. A. (1998). Political regimes and the extractive capacity of governments: Taxation in democracies and dictatorships. World Politics, 50(3), 349–376. Christians, A. (2009). Global trends and constraints on tax policy in the least developed countries. University of British Columbia Law Review, 40, 239. Clist, P. (2016). Foreign aid and domestic taxation: Multiple sources, one conclusion. Development Policy Review, 34(3), 365–383. Coplin, N. (2018). Oxfam has joined the Addis Tax Initiative: Here’s why. Oxfam, 29 May. https://​ politicsofpoverty​.oxfamamerica​.org/​2018/​05/​oxfam​-has​-joined​-the​-addis​-tax​-initiative​-heres​-why/​ (accessed 24 May 2021). Cottarelli, C. (2011). Revenue mobilization in developing countries. IMF Fiscal Affairs Department. www​.imf​.org/​external/​np/​pp/​eng/​2011/​030811​.pdf (accessed 24 May 2021). Crivelli, E., & Gupta, S. (2017). Does conditionality mitigate the potential negative effect of aid on revenue? Journal of Development Studies, 53(7), 1057–1074. Damme, L., Misrahi, T., & Orel, S. (2008). Taxation policy in developing countries: What is the IMF’s involvement? Bretton Woods Project, DV406 Consultancy Project. Dolan, L. R. (2019). Rethinking foreign aid and legitimacy: Views from aid recipients in Kenya. Studies in Comparative International Development, 55, 143–159. Doyle, D. (2015). Remittances and social spending. American Political Science Review, 109(4), 785–802. Drummond, J., & Their, A. (2018). Opinion: 3 years since the launch of Addis Tax Initiative, what’s been achieved? Devex, 20 August. www​.devex​.com/​news/​opinion​-3​-years​-since​-the​-launch​-of​-addis​-tax​ -initiative​-what​-s​-been​-achieved​-93302 (accessed 24 May 2021). Dunning, T. (2008). Crude Democracy: Natural Resource Wealth and Political Regimes. Cambridge University Press. Ehrhart, H. (2013). Elections and the structure of taxation in developing countries. Public Choice, 156, 195–211. Escribà-Folch, A., Meseguer, C., & Wright, J. (2015). Remittances and democratization. International Studies Quarterly, 59, 571–586. Eubank, N. (2012). Taxation, political accountability and foreign aid: Lessons from Somaliland. Journal of Development Studies, 48(4), 465–480. Feger, T., & Asafu-Adjaye, J. (2014). Tax effort performance in Sub-Sahara Africa and the role of colonialism. Economic Modelling, 38, 163–174. Fjeldstad, O. (2013). Taxation and development: A review of donor support to strengthen tax systems in developing countries. WIDER Working Paper, No. 2013/010. Gupta, S., Clements, B., Pivovarsky, A., & Tiongson, E. R. (2003). Foreign aid and revenue response: Does the composition of aid matter? IMF Working Paper, WP/03/176. International Monetary Fund (2002). Financing for development: Implementing the Monterrey consensus. www​.imf​.org/​external/​np/​pdr/​FfD/​2002/​imp​.htm (accessed 24 May 2021). International Monetary Fund (2011). Tax policy and administration. www​.imf​.org/​external/​np/​otm/​ 2010/​100110​.pdf (accessed 24 May 2021). Johnson, D. C. (2000). Carl S. Shoup, 97 shaped Japan’s tax code. New York Times, 31 March. www​ .nytimes​.com/​2000/​03/​31/​business/​carl​-s​-shoup​-97​-shaped​-japan​-s​-tax​-code​.html (accessed 24 May 2021).

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22. The politics of taxing the digital economy Rasmus Corlin Christensen and Wouter Lips

1. INTRODUCTION The age of ‘digital capitalism’ offers a fundamental challenge to tax systems around the world. In this chapter, we discuss the ongoing political struggles to tax (or not tax) multinational companies operating in the digital economy. These struggles, we argue, result from wide-scale transformations of modern economies and geopolitical shifts, which are breaking apart historical alliances and reconfiguring the political interests of countries across the globe. Specifically, we survey the changing economic and political interests and battle lines at play in transatlantic relations, where the coalition between Europe and the United States (US) has splintered. And we discuss the increasing influence of developing and emerging economies, whose interests are fragmenting and where resistance to existing global tax standards persists. This raises new questions about relative power capacities of large and small states to shape international taxation, as well as the extent of change that digitalization is affecting on the core dynamics of international tax politics. At its core, digitalization has enabled new business models that challenge tax rules and norms based on ‘brick and mortar’ commerce. Digital businesses are more mobile, rely on user participation, extract user data and exploit network effects, and many digital markets are strongly concentrated amongst a small number of large firms. One particularly significant political issue that has emerged in recent years is the taxation of those large digital firms. The prominence of big tech firms like Facebook, Apple and Google across contemporary societies has fostered a broad reconsideration of regulation affecting the sector, ranging from privacy to security, competition, innovation and taxation. In the tax domain, the scope and scale of digital transformations arguably offers the most significant test in recent decades to both the traditional political settlement underlying the international tax system as well as the political science theories underlying our understanding of these settlements. This chapter is structured as follows. First, we outline the historical background and the economic transformations underpinning the emergence of the digital economy. Next, we analyse the empirics of taxing the digital economy, focusing on the high-profile government struggles over the tax payments of large digital companies led by the Organisation for Economic Co-operation and Development (OECD) and the G20, the powerful forum of global political leaders. (In this chapter, we focus on intergovernmental politics. For a discussion of expertise and bureaucratic politics, see Eccleston & Johnson, this volume.) In the conclusion, we reflect on these questions and set out consequent questions for further research.

338

The politics of taxing the digital economy  339

2.

HOW DIGITALIZATION CHALLENGES ESTABLISHED TAX PRINCIPLES

The scale and consequences of the ongoing digitalization of national and global economies are immense. Technological change is of course a permanent feature of history, changing practices, shifting battlegrounds and reconfiguring the winners and losers from economics and politics (Drezner, 2019; Rosenau & Singh, 2002). The information communications technology revolution that has marked the technological transformation of our time since roughly the 1990s is characterized as driven by disruptive technologies and intangible assets, leading to a new form of ‘capitalism without capital’ (Haskel & Westlake, 2017). This ‘digitalization of the economy’ is an umbrella term for a wide range of new revenue models made possible by computer-driven network technology, and ever increasing processing power that allows for faster exploitation of large volumes of data. The most common of these are: (1) advertisement-based revenue models (such as Facebook or Google); (2) subscription-based services (for example Netflix); (3) providing an online marketplace linking customers and sellers (these can be business to business (Indiamart), business to consumer (Zalando) or even peer to peer (Airbnb)); and (4) electronic goods or service sellers (for example iTunes or Mechanical Turk) (Hadzhieva, 2016; OECD, 2015). We can observe some key features that distinguish these revenue models from the traditional economy. First among these is mobility. Mobility of (a) assets, in the form of easily movable intangibles such as software or intellectual property; (b) users who can interact with a company regardless of location; and (c) business functions, which can be managed from virtually anywhere through telecommunication (OECD, 2015, pp. 65–67). This mobility allows firms in the digitalized economy to exploit ‘scale without mass’, performing activities and accessing customers across the globe without a corresponding physical presence (OECD, 2018c). A second feature is the heavy reliance on user participation and exploitation of (personalized) data for value creation, so much that data is sometimes dubbed ‘the new oil’, as it can be seen as an extractive (OECD, 2015, pp. 68–70; The Economist, 2017) that companies ‘mine’ from a population in a given country. Collected data can, for example, be used to optimize services and supply chain processes or to sell targeted advertisements. One tax-related debate is whether mined user data provide additional value to a company’s operations and as such should lead to a taxable presence. Third is the importance of network effects and linked with that the use of multi-sided business models. A digital business gains a competitive advantage if it can grow a larger network, which refers both to a larger user base (more users on a marketplace, for example, lead to more customer reviews) and to connected services (for example, a banking app letting you buy train tickets directly from your account). Multi-sided business models logically follow from these network effects. A company selling music subscriptions might also sell, at the same time, advertisements and sign music artists. This is not merely the same as a company having different products or large portfolios, since all these sides of the business interact with each other (OECD, 2015). A subscription service with more exclusive artists is more attractive to users, and a service with more users is worth more to prospective artists. A fourth feature of the digital economy that follows from the importance of data and competitive advantage of network effects is a tendency towards monopolistic or oligopolistic firm behaviour (OECD, 2015, pp. 70–73). This leads to strategies of venture capital injections to

340  Handbook on the politics of taxation offset losses, and aggressively acquiring start-up companies before they can become rivals (‘buy and kill’) (Waters, 2020). Many of today’s well-known digital giants, such as Amazon or Twitter, have been operating at a net loss for many years while trying to achieve a dominant market position, before leveraging that position to make a profit. These features of digitalization are uprooting conventional understandings of the economy but also, importantly, long-standing principles in international taxation. Cross-border e-commerce challenges the local collection of value-added tax (VAT) and consumption taxes, with customers, intermediary platforms and sellers in different jurisdictions. This prompted the OECD to offer specific guidance for VAT collection for e-platforms (OECD, 2020) and the European Union (EU) Council to harmonize VAT rules under the digital single market package (EU Council, 2020; see also Römgens & Roland, this volume). Digitalization is also leading tax administrations to adopt certain features of digital economy companies. Some tax administrations for example are testing big data collection and machine learning to help them combat tax fraud (Pinto et al., 2018). These examples contribute to unsettling tax politics across the board. But a particularly unique and important expression in international taxation – where the intersection of digitalization and other macro trends has created a situation of rapidly escalating issue salience and unprecedented political unrest (Christensen & Hearson, 2019a) – is corporate taxation in the digital economy. This will be the main focus of the chapter. Most centrally, the economics of digital business models has rendered the national and international rules designed for taxation of corporate income outdated. The ‘rootlessness’ of digital businesses, reliance on intangible assets and centrality of user involvement is fundamentally at odds with international tax rules designed in the early twentieth century for brick-and-mortar commerce, anchored in the physical presence of factories and employees. This has given digital companies opportunities for base erosion and profit-shifting practices (OECD, 2015, p. 1) – or sometimes outright tax avoidance – that follow specifically from their business models, leading to unfair competitive advantages over domestic companies. Also, the immense market power of some digital tech companies, some of whom have yearly revenues larger than the gross domestic product of a small European country (Belinchon & Ruqayyah, n.d.), has left states puzzled as to how they can still exercise their tax prerogative. Hager and Baines (2020) confirm that rising corporate concentration in the US has indeed led to lower worldwide effective tax rates for large corporations. Expert policy-makers in turn have sought to tweak the old rules to align them with modern business realities under the preferred idiom of bringing taxation in line with ‘value creation’, a contested term hiding away the underlying, contentious politics (Christians & van Apeldoorn, 2019; Muniesa, 2017). So far, policy-makers have fallen short of brokering a new consensus, leading to further concern and conflict (Büttner & Thiemann, 2017; Christensen & Hearson, 2019b; Christensen, 2020). As economic realities are shifting, political interests are moving. For almost a century, the politics of international taxation had a stable basis, characterized by clear interest coalitions and an ‘expert consensus’ mode of policy-making (Genschel & Rixen, 2015; Rixen, 2008). In the current era, however, technological changes are destabilizing historical alliances. ‘Scale without mass’ allows digital firms market access without corresponding capital exports or the need for a permanent establishment, leading to a taxable presence in a given market. This diminishes the importance of the traditional distinction between capital-exporting and importing countries. Instead, market size – a key gauge of user participation in digital business

The politics of taxing the digital economy  341 models – is becoming a core factor. Referring to market presence for taxing purposes is seen as a way to undercut digital firms’ market exit options, but at the same time also as a way of redistributing taxing rights, with population-heavy countries such as China and India being especially vocal about reforming the distribution of taxable profits. At the same time, superstar digital firms like the US’s Google, Apple, Facebook and Amazon and others have become associated with large-scale tax avoidance as exposures in popular media have attracted significant attention, drawing the ire of European policy-makers (Lips, 2019b).

3.

NEW INTEREST CONSTELLATIONS IN THE STRUGGLE TO TAX BIG TECH

Importantly, these changes are not happening in a global economic and political vacuum. International tax politics is firmly embedded within the broader structures of global economic governance (Christensen & Hearson, 2019a). In recent years, states have become more interventionist, willing to act unilaterally to appease voters, often in direct contradiction to the interests of historical allies and the international policy-making community. In the digital corporate taxation context, France has been notably aggressive in pursuing special taxes on digital giant firms in the face of OECD and US opposition (Lips, 2019b; Rappeport et al., 2018). The geopolitical balance is also shifting, as emerging economies like India, China and Brazil become increasingly powerful and vocal, working to align with established global standards while asserting their own policy interests (Hearson & Prichard, 2018; Lesage et al., 2019). And the broader context of public interest has shifted as well, with exploding media attention and expanding engagement of diverse interest groups in the politics of global economic and tax governance (Dallyn, 2016; Dover, 2016). 3.1

International Regulatory Initiatives on Corporate Taxation

Together, these dynamics have culminated in a historic challenge to national and international tax systems. The most high-profile example is the contemporary government struggles over the tax payments of large digital companies, led by the OECD and the G20. Those discussions are not entirely new, however. Already in the 1990s, OECD countries were discussing the impact of digitalization on international tax standards, with a focus on e-commerce, an increasingly significant political theme in the context of the 1990s IT boom. OECD countries in 1998 set out the ‘Ottawa Taxation Framework Conditions’ (OECD, 1998), which listed a number of broad principles for taxation applying to electronic commerce: neutrality, efficiency, certainty and simplicity, effectiveness and fairness and flexibility. The following years focused on bringing these principles into practice, yet as Cockfield’s (2006) survey almost a decade later showed, countries showed minimal appetite for implementing new initiatives on taxing e-commerce in national legislation, revealing the weakness of the Ottawa outcomes. The digital tax agenda was only truly revived in 2013 with the OECD/G20 ‘Base Erosion and Profit Shifting’ (BEPS) project. A comprehensive project, its first action item (at the insistence of the French government) was to ‘address the tax challenges of the digital economy’ (OECD, 2013). Its position as the first item symbolized the importance of the issue. Yet after two years of negotiations – flanked by significant progress in other areas of the BEPS project – the action item had failed to deliver strong actionable initiatives. Notably, the US was adamantly

342  Handbook on the politics of taxation opposed to ring-fencing and specific targeting of digital companies for tax purposes (Lips, 2019a, p. 114). Following this lack of global political action, a number of countries opted to launch unilateral initiatives to increase the taxation of digital firms, including France, India, Italy, Spain and the United Kingdom (UK). On French insistence, the European Commission also launched an EU-wide ‘digital services tax’ (DST) directive proposal specifically targeted at large digital firms (European Commission, 2017; see also Römgens & Roland, this volume) (henceforth ‘the EU’s proposal(s)’). These initiatives had profound consequences for the global political landscape. The raft of unilateral measures contributed to the alignment of European states’ approaches to taxing large digital firms and increased the threat of uncoordinated action, opening a window for reform within the global policy-making community (Lips, 2019b; Robert, 2019). Perhaps more famously, unilateral action on taxing the digital economy also prompted a geopolitical spat between US President Trump and French President Macron, the latter being accused of anti-US bias following France’s introduction of a special tax on large digital firms (Rappeport et al., 2018). At the behest of the G20, then, the OECD relaunched its policy work in a more comprehensive reform programme. On an ambitious timetable, the new two-pillared project set out to achieve a global consensus by 2020 on a redistribution of taxing rights to account for digital business models, and a new global minimum tax system to ensure digital businesses – and other large multinationals – are effectively taxed at a minimum rate (OECD, 2018c, 2019). The discussions at the G20 and the OECD (ongoing at the time of writing) lay bare the new political landscape for taxing the digital economy. Across a plethora of technical policy proposals under debate, two main lines of contention have appeared in global discussions: more effective market-based taxation and addressing the structural power of large tech firms. The first debate attempts to uproot the traditional conceptual centre of the international tax system, namely the balance between taxing rights allocated to source and residence countries (see Hearson & Rixen, this volume). Emphasizing the value added in global production chains by ‘market jurisdictions’, i.e. countries with large consumption, user or employee bases, these countries seek a relatively larger slice of the corporate tax cake. The second debate aims at negating the tax consequences of the ‘scale without mass’ ability of digital businesses, allowing them to generate significant economic activity and revenue from a country without any physical presence there, thus avoiding local corporate income tax liabilities. Emphasizing the local contributions of consumers, users and employees in a new global tax consensus would give countries a legal grip on such ‘rootless’ digital business models, effectively strengthening and ‘transnationalizing’ their authorities (Crasnic et al., 2017). These two lines of contention reflect, in particular, the contested geopolitical weight of emerging market jurisdictions such as China and India, who had no part in negotiating the original source-residence settlement, in contrast to entrenched powers like the US (home of many of the largest global digital tech firms), as well as broad social discontent with the power of big tech in Europe and beyond. 3.2

Transatlantic Interests and Battleground: A Historic Bloc Divided

The taxation of the digital economy conundrum cross-cuts many geopolitical and economic developments, but the most visible and divisive one has been the transatlantic row between the US and the EU, or more correctly the larger EU states with France in the lead. Figure 22.1 shows an analysis of the countries most associated with the March 2019 OECD public con-

The politics of taxing the digital economy  343

Figure 22.1

Geography of digital tax consultation topics, March 2019

sultation letters, which tells us that despite the supposed global nature of the digital economy negotiations, the transatlantic issue is where most stakeholders’ attention is aimed. Investment ties between the EU and the US are massive. They are each other’s largest partners for foreign direct investment, both in inward and outward terms (Akhtar, 2019). However, almost two-thirds of US investment in the EU goes through, in order of magnitude, the Netherlands, the UK, Luxembourg and Ireland (Akhtar, 2019). Countries that are notorious locations for tax-related corporate profit shifting (Garcia-Bernardo et al., 2017; Tax Justice Network, 2019). Historically, the US and (Western) Europe have been on the same side of the ‘residence-source’ divide. They have been net capital exporters towards the rest of the world (Lips, 2019a), and have benefited both from the residence bias in the international corporate tax treaty templates, as well as the OECD’s institutional dominance. Several developments following the Global Financial Crisis have caused this loose coalition to unravel. On the European side, leaks and popular anger over large multinationals’ tax avoidance have created the political conditions to revise source taxation rules for digital companies. This is alongside popular discontent due to dwindling government budgets, the success of populist parties in several European states and the lack of large EU tech firms. Furthermore, this was enabled by the regulatory maturing of the EU as a viable forum for tax policy-making (Lips, 2019b). The US on the other hand wishes to avoid what they see as an ‘EU cash grab’ and wants to preserve the tax competitiveness of their tech companies, or at least prevent them from a proliferation of unilateral taxes. Smaller European tax havens have also resisted coordinated European efforts at corporate tax reform (Khan & Brunsden, 2018), both to protect their incomes from attracting multinational profits and ideologically resisting the EU Commission’s efforts to gain more competence over taxation matters (Irish Times, 2018). While the previous EU Commission had attempted European-wide tax governance (see e.g. Hakelberg, 2015 or European Commission, 2011), it was the 2014–2019 Juncker Commission that, somewhat ironically, made international tax avoidance one of its foci. The self-described ‘last chance Commission’ felt a strong political need to prove the added value of the supranational EU level, in light of anti-EU and populist sentiments. Demonstrating to the public

344  Handbook on the politics of taxation that the EU could impose fair taxation on large multinationals that were too powerful for even the largest EU states to tackle alone was one role the Commission saw for itself (European Commission, 2015; see also Römgens & Roland, this volume). This political pressure would not subside during the entire term of the Juncker Commission. First of all, scandals and leaks by civil society organizations, most notably the International Consortium for Investigative Journalism, at well-timed intervals were heavily mediatized in Europe. Most leaks involving corporations were focused on the EU as well, such as LuxLeaks on selective advanced pricing agreements (2014), or the Paradise Papers in which Apple’s profit shifting through Jersey was the main story (2017). The Commission itself would also draw media and political attention to multinational tax avoidance with its state aid cases, led by competition commissioner Margrethe Vestager. Remarkably, the EU Commission used its far more comprehensive competence on competition to gain more regulatory capacity in corporate tax policy-making. It did so by arguing that certain tax rulings granted by member states to multinational enterprises were in fact unfair state aid. It then ordered these states to recuperate due taxes, or face a fine. The state aid cases involved digital companies such as Apple, but their most direct impact on the digital tax debate was that they put the tax relationships with the US on edge (see also Römgens & Roland, this volume). US policy-makers accused the EU of a cash grab and downright slammed the EU tax climate as hostile (Jopson & Oliver, 2016). This signalled to the US what would happen if no multilateral solution on the digital tax conundrum would be reached: uncoordinated unilateralism that would affect its multinational enterprises much more deeply than a multilateral agreement they could steer would. The slow OECD progress on digital taxation following the release of BEPS in 2015 prompted several EU members to contemplate interim solutions to protect their revenues. The EU Commission responded to this development with an EU-wide proposal in March 2018 to avoid market-disturbing incoherencies (personal interview, 2018 Brussels). The EU’s Proposals consisted of two directive proposals: (a) a short-term proposal for a 3 per cent DST on the revenue of certain digital transactions by companies generating €750 million or more in revenue worldwide and €50 million in the EU (European Commission, 2018b); and (b) a long-term proposal for a significant economic presence, amending the need for a fixed permanent establishment as the basis for tax liability (European Commission, 2018a). However, the last proposal was not discussed in the Council. The EU is, of course, far from a unitary actor and camps between members immediately formed. France instantly came out in favour, as did Spain and Italy (Lips, 2019b). These large states’ revenues are the most hurt by digital companies’ profit shifting. They provide large user bases, but see little tax revenue from the profits generated in the EU by large tech companies. For France, leadership on this issue is also a way to further President Macron’s plan for an EU as a more coherent bloc on the world stage (France Diplomatie, 2020), and a way to appease populist anti-EU voters. Ireland, along with Luxembourg and initially the Netherlands, spoke out against (Plucinska et al., 2018). These countries arguably are the ‘winners’ of digital tax competition, as they succeed in attracting the shifted profits of multinational enterprises (Garcia-Bernardo et al., 2017). Their main argument was that the EU should not go beyond what is decided in the OECD, so as not to disturb the cohesiveness of the tax rules and to not damage the investment attractiveness of the EU. It is likely these arguments are a balance between genuine concerns and a veiled protection of their tax competition model. Germany was more ambiguous. On the one hand, it was more wary of upsetting already tense EU–US

The politics of taxing the digital economy  345 economic relations and especially feared a spillover into trade policy, as there were discussions about tariffs on EU steel products around the same time (Khan & Brunsden, 2018). Germany was also aware that a digital service tax could possibly extend to the German car industry. Several Nordic and Baltic countries, such as Finland and Estonia, hotspots in the EU tech sector (Eurostat, 2019), were also on the fence about a European DST – although not downright opposed as they didn’t like the idea of uncoordinated unilateral DSTs either – for fear of hitting their own tech companies (Plucinska et al., 2018). Interesting to note is the use of revenue as the tax base for the European DST plans, which was also a focal point of criticism. Opponents pointed out that revenue is not an adequate proxy for value creation, as a company can have a large revenue turnover, while making small or no profits. Opponents also expressed concerns that this could easily lead to (economic) double taxation (Cape, 2018). Politically, there are two main advantages of this revenue basis, however. First, revenue taxes are not covered by the current OECD model tax treaty and as such challenges by other countries on the legality of this type of tax face an additional hurdle (Gottlieb & Ali, 2019). Second, revenue is intrinsically linked with sales and as customers are the least mobile part of a company’s value chain, it is much harder to shift revenue than accounting profits. This theoretically makes a revenue tax a pressure tool that is politically robust against both other states’ and companies’ reactions. The EU Council did not adopt the Commission’s proposals, as the unanimity requirement gave a veto to a group of small EU states led by Ireland. However, several countries, including France, the UK, Austria and Spain, still contemplate or have adopted a unilateral version of the DST. This continues to invoke tensions with the US, especially with France, whose tech multinational enterprises have most to lose from these policies. However, the Commission’s proposal did give a strong impulse to the lagging OECD negotiations in 2018–2019, as they increased the sense of urgency. Despite failing to be implemented, the proposal did manage to increase Europe’s influence, and the EU’s standing as a viable regulatory actor, in international tax governance (Lips, 2019b). In comparison to the BEPS years, the context in the US has also greatly changed. Its 2017 Tax Cuts and Jobs Act (TCJA) had introduced two new anti-avoidance provisions: global intangible low-taxed income and base erosion and anti-abuse tax, along with a corporate tax rate cut from 35 to 21 per cent, going from one of the highest in the OECD to just below average. It also reduced deferral opportunities that allowed US multinational enterprises to indefinitely let foreign profits go untaxed until repatriation (Heineman & Spengel, 2018). By using this provision in combination with low-tax jurisdictions, US multinational enterprises could avoid source taxation through profit shifting and postpone residence taxation (Lips, 2019a), resulting in the kind of double non-taxation that angered European countries. Although the rationale behind the TCJA is more complex than this, one of the reasons behind the reform was to incentivize US MNOs to repatriate their profits. The idea was that if the crackdown on profit shifting through BEPS and the EU’s actions meant those offshore profits were going to be taxed from now on, they might as well be reinvested and subsequently taxed by the US instead of European countries (Knott, 2019). Introducing anti-abuse provisions that went beyond what was agreed in BEPS, however, made it harder for the US to deny other countries doing the same. This led to a commitment by the US for a multilateral solution, albeit based on the TCJA provisions. This position change is even explicitly named in the OECD report to the G20 leaders: ‘Following the US tax reform, the United States has in particular agreed to engage in the search of a global solution which would address further challenges’

346  Handbook on the politics of taxation (OECD, 2018b). The US’s clear interest in this is two-fold: avoid a proliferation of unilateral taxes, and avoid any solution that ring-fences tech companies. One advantage the US has over the EU in this regard is its regulatory capacity: the ability to enforce coherent tax rules over its entire economic zone, and then push that domestic template in international negotiations (see also Hakelberg, 2020; Crasnic & Hakelberg, this volume; Römgens & Roland, this volume). Following the DST saga, the European leadership role was firmly taken up by France, and it became the main speaking partner for the US. This dynamic has been driving the transatlantic momentum towards a solution, also at the OECD level. Arguments between them at the G7 finance ministers’ meeting in June 2019 reveal that the French unilateral DST is a thorn in the side of the US, but that France is explicitly seeing the DST as a pressuring tool on global negotiations. As finance minister Bruno Le Maire noted: ‘I’m ready to wait, but not to wait for eternity’ (Mallet, 2019). Over the course of 2019, there were threats of retaliatory tariffs on French luxury goods, such as wine, by the US in response to the DST. These squabbles have continued to move back and forth with threats of tariffs. The two countries reached a truce however at the beginning of 2020: the US would not impose tariffs on French imports, while France would suspend the collection of DST until an OECD compromise was reached. The tax would still accrue however for companies offering digital services in France (Giles, 2020). This might seem like a win for the US, but also allows France to continue to wield the DST pressure function. The compromise temporarily appeased Franco-US disagreement, but the resolution will depend on whether it is possible to reach a satisfactory agreement in the OECD. At the time of writing, the outlook for negotiations remains murky and the OECD has indicated negotiations will likely extend beyond 2020, increasing the risk of geopolitical conflict. 3.3

Developing and Emerging Economies: Fragmentation and Institutional Resistance

While most accounts of the politics of taxing the digital economy revolve around high-profile transatlantic struggles, the increasing voice and influence of emerging and developing economies is an underappreciated dimension. China and India have been particularly prominent in recent discussions. As OECD tax chief Pascal Saint-Amans expressed in a telling manner: When European officials say, ‘We want to tax digital companies, even if they pay their taxes in the US’, it’s more or less what Indian officials are telling French, German or other companies. That’s to say: ‘These companies operate on our territory, but not enough of their profits are staying here, so we want the right to tax them.’ (France 24, 2019)

Broadly speaking, the policy interests of emerging and developing economies depart in multiple ways from the traditional basis of OECD tax policies, designed without their input and to their disadvantage (Genschel & Seelkopf, 2016). Historically, developing countries were overwhelmingly net capital importers and ‘source’ countries, hosting local economic activity that generated income, rather than ‘residence’ countries, hosting the headquarters and intellectual property of large multinational corporations (cf. Hearson & Rixen, this volume). Still, they traditionally acquiesced to an international tax system biased against them (by allocating taxing rights away from them) in order to facilitate foreign investment (Rixen, 2008, pp. 159–161). More recently, however, the growing economic power and geopolitical sway of China and India – but also Brazil, South Africa and other emerging economies – has enabled them to become more expressive in international economic policy-making. They are simultaneously

The politics of taxing the digital economy  347 contesting and adapting to liberal international institutions while also seeking alternative pathways (de Graaff et al., 2020). This is also the case in international tax policy-making, where emerging powers are pursuing their own policy interests, institutionalizing their membership in the G20 and the OECD’s ‘Inclusive Framework’, while challenging established tax norms and standards (Hearson & Prichard, 2018; Lesage et al., 2019). There are several economic and institutional similarities between Brazil, Russia, India, China and South Africa that shape new common challenges to international tax policy-making (Lesage et al., 2019, pp. 720–725). Discussing the specific case of China, Hearson and Pritchard highlight the economic shifts underlying the country’s changing international tax policy preferences: moving from a capital importer to a capital exporter, from factor-driven to innovation-driven economy, from ‘world factory’ to ‘world market’ and from modernization of manufacturing to full value-chain modernization (2018, p. 1295). These trends are relevant to comparable emerging markets. For instance, India equally offers a ‘world market’, fostering a shared preference for more allocation of international tax revenues on the basis of market size, rather than the location of corporate residence. Yet there is also significant heterogeneity in the contemporary interests of emerging economies, in particular when it comes to taxing the digital economy. The presence of giant digital companies in China – including firms such as Alibaba, Tencent and Baidu – is instrumental. India hosts a few digital giants, such as Jio and Flipkart, and in fact has a significantly greater volume of information and communications technology services exports than any other emerging economy (World Bank, 2019). Brazil also hosts B2W, Africa’s largest e-retailer Jumia stems from Nigeria, while Russia has Yandex and Mail.Ru – all large digital firms. But the concentration of China’s sector is paralleled only by the US. This is important because the digital tax agenda is significantly driven by a focus on giant firms. This aligns China’s interests more closely to the US, as both seek to avoid increased tax on these firms, although China so far has been relatively silent in global negotiations (Dai, 2019). Ongoing contestation between the two powers over technology and security could also throw a wrench into alliance building (cf. Farrell & Newman, 2019). Meanwhile, India’s actions line up more consistently with France’s, as both have introduced new special taxes on (mostly foreign) digital firms, aimed at establishing more market-based taxation (OECD, 2018c). Another factor of divergence is institutional. In contrast to both China and India, Brazil has sought an increasingly close alignment with the ‘OECD way’ in international tax policy. Brazil, Russia, India, China and South Africa have all been critical of the OECD and supportive of alternative forums such as the United Nations through the ‘Group of 77’ (Edwards, 2017; Lesage et al., 2019, p. 727). But although Brazil’s international tax policies have historically departed significantly from OECD standards, the country has formally applied for accession to the OECD to strengthen its close political and economic ties with OECD members (Soto, 2017). Accession requires compliance with core OECD tax principles, something the Brazilian bureaucracy has been working on since 2018 (OECD, 2018a). Economic wealth plays a role, too. As the poorest of the G20 countries, India often aligns its interests – at least discursively – more closely with developing countries (Wade, 2011, p. 356). While China, for instance, has positioned itself ‘as a champion of developing-country concerns’, their actions seem to be aimed ‘not at generating general benefits for all developing countries, but at carving out special benefits for China’ (Hearson & Prichard, 2018, p. 1304). In the OECD/G20 project, India has spearheaded multiple proposals to radically reform taxation of digital firms through the ‘G24’ group of developing and emerging economies

348  Handbook on the politics of taxation (McLoughlin, 2019). These proposals have focused on expanding the rights of market countries to tax the profits of corporations with no physical presence in the country (a key hallmark in the current paradigm), based on such a corporation earning revenue from local activities and having a significant number of local users (OECD, 2018c, p. 138). In other words, India and the G24 want to redistribute tax revenues towards jurisdictions with large markets, at the expense of countries that have large home-grown digital giants operating abroad. The impact of emerging and developing country interventions in global discussions on taxing the digital economy, however, remains an open question. This is in part due to a lack of capacity to participate and influence, and in part due to a focus on other issues. The world’s least-developed countries, in particular, face unique challenges in relation to international tax cooperation, associated with tax avoidance and evasion, tax competition and institutional restrictions on the taxation of foreign capital (Hearson, 2017). Recent global tax reform has been criticized for not taking the interests of developing countries into account (ActionAid, 2014; Burgers & Mosquera, 2017). And while the push to allocate further taxing rights to ‘market jurisdictions’ is seen as welcome by some low-income countries disadvantaged by the current international tax framework, many developing countries have comparably small markets, meaning they would not gain substantially from more market-based allocation. Indeed, the African Tax Administration Forum, in its commentary on the OECD/G20 digital tax project, notes its strong support for ‘the common objective of all of the proposals to allocate more profits to market jurisdictions’, but also warns that proposals should not ‘disadvantage small African economies’ (ATAF, 2019). As the African Tax Administration Forum’s Secretary General has noted, from the African perspective, ‘the starting point for discussions should be the challenges facing Africa, not the solutions being negotiated among larger countries’ (Hearson, 2019).

4. CONCLUSIONS Digitalization of the economy and the market power of digital giants offers a fundamental challenge to the international tax system, founded on twentieth-century principles of permanent physical presence and tangible goods. It also exposes new battle lines between states in the reconfiguration of international tax rules, as old divisions between ‘source’ and ‘residence’ countries fade. As such, the contemporary era of ‘digital capitalism’ is changing the economic and political interests of states, creating new alliances and breaking up old ones. This chapter illustrates the value of proceeding with a political economy analysis of how contemporary economic transformations are intrinsically linked to political unsettling. In particular, we have highlighted how the rise of the digital economy fosters important evolutions from the historical order where the bloc of OECD economies, largely net capital-exporting countries, collectively decided upon tax rules that disadvantaged capital-importing economies by restricting their rights to tax at source. First, there is the internal discord within the OECD bloc, illustrated most markedly by the transatlantic conflict between the US and the EU. This discord has created an atmosphere where the appetite for revolutionary reform proposals has grown significantly. The OECD’s top tax bureaucrats are now openly trying to broker a global agreement ‘going beyond the arm’s length principle’ (OECD, 2019), the founding principle of the twentieth-century international tax system – something that was unthinkable even a few years ago.

The politics of taxing the digital economy  349 Second, the inclusion of large and powerful emerging markets such as India, Brazil and China has moved discussions and alliances away from the traditional US–EU axis. China and India are countries with large consumer markets, and as such favour allocating more taxing rights on a market basis. And indeed, the direction of travel in international taxation is, across all the different policy proposals being considered, that jurisdictions with large consumer bases will experience an increase in tax revenue as a result of the new rules. Yet their political preferences depart in important ways: whereas China, with its large home-grown digital companies, favours a limited redistribution of the tax base towards user jurisdictions, India has aligned itself with e.g. France in pushing for exactly such a redistribution. These insights open up new questions about the politics of taxing the digital economy. Specifically, we point to two directions for further inquiry. First, how much will digitalization uproot the historical order of international taxation? While existing scholarship has highlighted the stable, evolving regime (Genschel & Rixen, 2015), digital transformations substantially challenge both established political agreements and scholarly theories about international taxation. Economic changes are evident, and the potential for political rupture is significant – the early indications of which we have already seen – with power theories helping us understand shifts in the geopolitical balance away from the US. However, the window for a new global compromise remains small, and ongoing discussions illustrate the persistence of incremental solutions towards more market-based taxation, consistent with expectations from historical institutionalist approaches (cf. Hearson & Rixen, this volume). Even though the continued usefulness of the arm’s length principle is being reconsidered, whether any (small) departures from the long-standing core of the international tax system would lead to a material change in global distributional outcomes is unclear. It may well be that changes enacted end up being cosmetic, while the actual allocation of taxing rights remains highly skewed towards historically dominant countries, achieved through largely symbolic reforms – a type of outcome that has happened before (Büttner & Thiemann, 2017; Eccleston & Woodward, 2014; Rixen, 2008). Third, the new international tax politics emerging from the digital debate raises questions about the views and influence of economically less powerful countries. Tax havens are one such group, the small countries that currently ‘win’ tax competition by attracting intangible capital and virtual profits through offering exemptions, low nominal tax rates or favourable tax rulings – such as Ireland, Luxembourg or Bermuda. At first glance, these countries will likely be worse off under a global compromise that promises to reallocate taxing rights to market jurisdictions and enforce a minimum level of effective taxation – and thus they are likely to fight back. Politically such resistance can be more or less effective, depending on the visibility and intensity of resistance (cf. Crasnic & Hakelberg, this volume). Historically, small ‘tax havens’ have successfully resisted the OECD’s attempts to curb tax competition (Sharman, 2006). Recently, too, a coalition of European governments led by Ireland was successful in stopping the EU DST. Yet in the new politicized environment of international taxation, with rising public attention and geopolitical powers increasingly willing to crack down on tax havens (Christensen & Hearson, 2019a), effective resistance is not a given. Small developing countries, too, are at risk of being overrun in contemporary global tax debates. These are countries without populations with large purchasing powers, and with little ability to attract capital through tax competition. Most of them are part of the discussion through the BEPS Inclusive Framework but there is a distinct possibility that the final solution won’t address their concerns, such as revenue-raising struggles, administrative

350  Handbook on the politics of taxation capacity or scepticism about institutional legitimacy and representation at the OECD and the G20. Scholars of the micro politics of expertise might question how negotiators from these developing countries fare in the OECD discussions on digital tax policy. While many small developing countries have been granted a formal voice in negotiations, the changing economic and political context raises the question of whether they will still end up marginalized in digital tax reforms if they cannot translate voice into influence, and whether they will implement the eventual reform outcomes anyway, in order to comply with global tax governance. The politics of taxing the digital economy is the first litmus test of how inclusive the new Inclusive Framework really is.

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352  Handbook on the politics of taxation Hearson, M. (2017). The challenges for developing countries in international tax justice. Journal of Development Studies, 1–7. https://​doi​.org/​10​.1080/​00220388​.2017​.1309040 Hearson, M. (2019). Africa responds to the Inclusive Framework’s digital tax agenda. International Centre for Tax and Development, 7 August. www​.ictd​.ac/​blog/​africa​-responds​-to​-the​-inclusive​ -frameworks​-digital​-tax​-agenda/​ (accessed 1 June 2021). Hearson, M., & Prichard, W. (2018). China’s challenge to international tax rules and the implications for global economic governance. International Affairs, 94(6), 1287–1307. Heineman, F., & Spengel, C. (2018). Analysis of US Corporate Tax Reform Proposals and their Effects for Europe and Germany. ZEW. Irish Times (2018). Ireland not alone in opposing EU digital tax plan. www​.irishtimes​.com/​business/​ economy/​ireland​-not​-alone​-in​-opposing​-eu​-digital​-tax​-plan​-1​.3429999 (accessed 24 May 2021). Jopson, B., & Oliver, C. (2016). US lawmakers slam ‘hostile’ EU tax climate. Financial Times. https://​ next​.ft​.com/​content/​a40e4b34​-c9c7​-11e5​-be0b​-b7ece4e953a0 (accessed 24 May 2021). Khan, M., & Brunsden, J. (2018). France and Germany abandon plans for EU digital tax. Financial Times. www​.ft​.com/​content/​fc7330d4​-f730​-11e8​-af46​-2022a0b02a6c (accessed 24 May 2021). Knott, A. M. (2019). Why the Tax Cuts and Jobs Act (TCJA) led to buybacks rather than investment. Forbes. www​.forbes​.com/​sites/​annemarieknott/​2019/​02/​21/​why​-the​-tax​-cuts​-and​-jobs​-act​-tcja​-led​-to​ -buybacks​-rather​-than​-investment/​#3ebc309837fb (accessed 24 May 2021). Lesage, D., Lips, W., & Vermeiren, M. (2019). The BRICs and international tax governance: The case of automatic exchange of information. New Political Economy, 25(5), 715–733. Lips, W. (2019a). Great powers in global tax governance: A comparison of the US role in the CRS and BEPS. Globalizations, 16(1), 104–119. Lips, W. (2019b). The EU Commission’s digital tax proposals and its cross-platform impact in the EU and the OECD. Journal of European Integration, 1–16. Mallet, V. (2019). G7 nations struggle to reach compromise on digital tax. Financial Times. www​.ft​ .com/​content/​53ef927a​-a8bc​-11e9​-b6ee​-3cdf3174eb89 (accessed 24 May 2021). McLoughlin, J. (2019). Global digital tax talks juggling developing countries’ goals. Worldwide Tax Daily, 5 February. Muniesa, F. (2017). On the political vernaculars of value creation. Science as Culture, 26(4), 445–454. OECD (1998). Electronic Commerce: Taxation Framework Conditions. OECD Publishing. www​.oecd​ .org/​tax/​consumption/​1923256​.pdf (accessed 1 June 2021). OECD (2013). Action Plan on Base Erosion and Profit Shifting. OECD Publishing. www​.oecd​-ilibrary​ .org/​taxation/​action​-plan​-on​-base​-erosion​-and​-profit​-shifting​_9789264202719​-en (accessed 24 May 2021). OECD (2015). Action 1: Final report addressing the tax challenges of the digital economy. Base Erosion and Profit Shifting Project. http://​dx​.doi​.org​.10​.1787/​9789264202719​-en OECD (2018a). OECD and Brazil launch project to examine differences in cross-border tax rules. www​ .oecd​.org/​tax/​transfer​-pricing/​oecd​-and​-brazil​-launch​-project​-to​-examine​-differences​-in​-cross​-border​ -tax​-rules​.htm (accessed 24 May 2021). OECD (2018b). Secretary-General report to the G20 leaders. OECD (2018c). Tax challenges arising from digitalisation – interim report 2018. OECD (2019). Programme of work to develop a consensus solution to the tax challenges arising from the digitalisation of the economy. OECD/G20 Inclusive Framework on BEPS. www​.oecd​.org/​tax/​ beps/​programme​-of​-work​-to​-develop​-aconsensus​-solution​-to​-the​-tax​-challenges​-arising​-from​-the​ -digitalisation​-of​-the​-economy​.htm (accessed 24 May 2021). OECD (2020). The Role of Digital Platforms in the Collection of VAT/GST on Online Sales. OECD Centre for Tax Policy, 19 March. www​.oecd​.org/​tax/​consumption/​the​-role​-of​-digital​-platforms​-in​-the​ -collection​-of​-vat​-gst​-on​-online​-sales​-e0e2dd2d​-en​.htm (accessed 24 May 2021). Pinto, M. S., Kovago, A., & Crawford, M. (2018). Impact of Digitalisation on the Transformation of Tax Administrations. IOTA. Plucinska, J., Vinocur, N., & Smith-Meyer, B. (2018). Europe’s digital tax map: Where countries stand. www​.politico​.eu/​article/​europe​-digital​-tax​-map​-where​-countries​-stand​-analysis​-deep​-divisions/​ (accessed 24 May 2021).

The politics of taxing the digital economy  353 Rappeport, A., Schreuer, M., Tankersley, J., & Singer, N. (2018). Europe’s planned digital tax heightens tensions with US. New York Times, 20 March. www​.nytimes​.com/​2018/​03/​19/​us/​politics/​europe​ -digital​-tax​-trade​.html (accessed 24 May 2021). Rixen, T. (2008). The Political Economy of International Tax Governance. Palgrave Macmillan. Robert, H. (2019). Digital giants face tax setback after G20 agreement. Financial Times. www​.ft​.com/​ content/​f00d2f70​-8a6f​-11e9​-a1c1​-51bf8f989972 (accessed 24 May 2021). Rosenau, J. N., & Singh, J. P. (eds) (2002). Information Technologies and Global Politics: The Changing Scope of Power and Governance. State University of New York Press. Sharman, J. C. (2006). Havens in a Storm: The Struggle for Global Tax Regulation. Cornell University Press. Soto, A. (2017). Exclusive: Brazil eyes OECD membership to woo investors after recession – sources. Reuters, 26 April. www​.reuters​.com/​article/​us​-brazil​-oecd​-membership​-exclusive/​exclusive​-brazil​ -eyes​-oecd​-membership​-to​-woo​-investors​-after​-recession​-sources​-idUSKBN17S2U4 (accessed 24 May 2021). Tax Justice Network (2019). Corporate Tax Haven Index – 2019 results. https://​co​rporatetax​havenindex​ .org/​introduction/​cthi​-2019​-results (accessed 24 May 2021). The Economist (2017). The world’s most valuable resource is no longer oil, but data. 6 May. www​ .economist​.com/​leaders/​2017/​05/​06/​the​-worlds​-most​-valuable​-resource​-is​-no​-longer​-oil​-but​-data (accessed 24 May 2021). Wade, R. H. (2011). Emerging world order? From multipolarity to multilateralism in the G20, the World Bank, and the IMF. Politics and Society, 39(3), 347–378. Waters, R. (2020). Big tech’s ‘buy and kill’ tactics come under scrutiny. Financial Times. www​.ft​.com/​ content/​39b5c3a8​-4e1a​-11ea​-95a0​-43d18ec715f5 (accessed 24 May 2021). World Bank (2019). ICT service exports (BoP, current US$): Data. World Bank Development Indicators. https://​data​.worldbank​.org/​indicator/​BX​.GSR​.CCIS​.CD​?most​_recent​_value​_desc​=​true (accessed 24 May 2021).

PART IV PREFERENCE FORMATION

23. Why do people pay taxes? Explaining tax compliance by individuals Alice Guerra and Brooke Harrington

1. INTRODUCTION Taxation is one of the defining political acts of nation-states (e.g., Skocpol, 1979; Kiser & Kane, 2001). It is not only a source of revenue, but an enactment of taxpayers’ recognition of themselves as members of a polity, giving their consent to be governed (Fjeldstad, 2001). To the extent that taxpayers withhold this consent – that is, if a gap arises between the amount of tax owed and the amount actually collected – states face not only a fiscal deficit, but a problem of legitimacy (Schmidt, 2015). In tax compliance, three topics of shared interest across the social sciences intersect: social norms, law, and the provision of public goods. As a result, social scientists have long been preoccupied with understanding how states secure the cooperation of taxpayers in negotiating voluntary transfers from individuals to collective institutions of governance (Simmel, 1950 [1908]; Weber, 1993 [1927]). There has been increased interest in this topic, both in academic and policy circles, since the Global Financial Crisis of 2008 and the critical shortfalls of tax revenue that followed (Slemrod, 2019). Still, fundamental questions about the causes and contextual factors shaping voluntary tax compliance remain unanswered. This review will identify key advances in recent scholarship, as well as areas where knowledge gaps persist and new information is needed. The chapter focuses on studies that examine individuals’ actual tax compliance, rather than their attitudes (e.g., tax morale),1 and that document causal relationships, rather than correlations.2 Hence, our review primarily compromises experimental studies of tax compliance conducted by economists; in this effort, we pick up where other recent reviews left off (e.g., Mascagni, 2018; Alm, 2019). In the real world, tax compliance cannot be directly observed as it happens, data are difficult to gather, and it is nearly impossible to isolate the impact of causal variables – such as tax or audit rates – among the many factors that might influence individuals’ compliance decisions (for a similar discussion, see Torgler, 2002; Mascagni, 2018). Experimental methods allow us to overcome many of those obstacles, though they have their own disadvantages, such as concerns about external validity.3 To address these shortcomings, recent work increasingly relies on large-scale field tax experiments (e.g., Hallsworth et al., 2017; Bott et al., 2019; for a review, see Mascagni, 2018), or combinations of different methodologies, such as a mix of laboratory and field experiments (Koessler et al., 2019); field and online experiments supplemented with administrative data (López-Luzuriaga & Scartascini, 2019; Antinyan et al., 2020); or a mix of laboratory and online experiments (Chan, 2019; Gangl et al., 2020). The results indicate coherence with the findings of older studies, despite the different data-gathering strategies used. The remainder of the chapter is structured as follows. First, we review insights from tax compliance experiments, highlighting those published after 2017. Though we briefly review some of the main findings of prior contributions (e.g., reviews by Mascagni, 2018 and Alm, 355

356  Handbook on the politics of taxation 2019), our focus on the post-2017 studies is among the key original features of this chapter. We then point out the open questions and avenues for future research that this new work suggests. In conclusion, we sum up the state of the art in research on individual tax compliance, then highlight policy implications.

2.

DETERMINANTS OF INDIVIDUAL TAX COMPLIANCE

The literature on individuals’ tax compliance is vast, spanning many empirical settings and methodologies. However, underlying most of this research over the past decades has been a theoretical framework for understanding taxpayer behaviour established by Allingham and Sandmo (1972) along with Srinivasan (1973); their work, in turn, can be understood as a special application of the analytic models created by Becker (1968), in his economics-of-crime research, and by Mossin (1968), in his economics-of-uncertainty framework. Thus, the shared theoretical framework for analysing tax compliance for nearly 50 years has been based on those economists’ assumptions about individuals making cost/benefit analyses under conditions of uncertainty. This approach generally concludes that when individuals weigh the potential gains from tax evasion against the risks of punishment and detection, they usually opt to comply because the costs outweigh the benefits. As this line of research has evolved, scholars have refined the basic model by adding other factors thought to affect compliance decisions, such as norms, prosociality (Ponzano & Ottone, 2019), and moral attitudes (Robbins & Kiser, 2020; see also Erard & Feinstein, 1994; Myles & Naylor, 1996; Traxler, 2010; Bruno, 2019).4 The empirical literature on tax compliance has extensively tested models’ predictive power. Overall, the findings indicate that tax compliance by individuals depends on multiple factors at each of three levels of analysis. At the micro level, several studies indicate that variation in compliance stems both from personal characteristics (such as demographic traits) and from individual responses to external stimuli, such as incentives and penalties. At the meso level, shared social beliefs about fairness, as well as objective conditions of socio-economic inequity, influence taxpayer behaviour, as does sharing information about compliance – one’s own and others’. These effects are sometimes counterintuitive, and point to intriguing new research opportunities. Finally, at the macro level, the policies and practices of public institutions – from enforcement to incentives – play a significant role in tax compliance. We have summarized the most recent literature on these factors in Tables 23.1 and 23.2. A selection of papers found in a literature search of the main databases containing scholarly publications on taxation (e.g., EconLit, Google Scholar, and Science Direct) can be found in Table 23.1, listed alphabetically. This search was conducted on a rolling basis between January 2018 and October 2020, using keywords such as “randomized controlled trial,” “field experiment,” “lab experiment,” “tax evasion,” “tax compliance,” “tax non-compliance,” and “tax morale.” While the list cannot be comprehensive due to the large volume of publications in this area, it provides a sense of the range of research occurring at the cutting edge of this field. The studies involve both students and adult taxpayers, and span a wide range of sample sizes (from 54 to approximately 34,000 participants); they also include a variety of experimental methods, including laboratory studies, fieldwork, online experiments, and a few survey experiments. Geographically, most of the studies on the list reflect the historical focus in experimental tax compliance research on countries in Europe and the United States (US) (but see Fjeldstad,

Why do people pay taxes?  357 Table 23.1 Authors

A selective list of experimental contributions on individual tax compliance Methodology

Location

2018

Lab experiment

Copenhagen and Bologna

Italy

Alm et al. (2019)

2019

Lab experiment

Colombia

Antinyan et al.

2020

Administrative

National household

Colombia Armenia and

122 subjects 1,448 subjects (Armenia); 1,844 US

data and online

survey administered in

US

participants from Prolific

 

14,509 subjects

Italy

95 subjects, mainly students in economics

Guerra and

Year

Harrington (2018)

(2020)

Country Denmark and

Subject pool size 180 subjects, mainly students

survey experiment the Republic of Armenia and online survey experiment via Prolific Batrancea et al.

2019

Lab experiment

(2019) Bernasconi and

44 nations from five continents

2020

Lab experiment

Venice, north of Italy

Bernhofer (2020) Bott et al. (2019)

2019

Buckenmaier et al. 2018

Field experiment

Norway

Norway

15,000 taxpayers

Lab experiment

Trento

Italy

268 undergraduate students

University of

Germany

348 students

US

98 Americans from Mechanical Turk;

(2018) Casal et al. (2019) 2019

Lab experiment

Erlangen-Nuremberg Chan (2019)

2019

Online

Online experiment

experiment and

(Amazon Mechanical

312 Australian students for the lab

lab experiment

Turk and Prolific

experiment; 244 British citizens from

Academic); US research

Prolific Academic

university D’Attoma (2020)

2020

Lab experiment

Five universities in the

US and Italy

US and four in Italy Enachescu et al.

2019

Online survey

(2019)

experiment

Engel et al. (2020) 2020

Lab experiment

Austria

Austria

University of Trento,

Italy

Italy Farrar et al. (2019) 2019 Fochmann and

2019

Online

Amazon Mechanical

experiment

Turk

Lab experiment

Leibniz University

Wolf (2019)

694 subjects, mainly students (424 from US, 270 from Italy) 523 Austrian taxpayers 54 students of various majors, 18 in each treatment

Online

210 US taxpayers

Germany

59 participants in Hannover and 146 participants in Cologne

of Hannover and University of Cologne

Gangl et al. (2020) 2020

Austria

199 Austrian participants recruited

Online and lab

Online experiment;

experiment

public university in

online via postings in newspaper

Austria

comment sections, among family and friends of students, and among Rotary Club members; 263 Austrian university students for the lab experiment

Garcia et al. (2020) 2020

Lab experiment

Public university in

Portugal

Portugal

74 undergraduate and master students, of which 16 were assigned to the control group and 58 to the treatment group

Jacquemet et al.

2019

Lab experiment

Strasbourg University

France

63 participants, mostly students

2020

Lab experiment

Strasbourg University

France

129 subjects, mostly students

(2019) Jacquemet et al. (2020)

358  Handbook on the politics of taxation Authors Koessler et al.

Year 2019

(2019)

Methodology

Location

Country

Field and lab

For the field experiment: Switzerland

experiment

Trimbach; for the lab

and Germany

taxpayers; for the lab experiment: 260

Pakistan

1,008 eligible Pakistani income tax filers

participants, most of them students

experiment: Osnabrück Koumpias and

2019

Survey

Pakistan

experiment

Martinez-Vazquez

Subject pool size For the field experiment: 2,010 Trimbach

(38.09 average year old)

(2019) LaMothe and

2020

Bobek (2020)

Online

Amazon Mechanical

experiment

Turk and TurkPrime

Field experiment

Argentina

Online

211 US taxpayers

Argentina

700 taxpayers

(Litman et al., 2017) López-Luzuriaga

2019

and administrative

and Scartascini

data

(2019) Masclet et al.

2019

Lab experiment

(2019)

Half sessions conducted Canada and in Montreal, Canada;

432 subjects, mainly students

France

half sessions conducted in Rennes, France McKee et al.

2018

Lab experiment

(2018)

Tennessee and

US

730 participants (463 students and 267

Appalachian

non-students)

Meiselman (2019) 2019

Field experiment

Detroit, US

US

7,142 individuals

Ortega and

2020

Field experiment

Colombia

Colombia

20,818 taxpayers

2018

Lab experiment

Different locations in

Italy and

638 participants: 311 in Italy and 327 in

Italy and Sweden

Sweden

Sweden

Multiple locations in

Italy, UK, US, 2,537 lab participants (across different

Italy, UK, US, and

and Sweden

locations)

US

34,334 tax delinquents

Scartascini (2020) Ottone et al. (2018) Pampel et al.

2019

Lab experiment

(2019)

Sweden Perez-Truglia and

2018

Field experiment

Troiano (2018) Ponzano and

Wisconsin 2019

Lab experiment

Ottone (2019) Vossler and

Kentucky, Kansas, and

2018

Lab experiment

Different locations in

Italy, UK, and 998 subjects, of which 311 in Italy, 327 in

Italy, UK, and Sweden

Sweden

Sweden, and 360 in UK

Tennessee and Virginia

US

715 participants

Gilpatric (2018)

2001). However, there has been increasing interest in analysing challenges for tax revenue generation in developing countries, particularly by means of field experimentation (Hallsworth, 2014; Castro & Scartascini, 2015; Ortega et al., 2016; Hallsworth et al., 2017; Flores-Macías, 2018; Castaneda et al., 2020; for a review, see Mascagni, 2018). As part of this increase in the range of geographical settings for tax research has come an expansion of empirical questions relevant to those new settings. An example is recent work on the practice of “forbearance,” in which politicians in developing countries permit voters to ignore their tax obligations by refusing to sanction non-compliance (Holland, 2016). This strategy gains votes for the politicians and maximizes their rents (Holland, 2015, 2016; Ortega et al., 2016); such phenomena deserve further research attention because they complicate models created in developed countries by changing the assumed relationship between the government and the governed. To complement Table 23.1, Table 23.2 lists key insights of these recent studies, and indicates whether the main independent variable(s) have either positive, or negative, or null impact on individuals’ tax compliance. The insights are categorized in terms of the three levels

Why do people pay taxes?  359 Table 23.2

Determinants of individuals’ tax compliance

Micro-level factors

 

“Stick” approach (negative economic factors)

 

Audit rates (+)

Guerra and Harrington (2018); Alm et al. (2019); Bernasconi and Bernhofer (2020)

Post-audit “bomb-crater” effect (-)

Alm et al. (2019); Bernasconi and Bernhofer (2020)

Spillover effects across taxes (+)

Ortega and Scartascini (2020); López-Luzuriaga and Scartascini (2019)

Financial penalties (+)

Guerra and Harrington (2018); Bernasconi and Bernhofer (2020)

Tax rates (-)

Guerra and Harrington (2018); Ponzano and Ottone (2019)

Tax rate increased after an audit (+)

Alm et al. (2019)

Information on tax liabilities and audit process (+)

McKee et al. (2018); Vossler and Gilpatric (2018)

 

 

“Carrot” approach (positive economic factors)

 

Commitment-based devices (+)

Koessler et al. (2019); Jacquemet et al. (2020)

In-kind rewards (+)

Koessler et al. (2019)

 

 

“Personal traits” approach

 

Emotions (+/.)

Olsen et al. (2018); Enachescu et al. (2019); Jacquemet et al. (2019)

Pro-sociality (+)

Ponzano and Ottone (2019)  

Meso-level factors

 

Sharing information on tax behaviour; evoking group Bott et al. (2019); Garcia et al. (2020); Meiselman (2019); Perez-Truglia identity (+/.)

and Troiano (2018)

Equity considerations (.)

Casal et al. (2019)

National identity (+/-)

Chan (2019); Koumpias and Martinez-Vazquez (2019)

Fairness considerations (.)

Engel et al. (2020)

 

 

Macro-level factors

 

Taxpayer influence over spending (+):

Pampel et al. (2019); D’Attoma (2020)

Whistleblower programmes (+)

Bazart et al. (2020); Masclet et al. (2019); Buckenmaier et al. (2018); Farrar et al. (2019)

Trust in institutions/authorities (+):

Batrancea et al. (2019); Antinyan et al. (2020); Gangl et al. (2020)

Tax return preparation methods: tax software (-);

LaMothe and Bobek (2020) (tax software versus human tax professional);

prepopulated tax returns (+/-)

van Dijk et al. (2020) (prepopulated tax returns)

Redistribution (+)

Guerra and Harrington (2018); Ponzano and Ottone (2019); Nemore and Morone (2019)

Country effects

Guerra and Harrington (2018); Ottone et al. (2018); Ponzano and Ottone (2019); D’Attoma (2020)

Note: A plus (minus) sign indicates that the relationship between tax compliance and its respective determinant was found to be positive (negative), while a “(.)” sign indicates no significant result about the relationship.

of analysis. Below, we draw on a subset of the studies shown in Table 23.2 to point out key findings and the most promising avenues for future research. 2.1

The Micro Level

Previous research has sketched a fairly consistent picture of compliant taxpayers’ individual characteristics, such as age, gender, emotions, and neural activities. There is a particularly clear pattern when it comes to gender: for example, Bruner et al. (2017) and D’Attoma et al. (2017) find that women are significantly more compliant than men in all the countries where

360  Handbook on the politics of taxation they conducted tax experiments (the US, United Kingdom (UK), Sweden, and Italy). Other recent research suggests there may be a biochemical basis for this gender difference: Arbex et al. (2018) show that higher testosterone levels among Canadian male subjects were (weakly) linked to lower levels of tax evasion; this is consistent with evidence that higher testosterone levels increase males’ prosocial behaviour (Dreher et al., 2016). We also know that individuals are more likely to be compliant if they score high on other-regarding preferences (Gintis et al., 2005; Ponzano & Ottone, 2019), psychological measures of concern for others’ well-being (Christian & Alm, 2014), or on measures of patriotism (Konrad & Qari, 2012; Gangl et al., 2020). Those who experience emotional distress at the prospect of violating social norms – as measured by skin conductance responses (Coricelli et al., 2010) or heart rate variability (Dulleck et al., 2016) – are also more likely to pay their taxes on time and in full. This is linked not only to gender, but to age: older people typically hold stronger moral attitudes about social norms and duties, leading them to comply with their tax obligations to a greater degree than younger people (Andrei et al., 2014). In contrast, compliance is lower among individuals who are younger and male (or who score high on psychological measures of male-linked personal attributes5), along with those who employ professional tax preparers (Alm & McKee, 2004, 2006; Kastlunger et al., 2010; Alm, 2019). A central concern of present-day micro-level research is to identify factors that can influence individuals in the direction of greater compliance. A robust stream of research has examined the roles of audits and fines on individual taxpayers’ decisions (e.g., Kirchler, 2007); however, recent studies have foregrounded the limitations of enforcement tools. For one thing, systematic misperception of enforcement processes by taxpayers results in the mistaken belief among many that even if they are audited, their evasion will not be detected (Bernasconi & Bernhofer, 2020). Second, it appears that the negative emotions associated with tax enforcement may be a double-edged sword. On the one hand, the guilt, shame, and other emotions aroused by enforcement can produce short-term increases in compliance (Jacquemet et al., 2019). Longer term, however, the negative emotions evoked by enforcement can produce a backlash; a recent survey study by Enachescu et al. (2019) indicates that the anger and fear subjects report feeling about the prospect of tax audits reduces their intent to comply with their real-world tax obligations in the future. Future research should examine this phenomenon more closely in a laboratory setting where compliance can be observed, since self-reported attitudes and intentions can diverge markedly from actual behaviour (Guerra & Harrington, 2018). Partly in response to these findings about the unintended negative consequences of enforcement on tax compliance, recent research has examined whether incentives might be more effective than punishments. One particularly important result of this work has been the discovery that while all kinds of “carrots” work better than the “sticks” of audits and fines, non-financial incentives work best of all in encouraging tax compliance. Earlier work in this vein showed that cash incentives produced mixed results, sometimes reducing compliance if subjects perceived that rewards were not distributed equitably (Fochmann & Kroll, 2016). More recently, field and laboratory experiments by Koessler et al. (2019) produced a striking contribution: they found that in-kind incentives (such as the chance to win a voucher for a spa weekend) increased compliance significantly, not only compared to a no-incentive treatment, but also compared to a cash payment equivalent to the value of the voucher. As these findings suggest, many unanswered questions remain where the use of compliance incentives are concerned. The Koessler et al. (2019) study was conducted with Swiss taxpayers only, so future research should examine whether the effect can be generalized to other societies; in

Why do people pay taxes?  361 addition, future work should seek to pinpoint why in-kind incentives have this enhanced effect compared to cash, as well as what types of in-kind incentives are most effective in motivating different groups of taxpayers. Among the most interesting new developments at the micro level of research has been in the realm of harnessing cognitive biases to serve the goal of increasing individual tax compliance. Recent studies have made use of commitment bias (Schwenk, 1986), showing that compliance rates increase when individuals make a written commitment to comply prior to the due date of tax obligations. For example, Jacquemet et al. (2020) dramatically increased the number of fully compliant taxpayers in their lab experiment when one group of subjects was asked to sign an oath prior to the start of the study stating that they would “swear upon [their] honour that, during the whole experiment, [they] will tell the truth and provide honest answers.” In the group that signed the oath, 63.2 per cent of subjects were fully tax compliant, compared to 49 per cent in the control group, which was not given the oath (p value = 0.047). However, this result must be considered in light of findings by Koessler et al. (2019), which showed that precommitments to comply with tax obligations were only effective when combined with rewards, and only enhanced compliance among subjects with high tax morale. The disparity in results may be due to differences in the form and context of the commitments subjects made in the two studies: whereas subjects in the Jacquemet et al. (2020) laboratory study signed a written oath, those in the Koessler et al. (2019) field experiment mailed a preprinted postcard to the tax authorities. Future research should build on these studies to clarify how different forms and contexts for tax commitments affect subsequent compliance behaviours. 2.2

The Meso Level

In some fields, such as public economics, it has been conventional to model taxpayer behaviour on the assumption that individuals make compliance decisions in isolation; to the extent that such models consider contextual factors, it has generally been through formal mechanisms such as law enforcement and punishment (Acemoglu & Jackson, 2017). Though this is widely acknowledged to be an incomplete analytical framework (Fortin et al., 2007; Alm, 2014), research designs have seldom incorporated contextual influence on tax compliance decisions. As a result, it is not clearly established which elements of taxpayers’ social environment have the greatest influence on behaviour. However, recent research indicates that questions of social influence, social identity, and reputation are highly salient. Human behaviour generally is highly sensitive to the norms set by others: most individuals will conform with the habits and customs of their social group, particularly when there is any uncertainty about the right course of action or a salient penalty for doing the wrong thing (Cialdini & Trost, 1998). In the domain of tax compliance, the phenomenon of social influence has typically been operationalized in cognitive-rational terms, such as knowledge about whether and to what extent others pay their mandated share of taxes. For instance, Alm et al. (2017) showed experimentally that compliance increases to a statistically significant degree when individuals are informed that others in their group are filing (or being audited) more frequently; by the same token, compliance declines when taxpayers are informed that others in their group are cheating (Alm et al., 2016a). This suggests that group cohesion, including a sense of shared identity and social position, influences tax compliance. This insight has been explored in greater depth by several recent studies. For example, Garcia et al. (2020) conducted a lab experiment to analyse the effect of

362  Handbook on the politics of taxation two different sources of information on individual compliance rates: “official” information provided by tax authorities, versus “unofficial” information provided by taxpayers’ peers. The findings reveal that official information exacerbates behavioural differences between “evaders” and “compliants”: that is, “evaders” are more likely to evade after they receive information about compliance rates from official sources, while such information makes “compliants” less likely to evade. In contrast, unofficial information changes everyone’s behaviour, regardless of whether they evaded or complied in previous rounds: that is, learning informally that all their peers have evaded makes all subjects evade more, while learning informally that all their peers have complied makes all subjects comply more. In a similar study of group influence, Bott et al. (2019) conducted a field experiment in Norway in which – shortly before the deadline for finalizing annual tax returns – some individuals received a letter stating that “the great majority” of the country’s taxpayers reported all their foreign income and assets. That minimal intervention nearly doubled the average amount of foreign income and assets reported by this group, compared to others who received a letter that did not report on the behaviour of other taxpayers. By the same token, the salience of group identity and conformity to a national norm, seemed to drive tax compliance in an experiment by Chan (2019); the study involved exposing American, Australian, and British subjects to their national flags (or the flag of a nearby and culturally similar nation) prior to engaging those individuals in a tax-reporting game. For all three nationalities, seeing their countries’ flags increased their tax compliance significantly compared to seeing the flags of nearby nations; furthermore, Chan (2019) was able to disentangle this causal effect from that of related variables, such as trust in government or the legitimacy of tax-funded expenditures. However, while the enhanced salience of group identity and cohesion can increase tax compliance, the reverse is also true: information and attitudes that decrease the sense of shared identity or cohesion decrease tax compliance. This has been implied by laboratory studies in the past: for example, Alm et al. (2016b) showed that tax compliance was negatively correlated with racial diversity, and even earlier studies (e.g., Spicer & Becker, 1980) showed that tax compliance declined with growth in inequality. This may be why recent field studies have found that appeals to taxpayers’ sense of civic duty – an attempt to motivate compliance through increasing the salience of group identity – have been unsuccessful in countries characterized by high levels of heterogeneity, inequality, or both. For example, a field study in Detroit – America’s most racially segregated city, and one of its most economically stratified (Williams & Emamdjomeh, 2018) – found that appeals to group identity constituted the least successful approach to motivating greater tax compliance among city residents (Meiselman, 2019). In this study, a sample of just over 7,000 suspected tax evaders were sent letters with one of four messages (each an experimental treatment) intended to induce the recipients to file accurate tax returns that year; the message appealing to their sense of civic belonging (“Detroit’s rising is at hand. The collection of taxes is essential to our success”) yielded the lowest proportion of returns filed, an even lower success rate than the message emphasizing ease of filing (“For your convenience, City Income Tax Form D-1040(R) is enclosed with this letter”). By the same token, a field study conducted in Pakistan – a country with among the highest levels of ethnic inequality worldwide (Alesina et al., 2016) – found that appeals to group cohesion and civic duty were ineffective at motivating tax compliance (Koumpias & Martinez-Vasquez, 2019). Similar to the study in Detroit, a variety of different messages were tested in the Pakistan study, and the one emphasizing the ways that taxpayers could contribute to national development turned out to be less effective than messages that simply

Why do people pay taxes?  363 explained and eased the process of filing tax returns. These new findings suggest that efforts to harness social influence and group identity in the service of enhancing tax compliance must be sensitive to national context: cohesion-based appeals do not work in societies that are highly fragmented. However, other recent research has begun to explore social influence in new ways that foreground identity at a more local level. For example, Perez-Truglia and Troiano (2018) conducted a large field experiment showing that the threat of damage to individuals’ identity in micro-local contexts was a very effective method of gaining tax compliance. The innovation of this experiment was to make the neighbourhood, rather than the nation-state, the unit of analysis for social influence. The study was conducted with over 34,000 tax delinquents who owed half a billion dollars in three US states: Kansas, Kentucky, and Wisconsin. The individuals had already been informed that the tax authorities had posted their names, addresses, and amount of tax owed online. One treatment group then received a letter stating that their neighbours had been informed about the online list, and were thus aware of the subjects’ tax delinquency; the compliance rates of this group increased by 20 per cent, significantly more than that of the other two treatment groups, who received letters specifying either the financial penalties they faced or tax delinquencies by others in their area, respectively. This result is consistent with findings from an earlier experiment by Onu and Oates (2015), using data from online “chat rooms” for taxpayers: their analysis showed that individuals were much more influenced to comply by the risk of reputational damage or loss of social status in the eyes of others than they were by information about audit rates and penalties. This lever of informal social influence has been employed by some tax agencies – notably HMRC in the UK, which publishes a list of the country’s top tax evaders.6 Building on these findings, future research could explore the application of other reputational penalties, and how these approaches vary in effectiveness cross-culturally. For example, can a technique employed successfully in India – such as the troupes of drummers that the city of Bangalore sends to play outside the offices of tax delinquents (Bowler, 2013) – be transplanted to the Americas or to Europe? The uses of social media in this context also deserve particular attention, due to their low cost and broad reach, but risk incurring backlash due to public perception that such strategies are unnecessarily invasive and therefore illegitimate (Chrisafis, 2019). Future research should investigate the conditions under which tax authorities’ use of public media – both to investigate non-compliance and to publicize the names of tax evaders – would be considered legitimate. 2.3

The Macro Level

It has long been known that trust in public institutions plays a significant role in tax compliance; recent experimental research has advanced primarily by specifying the components of that trust, and modelling the mechanisms through which it affects behaviour. Key components of public trust include belief in the legitimate uses of tax revenues, as well as belief in the capacity of state institutions to monitor and sanction taxpayers effectively. In both cases, a sense of control or participation on the part of taxpayers seems to enhance compliance significantly.7 This insight has been taken in novel directions in a series of recent experimental studies. In terms of perceived legitimacy, recent cross-national research shows that tax compliance increases when subjects are told that their contributions are being directed toward institutions

364  Handbook on the politics of taxation that enjoy broad public support and legitimacy, such as fire departments (e.g., Pampel et al., 2019; D’Attoma, 2020). This is consistent with neo-institutional theories of tax policy (Steinmo, 1993), which suggest that the uses to which taxes are put will influence compliance rates, and with earlier experimental studies showing that individuals are more compliant to the extent that they can exercise control over the distribution of tax revenues. This holds both in laboratory studies – where compliance increases when subjects are given the opportunity to vote on spending (Wahl et al., 2010; Casal et al., 2016) – and in field experiments showing that taxpayers in direct democracies (where spending is decided by referenda) are more compliant than taxpayers in representative democracies (Pommerehne & Weck-Hannemann, 1996). However, the same principle works in reverse, in that compliance declines when taxpayers perceive that their contributions and control have been usurped by illegitimate institutional activity. Individuals in many countries appear to be highly sensitive to issues of institutional redistribution of tax funds to in-groups versus out-groups; compliance is therefore contingent on who receives the benefits of taxpayer contributions. The distribution of public benefits to immigrants is a contentious issue in many countries, particularly following the austerity measures imposed after the 2008 Global Financial Crisis (Bloemraad et al., 2016; Bloemraad et al., 2019). Consistent with these findings, Nemore and Morone (2019) found that individuals express greater willingness to commit tax evasion to the extent that they perceive immigrants as a “threat to society.” These results, based on Italian data from the European Values Survey, do not identify why these individuals perceive immigrants as a threat, whether in connection with labour market competition, criminal activity, or some other reason. However, our own work in progress (Guerra & Harrington, forthcoming) investigates this issue further, with original laboratory research conducted in Italy: the same population investigated by Nemore and Morone (2019). Our data, gathered in a survey that followed a tax experiment, revealed a strong nativist bias in attitudes toward compliance. That is, immigrants are broadly considered illegitimate recipients of public goods, even when they contribute as taxpayers themselves (see also Van Oorschot, 2006; Finseraas, 2008). The implication is that institutions redistributing tax funds to immigrants will be perceived as acting contrary to the preferences of many taxpayers and therefore as illegitimate. However, broader cross-national comparative research is needed on this issue, because there is some indication that such attitudes may differ significantly between countries organized around liberal market economies versus those organized as welfare state regimes (Eger, 2010; Brady & Finnigan, 2014). These, and other important institutional distinctions – such as a society’s existing levels of non-immigrant diversity in race, ethnicity, and religion – deserve sustained attention in future studies of tax compliance. Thus, while Alm et al. (2016b) find a negative correlation between tax compliance and racial diversity, it is unclear whether the problem is racial heterogeneity itself, or if that difference proxies a conflict between natives and immigrants. Finally, a series of recent experimental studies have offered new insight into the oldest and best-explored dimension of macro-level institutional influences on tax compliance: the monitoring and sanctioning capacity of the state. Unsurprisingly, compliance increases when individuals are made aware that the government knows they are withholding information relevant to their tax obligations, and can impose meaningful penalties in consequence. Recent field experiments have underscored how little it takes to reap significant rewards from merely reminding taxpayers of these monitoring and sanctioning tools. For example, in Bott et al.’s (2019) study of Norwegian taxpayers, the most effective of several interventions was a letter

Why do people pay taxes?  365 simply stating “The tax administration has received information that you have had income and/or assets abroad in previous years.” Without accusing recipients of anything, much less conducting an audit, simply informing them of state monitoring increased the share of individuals who reported foreign income or assets by 65 per cent – and had an enduring impact on foreign reporting a year later, far outstripping the impact of any other treatment. Similarly, in Meiselman’s (2019) study of taxpayers in Detroit, the most effective treatment in terms of response rate and tax remitted was the letter underscoring the penalties for non-compliance. Moreover, López-Luzuriaga and Scartascini (2019) found that these informational campaigns create positive “spillover effects” for compliance; for example, taxpayers informed about increased penalties for property tax evasion are more likely to comply with all their tax obligations, such as payment of sales and income taxes.8 But perhaps the most impressive studies, in terms of demonstrating cost-effective institutional strategies for monitoring and sanctioning, have been those focused on whistleblower programmes. These programmes leverage social forces, like the sense that rules should be applied fairly, to reduce the distance between taxpayers and taxation institutions in an unusual way. Rather than giving taxpayers control over the ways their contributions will be spent – which is procedurally complex and time-consuming – the whistleblower programmes innovated by national tax agencies give taxpayers control over the collections process. This participation not only lends legitimacy to the process of tax collection, thereby increasing tax morale and the intent to comply, but it is extremely cost-effective, making it politically popular. Recent laboratory experiments have shown consistently that offering subjects the opportunity to report peers for tax evasion increases compliance significantly (e.g., Buckenmaier et al., 2018; Masclet et al., 2019). This is reflected in real-world settings, where whistleblower programmes in the US, Italy, and Greece have reaped tens of millions in taxes and penalties from evaders within very short periods – ranging from two to five years – and at low cost, in the form of bounties paid to whistleblowers (Chohan, 2020). The main contribution of the recent experimental studies has been to uncover the social processes underlying these results. Among the most interesting and unexpected findings has been how willingly individuals participate in peer-reporting programmes, even in the absence of financial rewards – or, more strikingly, when reporting incurs costs to the whistleblowers themselves. For example, Masclet et al. (2019) found that tax collections were 30 per cent higher when subjects were given the opportunity to report evasion by their peers; even more remarkably, the study found that the majority of subjects (nearly 62 per cent) blew the whistle even though they reaped no financial benefit from doing so. In fact, whistleblowers were charged 0.80 Canadian dollars for each report they made, deducted from their earnings in the study. This finding, in which subjects choose to punish evaders despite incurring costs to themselves, suggests links to the group cohesion and social influence dynamics discussed above. These motivations deserve more attention in future research, in part to understand the ways that institutions can work with meso-level social processes to encourage tax compliance. Better understanding of these dynamics can also protect institutions from the costs and legitimacy risks of false whistleblower reports.

3. CONCLUSIONS Taxation, and one’s role as a taxpayer, are linked to variables spanning the range of social scientific inquiry. These include the individual psychology of emotions and responses to stimuli

366  Handbook on the politics of taxation such as reward and punishment, as well as the sociology of group norms and cohesion, and the impact of politics and institutional history on patriotism and trust in government. Because the phenomenon of individual tax compliance is so broad in its roots and implications, a general conclusion we can draw from this review is that further advances will require multi-method, interdisciplinary, and cross-national approaches. Indeed, recent contributions have combined experiments (both in the laboratory and in the field) with survey and/or observational data, as well as incorporating cross-national or cross-regional comparisons. The key findings of research published post-2017 can be summarized as follows. At the micro level, it appears that “carrots” are more effective than “sticks” in motivating tax compliance. That is, rewards increase desired taxpayer behaviours compared to punishments, particularly when the rewards come in non-financial forms, such as vouchers for “treats” like a spa day (Koessler et al., 2019). This does not mean that punishments are completely ineffective; rather, recent research has highlighted the limitations of motivating compliance through audits and fines. These include the cognitive biases that lead individuals to misperceive their chances to escape detection and fines when audited (Bernasconi & Bernhofer, 2020), along with the emotional backlash effects that may ensue in the long term after taxpayers are threatened with audits (Enachescu et al., 2019). Further research is needed on “carrot” and “stick” strategies, both to advance scholarly knowledge of the phenomenon of tax compliance and so that policymakers can use these tools more effectively. As an example, we need to understand better why individuals misperceive the connection between audits and punishment, and whether it is possible to reframe emotions about tax enforcement so that anger does not undermine compliance in future. On the “carrot” side, open issues include the effectiveness of non-financial rewards for compliance: vouchers for spa days may be compelling for Swiss taxpayers, but what about individuals in different cultures or less-developed economies? For policymakers, a salient question will be: how little investment can the state make in such rewards while maintaining effectiveness? If adding one sentence to a letter (as in Bott et al., 2019) can significantly change compliance outcomes at the national level, is there a way to make similarly minor, inexpensive changes to evoke the response to non-financial rewards discovered by Koessler et al. (2019)? At the meso level, informing taxpayers about the behaviour of their peers evokes social influence and group dynamics in ways that can potentially motivate higher compliance rates – but only if used in context-sensitive ways. For example, recent evidence suggests that individuals in developed countries like Norway become more tax compliant when informed that their neighbours are complying (Bott et al., 2019); by the same token, invoking patriotic feeling among individuals from countries like Australia, the US, and the UK can enhance compliance (Chan, 2019). However, such appeals to group identity appear to break down when applied to individuals in communities that are highly fragmented, whether by ethno-racial or economic divisions. Thus, appeals to group identity have been ineffective in communities where diversity is a source of high conflict, from countries like Pakistan (Koumpias & Martinez-Vazquez, 2019) to cities such as Detroit (Meiselman, 2019). However, a more narrowly targeted approach, focused on public shaming of tax delinquents in their immediate neighbourhoods, has shown promise. The technique, already used in practice by tax authorities from London to Bangalore (Bowler, 2013), proved effective in a field experiment across three US states (Perez-Truglia & Troiano, 2018), suggesting that further research should concentrate on developing this area of knowledge. Research should focus on identifying relevant communities for specific groups of taxpayers: the sociological theory

Why do people pay taxes?  367 of “reference groups” (Merton & Rossi, 1968), which analyses individuals’ responsiveness to evaluation by others, would offer especially useful insight. Social media shows particular promise for exploring these avenues, but backlash from public perceptions of illegitimacy constitute a significant risk, as the experience of several European countries has shown (Chrisafis, 2019). For policymakers, breakthroughs in these areas could bring more effective and cost-efficient compliance campaigns, to the extent that tax authorities can make legitimate use of media (both legacy and social forms) in targeting influence campaigns to specific subtypes of taxpayers (for example, the self-employed) and their reference groups. Finally, at the institutional level, recent studies have built on long-standing evidence that compliance increases when taxpayers view the uses to which tax revenues are put as legitimate. While the most direct way to ensure such perceptions of legitimacy is by allowing taxpayers to choose how their contributions are spent (as in the Swiss referenda examined in Pommerehne & Weck-Hannemann, 1996), institutions of direct democracy can be cumbersome and impractical in large nation-states. Some recent studies have identified targets of public expenditure that are widely accepted as legitimate, and therefore conducive to tax compliance, such as fire departments (e.g., Pampel et al., 2019; D’Attoma, 2020). Other research, such as Masclet et al. (2019), has taken this insight about the compliance benefits of control in an innovative direction by aligning taxpayers with enforcement institutions, rather than distributive ones; as they found, many individuals are willing to act as whistleblowers, even at cost to themselves, if it means enforcing rules viewed as legitimate. However, all these studies of macro-level institutional influence on tax compliance have thus far been limited to Europe and North America. Future research should investigate whether notions of legitimacy – both in terms of public expenditures and tax enforcement – prevalent in those regions apply elsewhere. While some recent studies suggest that national culture plays a negligible role in tax compliance (e.g., Guerra & Harrington, 2018), others suggest that cultural differences within and between countries may be more significant in the real world than within the laboratory (e.g., D’Attoma, 2020). By the same token, it will be particularly important for scholars and policymakers to understand the sources of perceived illegitimacy, such as the distribution of tax-funded benefits to immigrants. This issue – including its emotional components, like fear (Nemore and Morrone, 2019), and its significance to the contemporary political economy (Piketty, 2015) – illustrates the pressing need for broader cross-disciplinary approaches to tax compliance. This chapter is intended to inspire more of such research going forward.

NOTES 1. Drawing conclusions on the basis of survey data can be misleading, since actual behaviour may deviate from the attitudes as measured by survey responses (Ajzen & Fishbein, 1977; Guerra & Harrington, 2018). 2. For a review of survey-based studies on tax morale and its correlation with personal characteristics, social and institutional factors, see, among others, Torgler (2002). 3. For specific evidence on the external validity of tax compliance experiments, see Alm et al. (2010); cf. Choo et al. (2016) for an alternative view. For a general critique of laboratory experiments, see Levitt and List (2007). For robust evidence in response to that critique, see Falk and Heckman (2009), Camerer (2015), Frechette (2015), Harrison et al. (2015), Kagel (2015), and Kessler and Vesterlund (2015). 4. For an extensive discussion of models of tax compliance, see Hashimzade et al. (2013).

368  Handbook on the politics of taxation 5. Kastlunger et al. (2010) analyse gender role orientation of subjects using a questionnaire based on three psychometric measures: the femininity and masculinity scales of the Italian version of the Personal Attributes Questionnaire (Bonnes-Dobrowolny & Vicarelli, 1982), a 50-item preference rating scale of female-typical and male-typical occupations (Lippa, 2002), and six items from the Sex Role Identity Scale (Storms, 1979). 6. www​. gov​. uk/​g overnment/​p ublications/​p ublishing​- details​- of​- deliberate​- tax​- defaulters​- pddd (accessed October 2020). 7. See also Antinyan et al. (2020), who used administrative data from Armenia, and collected additional data via an online survey experiment with American participants. The results show that a more trustworthy government has a positive effect on citizens’ attitude toward whistleblowing. 8. See also Ortega and Scartascini (2020), showing that the method a government uses to communicate to taxpayers affects their tax behaviour. They conducted a field experiment with the National Tax Agency in Colombia with more than 20,000 taxpayers. They sent the same message to taxpayers with tax delinquencies (i.e., those who presented a tax declaration, had a tax to pay, but had not deposited the payment), but using different communication methods: letter, email, and personal visit. Their findings reveal that a personal visit is more effective than an email, and both are more effective than a letter, which is currently the most traditional method used by tax administrations.

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Why do people pay taxes?  373 Williams, A., & Emamdjomeh, A. (2018). America is more diverse than ever – but still segregated. Washington Post, 10 May. hwww​.washingtonpost​.com/​graphics/​2018/​national/​segregation​-us​-cities/​ (accessed 25 May 2021).

24. What do people want? Explaining voter tax preferences Sarah Berens and Margarita Gelepithis

1. INTRODUCTION In this chapter we set out to review what is known in Political Science about the tax preferences of voters, motivated by the belief that a solid understanding of public preferences is key to the analysis of politically feasible policy reforms. Tax preferences and tax attitudes have been the subject of increased scholarly attention within Political Science since the early 2000s. This increased scholarly attention has coincided with public outcries about the distribution of the tax burden exemplified by the Occupy Wall Street movement, and a renewed prominence of issues of tax justice on national policy agendas. In the United States (US) for instance, reforms that would radically increase the progressivity of the tax system were central in the 2020 campaigns of Democratic presidential candidates Bernie Sanders and Elizabeth Warren (Saez & Zucman, 2020a), garnering considerable popular support among younger cohorts. In this chapter, we focus on voter preferences regarding the taxation of individual citizens, and abstract from preferences about different forms of personal taxation (such as income taxes, social security contributions, value-added taxes, etc.) to concentrate the discussion on preferences about the overall level and progressivity of taxes that voters pay. The level and progressivity of taxation are of particular relevance to political scientists and other scholars interested in the distribution of wealth and income because, taken together, they determine how redistributive a tax system is. Using survey data from both the Global North and the Global South, we identify patterns of widespread and persistent public opposition to higher tax levels, but high and rising support for more progressive taxation. We review how public preferences about tax levels and tax progressivity are shaped by economic self-interest, but also by normative and causal ideas about the world. And we discuss how interests and ideas relevant to explaining tax preferences are themselves shaped by their institutional context. Looking more closely at the institutional determinants of tax preferences, it becomes clear that support for progressive taxation tends to be fostered only in institutional contexts that ensure those who pay more in taxes also benefit more from state spending. In Latin America, a region that encompasses many emerging economies and young democracies, the acquiescence of higher-income groups to progressive taxation is fostered by an institutional context in which benefits tend to be highly skewed toward the rich. Within the Organisation for Economic Co-operation and Development (OECD), the public is more supportive of tax progressivity in those countries where welfare state institutions ensure that benefits accrue predominantly to the middle classes. Overall, we suggest that some skepticism is in order about the extent to which public support for progressive taxation can underpin redistributive tax-and-transfer policies. The increasing support for progressive taxation that we see today should not be interpreted as 374

What do people want?  375 widespread support for the principle of redistribution, but rather as support for the much more conservative principle of reciprocity.

2.

INDIVIDUAL-LEVEL DETERMINANTS OF TAX PREFERENCES

2.1

The Willingness of Voters to Be Taxed Reflects Economic Self-Interest

People’s tax preferences are in part an expression of their own willingness to be taxed. In Public Economics, tax preferences are modeled as a function of the individual income of self-interested, rational individuals within a labor-leisure framework (Romer, 1975; Meltzer & Richard, 1981; Roemer, 1999). It is striking when studying tax preferences empirically the extent to which individual tax preferences do tend to reflect economic self-interest. Support for progressive taxation decreases with income (Barnes, 2015; Berens & Gelepithis, 2019; Edlund, 2003; Heinemann & Hennighausen, 2015), declining the further individual income lies above the mean (Finseraas, 2009; Rueda & Stegmueller, 2015). Although individuals with specific skills are not more likely to support progressive taxation, those in occupations with higher occupational unemployment rates are (Barnes, 2015). Economic recession increases support for tax progressivity among manual workers, whereas highly skilled professionals and managers are less willing to accept a higher share of the tax burden when unemployment rates rise (Dodson, 2017). Higher education levels, which reduce the risk of economic hardship and increase lifetime income (Rehm, 2011; Idema & Rueda, 2011), are also associated with reduced support for progressive taxation (Barnes, 2015; Berens & Gelepithis, 2019). Regarding tax levels, both high- and low-income earners are less likely to support higher taxes than those in the middle of the income distribution, reflecting the middle-class bias of public spending in rich democracies (Barnes, 2015). This highlights a key determinant of the willingness to pay higher taxes – reciprocity, or the expectation of receiving valuable goods or services from the state in return (Berens & Gelepithis, 2019). When forming tax preferences, individuals (or firms – for a review see Castañeda, this volume) consider both the cost of the taxes levied upon them and the corresponding personal benefit they derive from the provision of public goods under the fiscal contract of the modern welfare state (Levi, 1988). It is this insight – that willingness to pay higher taxes depends on receiving something valuable from the state in return – that explains why tax preferences are sensitive to the perceived trustworthiness of political institutions. It is well established that tax morale – the acquiescence of citizens to pay taxes – is sensitive to trust in the state and eroded by perceptions of clientelism and corruption (Bodea & LeBas, 2016; Timmons, 2010; Timmons & Garfias, 2015; Torgler, 2005, 2007; Torgler & Schneider, 2009).1 Political trust reduces fear that politicians will siphon off tax revenue to themselves rather than providing goods to benefit the taxpayer, and is therefore associated with less opposition to higher taxes (Barnes, 2015; Sears & Citrin, 1982) and reduced opposition to progressive taxes among the affluent (Flores-Macías, 2014). In the Latin American context, for instance, the ability of the Colombian government to credibly commit to spending on security policy increased support for tax progressivity among affluent voters, and support for higher taxes increased as political discretion in government spending was limited (Flores-Macías, 2018).

376  Handbook on the politics of taxation In addition to considering the way tax revenues are spent, there is evidence that materially self-interested voters also take into account whether higher taxes will negatively affect the economy, for example by disincentivizing individual effort, when forming tax preferences (Heinemann & Hennighausen, 2015). Such causal beliefs about human economic behavior tend to be rather stable. They are related but irreducible to ideology, which also remains a strong predictor of individual tax preferences (Roosma et al., 2016). 2.2

The Willingness of Voters to Be Taxed Reflects Perceived Self-Interest

Of course, voters are far from perfectly rational, and empirical work shows they are often poorly informed about tax matters (Bartels, 2005; Roberts et al., 1994). When citizens are poorly informed about how the tax burden is distributed across groups, or when they misperceive the level of income inequality, their tax preferences tend to be more conservative (Boudreau & MacKenzie, 2018; Franko et al., 2013). This can be seen in the US, where misperceptions about income inequality and distribution of the tax burden made possible widespread support for the regressive tax cuts in 2001 and 2003 among those who stood to lose from the reforms (Bartels, 2005). More recently, Boudreau and MacKenzie (2018) deploy a survey experiment in the wake of a tax reform in California in 2012, to illustrate that upwardly updating beliefs about the level of income inequality raises support for tax progressivity. Misperceptions about personal affluence also tend to dampen support for tax progressivity. Employing a survey experiment in Spain, Fernández-Albertos and Kuo (2018) find that those who learn that they are lower down the income distribution than they thought (in the lowest quintile) are more supportive of progressive taxation, whereas respondents above the median remain unaffected when informed about their true placement in the income distribution. Among high-income earners, the common belief that others are richer and will therefore bear the cost of progressive taxes increases support for such taxes (Cansunar, 2020, p. 3). 2.3

The Willingness of Voters to Be Taxed Reflects Normative Ideas

Although economic self-interest and perceived self-interest go a long way in predicting tax preferences, a still more accurate picture of the extent to which voters are willing to be taxed emerges when taking into account ideas about how the world ought to be. Normative ideas help make sense of policy preferences. There is evidence for instance that individuals do not necessarily choose the tax system that is most beneficial to their own material advantage, since they may also care about the wellbeing of others (Ackert et al., 2007; Heinemann & Hennighausen, 2015; Lü & Scheve, 2016; Scheve & Stasavage, 2016). The concept of “advantageous inequality aversion” captures the commonplace phenomenon whereby humans suffer utility losses when other people experience worse economic outcomes (Ackert et al., 2007, Lü & Scheve, 2016). Ideas about fairness play a crucial role in determining how other people’s economic wellbeing affects individual tax preferences. Support for higher and more progressive taxation declines with skepticism about whether inequality results from differences in individual effort (Heinemann & Hennighausen, 2015), and the willingness of individuals to be taxed is also sensitive to horizontal reciprocity, declining with the perceived unfairness of widespread free-riding on the tax contributions of others (Edlund, 1999; Barnes, 2015). Among low- and middle-income earners, more onerous tax demands are made of those perceived to be unfairly

What do people want?  377 favored by state institutions (Durante et al., 2014). Mass warfare for example fueled demand for more progressive taxation in Western democracies following public concerns that the wealthy had unfairly profited from the war while less privileged majorities had borne the brunt of its costs (Scheve & Stasavage, 2016). More recently, state-led bailouts within the banking sector following the financial crisis of 2008 fueled fairness-based compensatory demands for the rich to take on a higher share of the tax burden (Limberg, 2019). An interesting strand of public opinion research has tried to systematize how fairness concerns shape tax and spending preferences by identifying a number of criteria individuals tend to meet when they are considered “deserving” of tax-funded benefits. These include a lack of control over their economic situation, a familiar socio-demographic background that can inspire “social affinity” in the eyes of the taxpayer, and the ability to reciprocate financially over the life course (Oorschot, 2006; Larsen, 2008). People are more willing to pay taxes to fund state spending that accrues to “deserving” recipients like the elderly, rather than “undeserving” individuals like the unemployed (Larsen, 2008; Oorschot, 2006; Rothstein, 1998).

3.

PATTERNS OF TAX PREFERENCES IN THE OECD AND LATIN AMERICA

In this section we explore empirically how different income groups view tax increases around the world and compare this pattern with attitudes toward further tax progressivity. We make use of standardized public opinion surveys (International Social Survey Programme (ISSP), 2006, 2016; Latin American Public Opinion Project (LAPOP), 2012) and original survey data from Mexico and Brazil in order to investigate changes in attitudes over time. 3.1

Support for Higher Taxes Is Low and Stable

Across countries, higher levels of taxation are politically unpopular (Ballard-Rosa et al., 2017; Barnes, 2015; Roosma et al., 2016). In a sample of 27 OECD countries, an overwhelming majority of respondents consider taxes on both low- and middle-income individuals to be either about right or too high (Table 24.1). Only a very small minority of respondents considers taxes to be too low for low-income earners (3.3 percent) and for middle-income earners (4.8 percent). It is only for those with high incomes that a majority of respondents in our sample consider tax levels to be too low. Table 24.1

Tax level preferences

For those with …

Too low (%)

About right (%)

Too high (%)

high incomes taxes are …

52.09

28.08

19.82

middle incomes taxes are …

4.76

42.68

52.55

low incomes taxes are …

3.33

24.18

72.49

Note: Own calculation. The sample is restricted to high-income countries. Source: ISSP (2016).

378  Handbook on the politics of taxation 3.2

Support for More Progressive Taxes is Extensive and Increasing

Progressive taxation – where higher-income earners bear proportionately more of the tax burden – is widely viewed more favorably than tax increases. This is visible in the information about preferred tax levels at each level of income that is presented in Table 24.1, and recent research has underscored and substantiated this insight (Ballard-Rosa et al., 2017; Barnes, 2015; Roosma et al., 2016). Indeed the principle of tax progressivity enjoys the support of stable majorities of voters, in both advanced and developing economies (Ballard-Rosa et al., 2017; Berens & von Schiller, 2017; Roberts et al., 1994).2 Figure 24.1 shows average support for progressive taxation in advanced industrialized democracies using data from ISSP for 2006 and 2016. Support for tax progressivity tends to be lower in liberal and antipodean welfare states and in Denmark, which have until recently been associated with comparatively progressive tax systems (Ganghof, 2007, but see Saez & Zucman, 2020b).3 Support for tax progressivity increased over the decade in most countries, with the most remarkable expansion observable in New Zealand where it increased from 33 to 59 percent.

Source: ISSP (2006, 2016).

Figure 24.1

Support for progressive taxation in the OECD

What do people want?  379

Source: LAPOP (2012).

Figure 24.2

Preferences for progressive taxation in Latin America

Research on tax preferences in developing countries is limited by data availability, and the bulk of scholarly work usually focuses on willingness to pay since this is the primary challenge of poor, tax revenue-scarce countries (Bird, 2004). In this chapter, we discuss the Latin American context where some data on tax attitudes are available, and governments are capable of generating tax revenue, albeit suboptimally (Goñi et al., 2011). We can compare the picture from Figure 24.1 with patterns from Latin America, using public opinion data for 10 Latin American countries4 from the Americas Barometer5 LAPOP, from 2012 (Figure 24.2). These countries are comparable in terms of gross domestic product (GDP) and inequality, but have tax and welfare systems that offer a striking contrast to those of rich democracies. The distribution of responses is left skewed, showing pronounced support for a tax system that places a relatively larger tax burden on the rich compared to low-wage earners. In each country, majorities support either a moderately or decidedly progressive tax rate on income and capital.6 As in the OECD, support for tax progressivity in Latin America has been increasing over time. We illustrate this pattern with data from two representative subnational level surveys in Mexico (Puebla and Querétaro) and Brazil (Sao Paulo State) collected in November 2018 and August 2019 in Figure 24.3a.7 Comparing the average values from the subnational survey in Figure 24.3a, which are however fairly representative for Mexico,8 to tax progressivity support from LAPOP 2012 in Figure 24.2 shows an increasing demand over time. Compared to the national average of support for progressive taxation of 52 percent in Brazil in LAPOP 2012, we observe an average of 77 percent in 20199 in Figure 24.3b. Despite differences in the wording of the survey instruments and limitations to aggregate from the subnational to the national level, we notice an increase in support for progressive taxation within this decade from the descriptive statistics. The mounting demand for progressive taxation in Brazil is

380  Handbook on the politics of taxation

Source: (a) PQMex survey (2018); (b) Sao Paulo State Survey Brazil (2019).

Figure 24.3

Preferences for progressive taxation in Mexico and Brazil

particularly striking, given the outcome of the presidential elections in November 2018, which brought the right-wing populist candidate Jair Bolsonaro into office. 3.3

Support for Tax Progressivity: A Straightforward Expression of Support for Redistribution?

It is tempting to view high aggregate levels of support for progressive taxation as a policy-specific expression of public support for redistribution. This view does not hold up well to empirical scrutiny, however. Public opinion data from the ISSP (2016) in Figure 24.4b reveals that in some countries, such as France, Ireland, Australia, or the United Kingdom, a majority of respondents strongly favor greater state-led redistribution while at the same time being only mildly supportive of tax progressivity compared to the OECD average. Despite sharing similar individual-level determinants, support for redistribution10 and support for tax progressivity are not well correlated – ρ1=0.218 for the OECD ISSP 2006; ρ3=0.053, p-value 0.067 for Mexico (PQMex survey, 2018); ρ4=0.035, p-value 0.283 for Sao Paulo state survey (2019); ρ5=0.027, p-value 0.020 for LAPOP (2012). At the aggregate level, the regression line between tax progressivity preferences and support for redistribution for OECD countries is flat with few countries lying close to the diagonal in Figure 24.4b. In Latin America, tax and redistribution preferences are coherent in Guatemala, Peru, Costa Rica, and Chile (Figure 24.4a). In all other countries respondents are more supportive of progressive expenditure than progressive taxes. In the remainder of the chapter, we look at how support for tax progressivity relates systematically not just to individual-level characteristics, but also to the way that tax revenue is spent

What do people want?  381

Source: LAPOP (2012, 2016); own calculations.

Figure 24.4

Correlation of aggregated support for progressive taxation and preferences for redistribution calculations

in particular institutional contexts. Across both developing and rich country contexts, people are less likely to oppose progressive taxation if they are confident they will benefit from public spending. Rather than reflecting support for redistribution, support for progressive taxation more accurately reflects support for the much more conservative principle of reciprocity.

4.

RECIPROCITY NOT REDISTRIBUTION: A CLOSER LOOK AT THE INSTITUTIONAL DETERMINANTS OF TAX PREFERENCES

4.1

Tax Preferences and Institutional Variation in the OECD

Institutional explanations of tax preferences in OECD countries take as their point of departure a seminal distinction between the redistributive and the social insurance functions of modern welfare states (Ganghof, 2007, but see Saez & Zucman, 2020b).11 Welfare states fulfill two distinct functions, a “redistributive” function, transferring resources from richer individuals to poorer individuals, and an “insurance” function against the loss of income from the realization of various social risks. Since an individual’s support for higher tax levels depends on the extent to which they are eligible to receive the benefits of state spending, public support for high levels of taxation is strengthened by welfare systems characterized by earnings-related benefits – systems that “follow the biblical Mathew principle of giving more, in absolute terms, to the rich rather than the poor” (Korpi & Palme, 1998, p. 672; more recently Brady & Bostic, 2015). Support for tax progressivity also echoes this famous institutionalist logic of reciprocity. Using individual-level data from the ISSP’s Role of Government survey (Korpi & Palme,

382  Handbook on the politics of taxation 1998: p. 672; more recently Brady & Bostic, 2015) and country-level data on the distribution of welfare benefits, Berens and Gelepithis (2019) show how mature post-industrial welfare states generate different patterns of public support for progressive taxation, depending on the extent to which they emphasize redistributive spending “targeted to those without earnings,” or spending on insurance against loss of earnings. The progressivity of social expenditure is associated with weaker support for more progressive taxation. The average income household is less supportive of greater tax progressivity in countries with pro-poor benefit systems than in countries where programs that insure against middle-class risks make up a relatively larger part of social expenditure. 4.2

Tax Preferences and Institutional Trust in Latin America

While there is substantial cross-national variation in the progressivity of social spending in mature post-industrial welfare states, the primary beneficiaries of state spending are either average or low-income earners. This is not the case in Latin America. In the Latin American context, public spending commitments are often characterized as “truncated”, a term used to convey heavy investment in employment-based social insurance, and the existence of flat or regressive social transfers and informal access barriers that limit the benefits provided to the poor (De Ferranti et al., 2004; Diaz-Cayeros et al., 2016; Skoufias et al., 2010). Although the social policy landscape is currently going through a period of change, with governments increasingly investing in non-contributory social protection programs (Holland, 2018), according to Holland and Schneider (2017; Brooks, 2015; Carnes & Mares, 2014), these reforms do not yield a particularly redistributive effect. In truncated welfare states, redistribution is limited, and trust that the state will honor its public spending commitments equates to confidence that the affluent will get plenty back from their tax contributions. In the truncated welfare states of Latin America, it is therefore the rich that stand to gain most from tax revenue if the state honors its spending commitments, due to the regressive character of the social protection system. Average earners have less reason to believe that a reliable state will spend its tax revenues in their favor (Holland, 2018). This is reflected in patterns of support for tax progressivity. As Berens and von Schiller (2017) show with data from LAPOP for 10 Latin American countries in 2012, when the state is perceived as being unreliable and incapable of handling tax revenue in a purposeful and sensible way, high-income earners in Latin America are less likely to accept comparatively higher tax contributions (see also Flores-Macías & Sánchez-Talanquer, 2020). Conversely, where the state is seen as a reliable actor in the provision of public goods, the rich express insignificant opposition to the idea of progressive taxation. At the highest levels of institutional respect, the rich even support the idea of progressive income taxes. In the Latin American context, accepting a more or less extensive burden of taxation is highly intertwined with agreeing to a fiscal contract with the state in the first place. Here too institutional quality and reliability are a key driver. A less generous social protection system is associated with opting out of the fiscal relationship with the state and working in the informal economy in Latin America (Berens, 2020; see also Castañeda et al., 2020). Institutional variation across both the OECD and Latin America therefore underscores that the extent to which citizens can credibly expect to benefit from public spending financed by their tax contributions is highly influential in shaping tax preferences. In the Latin American

What do people want?  383 context, this logic of reciprocity offers some insight into the region’s longstanding and well-documented struggle to expand the tax base following trade liberalization in the 1980s and 1990s and the corresponding shift toward personal income and consumption taxes (Bastiaens & Rudra, 2018; Fairfield, 2013).

5.

CONCLUSION: REDISTRIBUTION, RECIPROCITY, AND TAX PREFERENCES

This chapter has reviewed voter preferences regarding the taxation of individual citizens, concentrating the discussion on preferences about the overall level and progressivity of taxes that voters pay, since it is these tax system parameters that determine how redistributive a tax system is. Using survey data from both the Global North and the Global South, we identified widespread and persistent public opposition to higher tax levels, but high and rising support for more progressive taxation. Tempting as it is to see the latter pattern as indicative of public appetite for redistribution through tax policy, closer analysis suggests otherwise. Echoing an institutionalist logic of reciprocity most commonly associated with Korpi and Palme (1998), the extent to which citizens can expect to benefit from public spending financed by their tax contributions is highly influential in shaping support for progressive taxation, in both rich and developing country contexts. In Latin America, the acquiescence of higher-income groups to progressive taxation depends on their confidence that the state will honor public spending commitments from which they are likely to reap substantial benefits. And within the OECD, the public is less supportive of tax progressivity in countries with pro-poor benefit systems than in countries where programs that insure against middle-class risks make up a relatively larger part of social expenditure. Tax progressivity is therefore not just a policy-specific way of expressing support for redistribution. Rather, it signals support for a more conservative principle – reciprocity – that is central to both interest-based and fairness-based accounts of tax preferences reviewed here. Future research might further scrutinize the mismatch between preferences for redistribution and tax progressivity, to better understand how voters link public spending with public financing. Most research on tax preferences either abstracts from the tax mix as this chapter has done, or focuses on the income tax as the most visible and progressive type of tax. Preferences regarding consumption taxes, capital taxes, and tax exemptions deserve further scrutiny given their importance in shaping overall tax system progressivity. In tax policy research in developing countries, most work focuses foremost on examining determinants of the willingness to be taxed. But once citizens agree to be taxed, what are the factors that allow governments to impose heavier tax burdens on those who have greater capacity to pay? In a context of weak institutions and low perceived vertical reciprocity, which factors or tax schemes incentivize or convince voters, especially the rich, to agree to greater tax progressivity? Survey experiments can be powerful tools for investigating individual preferences, and high-quality surveys in developing countries have become easier to conduct in recent years, making use of a range of quality control techniques (see Lupu & Michelitch, 2018). In addition, online surveys have become a valuable tool, yielding equally efficient results as face-to-face surveys (Coppock & McClellan, 2019). Conjoint analysis, list experiments,

384  Handbook on the politics of taxation vignettes, and priming experiments, which allow causal identification of decisive factors, are promising methodological innovations that can be valuable in future research seeking to explain tax preferences.

ACKNOWLEDGMENTS Funded by the Deutsche Forschungsgemeinschaft (DFG, German Research Foundation) – Project number 374666841 – SFB 1342.

NOTES 1. Guerra and Harrington (this volume) explore the determinants of tax morale in greater detail. 2. See Franko et al. (2013) and Page et al. (2013) for recent insights into why such preferences often do not translate into policy. 3. We restrict our sample to high- and middle-income countries, using the World Bank’s classification based on gross national income per capita. We only display countries which have been surveyed in both 2006 and 2016. 4. Data on tax preferences is scant compared to data on redistribution or social policy preferences. The tax progressivity item in LAPOP was only asked in 2012 and for a subset of Mexico, Guatemala, Costa Rica, Colombia, Peru, Chile, Uruguay, Brazil, Venezuela, and Argentina. Only half of the respondents of the regular LAPOP sample received the question. 5. We thank LAPOP and its major supporters (United States Agency for International Development, Inter-American Development Bank, and Vanderbilt University) for making the data available. LAPOP asks respondents: “For every 100 [local currency] that a rich person earns and 100 [local currency] that a poor person earns, in your opinion, how much should each pay in taxes?” Answer categories are fixed and allow respondents to choose between a distribution of 30 for the rich and 30 for the poor (a clearly regressive option), 40 for the rich and 30 for the poor (a moderately progressive option), and a ratio of 50–20 (a clearly progressive option). 6. We can assume that voters do not distinguish between wage income and income that results from capital income when answering the survey question, but rather think about returns in general. 7. We adjusted the LAPOP item to include an option for the middle-income group to avoid false interpretation from the respondent and an option which does not place the highest burden on the middle class, as the “regressive” option in the LAPOP item suggests (30 – paid by the rich; 30 – paid by the poor). We asked: “Concerning the governmental distribution of tax money, I would like to know what comes closest to your opinion and to tell me which of the following options you prefer.” The following three fixed-answer categories were provided: “A high income person must pay 50 pesos of taxes, a middle income person must pay 30 pesos and a low income person 20 pesos of taxes,” “A high income person must pay 40 pesos of taxes, a middle income person must pay 30 pesos and a low income person 30 pesos for taxes,” or “A high income person must pay 33 pesos, a middle income person must pay 33 pesos and a low income person must pay 33 pesos.” 8. Both states are in close proximity to Mexico City. Puebla is a poorer state, with a GDP per capita value below the national average, whereas Querétaro scores above. Levels of violence are below average in both states. 9. We collect randomized survey data for 1,008 respondents in Sao Paulo state and make use of the same survey question. Sao Paulo state is the most populous state in Brazil, with highly urban cities such as Sao Paulo, but it also contains very rural localities. Sao Paulo state reaches values that are close to the national average in terms of unemployment, export as percentage of GDP, and income inequality (IBGE, 2017). 10. Proxied by support for the statement that the government should seek to reduce income differences. 11. Institutional differences between welfare regimes (Holland & Schneider, 2017) continue to shape social policy preferences in many ways (Esping-Andersen, 1990, p. 58). Despite this,

What do people want?  385 Esping-Andersen’s typology has seemingly little explanatory power relating to patterns of support for tax progressivity.

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What do people want?  387 Roosma, F., Oorschot, W., & Gelissen, J. (2016). A just distribution of burdens? Attitudes toward the social distribution of taxes in 26 welfare states. International Journal of Public Opinion Research, 28(3), 376–400. Rothstein, B. (1998). Just Institutions Matter: The Moral and Political Logic of the Universal Welfare State. Cambridge University Press. Rueda, D., & Stegmueller, D. (2015). The externalities of inequality: Fear of crime and preferences for redistribution in Western Europe. American Journal of Political Science, 60(2), 472–489. Saez, E., & Zucman, G. (2020a). Online Tax Simulator. www​.taxjusticenow​.org (accessed May 25, 2021). Saez, E., & Zucman, G. (2020b). The Triumph of Injustice: How the Rich Dodge Taxes and How to Make Them Pay. W. W. Norton and Company. Scheve, K., & Stasavage, D. (2016). Taxing the Rich: A History of Fiscal Fairness in the United States and Europe. Princeton University Press. Sears, D. O., & Citrin, J. (1982). Tax Revolt: Something for Nothing in California. Harvard University Press. Skoufias, E., Lindert, K., & Shapiro, J. (2010). Globalization and the role of public transfers in redistributing income in Latin America and the Caribbean. World Development, 38(6), 895–907. Timmons, J. F. (2010). Taxation and credible commitment: Left, right, and partisan turnover. Comparative Politics, 42(2), 207–227. Timmons, J. F., & Garfias, F. (2015). Revealed corruption, taxation, and fiscal accountability: Evidence from Brazil. World Development, 70, 13–27. Torgler, B. (2005). Tax morale in Latin America. Public Choice, 122(1–2), 133–157. Torgler, B. (2007). Tax Compliance and Tax Morale: A Theoretical and Empirical Analysis. Edward Elgar Publishing. Torgler, B., & Schneider, F. (2009). The impact of tax morale and institutional quality on the shadow economy. Journal of Economic Psychology, 30(2), 228–245.

25. Business interest groups and tax policy Néstor Castañeda

1. INTRODUCTION In contexts where exit threats from internationally mobile capital are credible and business interest groups are over-represented in the policymaking process, increasing capital taxation has turned out to be an unrealistic option for both left and right governments (Genschel, 2002; Beramendi & Rueda, 2007; Jiménez, 2015; Fairfield, 2015a; Castañeda, 2017; Castañeda & Doyle, 2019). Across the world, corporations are now paying significantly lower tax rates than before the 2008 financial crisis.1 Business interest groups seem to be on the winning side of tax policymaking. They have relatively clear tax policy preferences – they are supposed to prefer lower levels of corporate and direct taxation, or at least, tax burdens that do not harm investment returns; and their ability to successfully promote these preferences depends on how well organized they are as special interest groups. In fact, recent scholarship on business influence has demonstrated that higher levels of internal coordination and integration to policymaking forums make them more influential across different policy areas – i.e., labour market policies and tax policy (Martin, 1999; Martin & Swank, 2004; Fairfield, 2015a; Castañeda, 2017). Not surprisingly, there is strong empirical evidence that business interest groups’ ability to influence tax policy will be rather limited where they are not well coordinated (Castañeda, 2017). In those scenarios, sector-centred business associations and conglomerates would rather focus on getting sector- or industry-level tax benefits (e.g., tax deductions, tax credits, etc.), and only those with informational advantages and enough resources available for lobbying can be successful (Drutman, 2015). Consequently, progressive governments could probably release some pressure on indirect taxation and introduce more progressive taxes when facing weakly organized business sectors. From this point of view, the business community can only influence the fiscal policymaking process and easily promote their preferred public policies where they are highly coordinated as special interest groups. Scholarship has also shown that the effect of business coordination on policymaking is usually magnified by the salience of policy issues (Smith, 2000; Drutman, 2015). Indeed, business interest groups seem to be more influential when policy issues are more technical and less salient for public opinion. Tax policy, for example, is both complex and not very salient.2 Consequently, increasing corporate taxes seems to be unfeasible where business interest groups are highly coordinated. In these contexts, governments are forced to increase consumption and payroll taxes to fund their activities and transfer the tax burden to less-organized groups of citizens. Based on this scholarship, this chapter explores the circumstances under which business interest groups are more likely to advance their tax policy preferences. The chapter contends that implementing progressive tax structures is only possible where business interest groups are fragmented and weakly coordinated for collective action. 388

Business interest groups and tax policy  389 The chapter is organized as follows. First, I discuss the concept of business power and introduce the notion of business coordination. I argue that certain organizational features of business interest groups make them more able to use their structural and instrumental power to influence tax policy. Second, I use the notion of business coordination to understand the organizational sources of business power. Third, I use the case of tax policy in Latin America to illustrate how business coordination could shape tax policy in developing economies. In this section, I pay special attention to the redistributive consequences of business coordination in highly unequal scenarios. Finally, in the conclusion I summarize my argument and briefly discuss some possible avenues for further research.

2.

BUSINESS POWER AND TAX POLICY

Literature on special interest groups has long argued that tax structures reflect the distribution of power among interest groups and the discrepancies in their policy preferences (Bartlett, 1973; Salamon & Siegfried, 1977; Hettich & Winer, 1988; Steinmo, 1989). This scholarship provides empirical evidence that business interest groups can influence policymaking not only where they can afford to do so, but especially, where they are able to solve their own internal coordination and information problems (Bernhagen, 2007). On the one hand, this literature shows that the interest groups’ degree of internal coordination explains their capacity to influence welfare, social, and economic policies (Martin & Swank, 2004; Culpepper, 2011; Castañeda, 2017). On the other hand, this scholarship also shows that different patterns in the organization of capital and its relationship with labour affect public policy outcomes (Rueda & Pontusson, 2000; Schneider, 2013). While the influence of business interest groups in the policymaking process is incontrovertible, its causal mechanisms and consequences are still overlooked. We know that money buys influence (De Figueiredo & Richter, 2014) and the patterns of business coordination matter (Martin, 1991; Swank & Martin, 2001; Martin & Swank, 2004, 2012; Castañeda, 2017). However, we know very little about the organizational attributes that make business interest groups influential in the policymaking process and the causal mechanisms that transform such influence into specific policy outcomes (Coen et al., 2010; Kluver, 2013). This knowledge gap is particularly salient in the field of tax politics. In tax policymaking, business interest groups’ political action is a “reactive” strategy. It is only triggered when their policy preferences differ substantially from those of the policymakers. As extensively discussed by political economy scholars, policymakers (e.g., presidents or finance ministers) are the first movers in the policymaking process. They are usually in an advantageous position for fiscal bargaining. Their policy preferences shape public policy debates (Cox & McCubbins, 2005; Spiller & Tommasi, 2007). Obviously, not all policymakers have the same policy preferences. For example, one could identify at least two types of policymakers: progressive policymakers who privilege redistribution over austerity (even if it requires them to increase taxes) and conservative policymakers who privilege austerity over redistribution (they prefer to cut spending rather than increase taxes).3 Recent research on business interest groups shows that they adapt their political strategies to the policymakers’ preferences and electoral incentives (e.g., Mahoney, 2008; Baumgartner et al., 2009; Hojnacki et al., 2012; Kluver, 2013; Castañeda, 2017; Castañeda & Doyle, 2019;

390  Handbook on the politics of taxation Kluver, 2020). However, beyond the fact that business interest groups are usually “reactive” actors, research on their role in fiscal policymaking is still very limited (Coen et al., 2010; Coen & Grant, 2016) and does not provide any conclusive answers to the questions on when and how they influence tax policies (Martin, 1989; Culpepper, 2011). Research on business interest groups provides useful insights about the sources of business power and the dynamics of business political influence, but it definitively overlooks the effect that different patterns of business coordination – i.e., their organizational structure for policy influence purposes – could have on the relationship between business and government and its policy consequences. For example, long-established scholarship on business interest groups argues that there are two sources of business political influence: structural and instrumental power (Miliband, 1969; Lindblom, 1977). Structural power refers to the ability of business interest groups to influence public policies by withholding investment flows and decisions that directly affect short-term economic growth (Lindblom, 1977; Culpepper, 2015). Instrumental power refers to their actual capacity to spend resources in political actions like lobbying, campaign spending, or informal networking (Miliband, 1969; Culpepper, 2011). The notion of structural power focuses on the relations between business and state. The notion of instrumental power focuses on the resources and strategies that business interest groups use to influence policies. The study of business structural power has been particularly prolific, especially after the 2008 financial crisis (Culpepper, 2015), because of the renewed scholarly interest in the “mutual dependence between holders of capital and the administratively superordinate authority” (Culpepper & Reinke, 2014; Culpepper, 2015, p. 398). For example, the notion of market leverage as an expression of policymakers’ expected reaction to fluctuating capital flows could be a useful way to illustrate the nature of structural power (Mahon, 1996; Castañeda, 2017). From this perspective, business interest groups are more influential in contexts where political stability depends on their performance or their investment flows; their political power relies on the credibility of disinvestment threats (Lindblom, 1977; Mahon, 1996; Fuchs, 2007). Therefore, one could expect that business interest groups will be more influential in less diversified economies because economic and political stability depends on the performance of some few industries or firms. Only in such scenarios, one could expect that disinvestment threats are credible. This emergent literature also discusses a necessary distinction between structural and instrumental power. Indeed, it seems crucial to distinguish whether policy outcomes are the result of business structural or instrumental power (e.g., Fairfield, 2015b; Young, 2015) – i.e., to identify which one is more decisive (Culpepper, 2015, p. 400). The distinction between structural and instrumental power is useful to identify some of the sources of political influence, or the firms or groups of firms that are better positioned to influence policies. However, it tells us very little about the organizational mechanisms behind business political action, how these mechanisms shape business interest groups’ preferences and their strategies for political action, and finally, under which circumstances business interest groups successfully set public policy agendas (Vogel, 1987). In order to do so, one would need to clearly identify the organizational structures that make business interest groups more influential in the policymaking process. For example, one would need to understand whether business unity and integration to policymaking forums make business more or less successful in keeping control of the political agenda (Smith, 2000). Indeed, highly coordinated business communities are usually better integrated to the policymaking

Business interest groups and tax policy  391 process. They also have better access to pivotal actors in the law-making process. And it is precisely these organizational features, rather than their relative structural power (or their market leverage), that make them better equipped to push their policy agendas (Martin & Swank, 2004, 2012; Castañeda, 2017). In contrast, moderately coordinated business communities are more exposed to free-riding and informational problems. They are only partially integrated to policymaking boards and their access to pivotal policymakers varies substantially from one industrial sector to another. These organizational features make them more prone to pursue limited policy agendas (Martin & Swank, 2004, 2012; Castañeda, 2017). In this chapter, I argue that these organizational attributes determine the ability of business to influence tax policy and the set of firms (or groups of firms) that benefit from political influence (i.e., organized business interest groups, economic conglomerates, or small and medium-sized enterprises (SMEs)). The rest of the chapter explores these organizational attributes and their consequences for tax policy. I discuss the notion of business coordination and its advantages to explain business influence in tax policymaking. Then, I illustrate the empirical implications of my argument by explaining how business interest groups influence tax policy in highly unequal societies. 2.1

Defining Business Coordination

The so-called business “instrumental” power consists of a set of attributes and resources that enable business interest groups (e.g., business associations, economic conglomerates, groups of firms, etc.) and firms to participate in the decision-making process and influence policy outcomes (Culpepper, 2015). It refers to several mechanisms of political influence: networks, participation in consultation committees, partisan linkages, organizational capacity, economic resources, and more generally, lobbying resources. In American politics, for example, the most common proxy for business instrumental power is the amount of money the business community spends in campaign contributions and lobbying. In fact, the increasing amount of data available on federal campaign contributions and lobbying has bolstered the study of business interest groups and their political influence in the United States (Bauer et al., 1963; Hall & Wayman, 1990; Akard, 1992; Smith, 2000; Hacker & Pierson, 2002; Vogel, 2003; Waterhouse, 2015; Drutman, 2015). These data have been crucial to understand business interest groups’ policy preferences and measure how influential they are in the policymaking process. Similar studies can be found for the case of the European Union and other developed countries (Kluver, 2013; Dur & Mateo, 2016). Beyond Western democracies, there are only a few countries where official or unofficial records of campaign contributions from business to political parties or individual politicians are available to the public. Some countries have recently implemented transparency laws that require politicians to disclose their campaign financial information, but the scope of these laws is still very limited (Norris & Van Es, 2016). In the absence of reliable data on campaign contributions and lobbying activities, the challenge is to find alternative ways to measure business instrumental power. This is an onerous task for several reasons. First, measuring the actual dimension of formal or informal social networks, or the family links between business and politicians, is a complicated task. Most of the time, we depend on information provided by biased informants or not completely reliable process-tracing analyses. Second, it is difficult to create reliable indicators for business

392  Handbook on the politics of taxation instrumental power if we do not really have theoretical mechanisms to evaluate how different expressions of it are interconnected. A reliable alternative is to assess the ability of the business community to influence the policymaking process as a result of their capacity for organizing its members for effective political action. As contended by the long-established scholarship on organizational theory, interest groups are more influential when they are internally coordinated (Olson, 1965). When the business community coordinates its political action, their policy preferences transcend the narrow or particularistic demands of their members, and business unity is easier to achieve (Smith, 2000). Business unity and clearer policy preferences substantially improve their bargaining position in the policymaking process (Martin & Swank, 2004, 2012). Therefore, business interest groups’ capacity to solve their own collective action problems could constitute a good metric of their capacity to influence the policymaking process (Smith, 2000; Martin & Swank, 2004, 2012; Castañeda, 2017). Indeed, we can define business coordination as the capacity of business interest groups to coordinate their members’ efforts for political action. Then, we can also argue that a higher level of business coordination will make business more influential in the policymaking arena, particularly when policy issues are technically complex and not very salient for public opinion (Culpepper, 2011). Obviously, the mechanisms of business coordination have evolved differently across countries. Peak business organizations (some people prefer to call them encompassing business associations or economy-wide business associations) flourished after the consolidation of the industrialization process in both developed (see Martin & Swank, 2008, 2012) and developing countries (see Streeck & Schmitter, 1999; Fuchs, 2007; Schneider, 2004). However, there is a more recent pattern of divergence in the mechanisms that business interest groups use to coordinate their political action. While some countries have witnessed the consolidation of traditionally powerful peak employers’ associations, other countries have recently witnessed the emergence of several sector-oriented business groups (sector coordination), or even highly fragmented and pluralist business associations (Martin, 1991; Hall & Soskice, 2001; Martin & Swank, 2012; Schneider, 2013). This is obviously not a minor issue because these divergent patterns of business coordination ultimately explain cross-country variation in the capacity of business to influence policies. For example, Martin and Swank (2012) show that business interests are quite influential in countries where business organizations are highly coordinated (e.g., Denmark and Sweden).4 They also show that business interest groups are less influential in countries where business organizations are coordinated only at the sector level (e.g., Italy, Germany) or in decentralized models of business coordination where the business community does not usually coordinate its political strategies (e.g., United Kingdom and United States). Based on these insights, one could argue that business interest groups are better equipped to unleash their instrumental power arsenal – and being more influential – in contexts where they are better coordinated for collective action. Business interest groups are better positioned to put in place their preferred policies if there are coordination mechanisms that maximize their sources of instrumental power. In other words, business coordination – rather than structural power – is a necessary condition for instrumental power to make business more influential. Unsurprisingly, assessing the degree of coordination among business interest groups is challenging. For example, one could use the notion of business centralization as a proxy of business coordination and assume that the business community is better coordinated where economy-wide business organizations are predominant (Wallerstein et al., 1997; Martin

Business interest groups and tax policy  393 & Swank, 2008, 2012). However, business interest groups can also be coordinated around sector-oriented organizations or even economic conglomerates (Schneider, 2013). Also, the mere existence of economy-wide business associations or pivotal economic conglomerates means nothing for policy influence activities if such organizations have limited or no access to decisive policymaking forums. Therefore, we would also need to evaluate whether business interest groups effectively engage with relevant policymakers. That requires us to assess whether representatives from peak associations or business conglomerates regularly meet with high-ranking government officials or labour union delegates, and whether they are relevant members of decisive policymaking forums. In other words, we would need to assess whether business interest groups are crucial players in relevant mechanisms of market coordination (Iversen, 1999; Iversen & Pontusson, 2000; Hall & Soskice, 2001). For example, in coordinated market economies, the business community usually participates in crucial bargaining instances like competitiveness policy forums, tax policy committees, international trade commissions, labour policy forums, etc. In fact, several scholars have shown that in macro-corporatist policy environments, peak business organizations “cooperate closely with government and labour at the highest level and firms are more likely to induce policies through the collective bargaining process or in tripartite advisory commissions of administrative governmental agencies” (Martin & Swank, 2012, p. 17). They also show that “highly organized associations offer governments an institutional vehicle through which to build business support and compliance for [social welfare] initiatives” (Martin & Swank, 2012, p. 17). In contrast, in sector-coordinated or more decentralized policy environments, business interest groups play a more modest role in policymaking forums.5 In this section, we have defined business coordination as the capacity of the business community to organize their members (firms or groups of firms) for political action. We have also contended that this organizational capacity is an essential condition to release effective tools of instrumental power and make business more influential in the policymaking process. Now, let us use this concept to understand the role of business in tax politics. 2.2

Business Coordination and Taxation

The discussion above is particularly relevant for the study of tax politics, because there is empirical evidence that progressive tax reforms are less likely to be implemented in contexts where business interest groups are highly coordinated to influence the policymaking process (Fairfield, 2015a; Castañeda, 2017; Castañeda & Doyle, 2019). In fact, this literature shows that, in those contexts, business interest groups might effectively weaken policymakers’ first-mover advantage. This literature also provides an analytical framework to understand the interaction between business and policymakers in tax policymaking. For example, they show that, when policymakers and business interest groups have similar tax preferences (e.g., when the finance minister is fiscally conservative), tax reforms will be only partial because neither of them is interested in altering the tax structure to promote fiscal redistribution. However, if there is no policy convergence (e.g., when the finance minister is fiscally progressive), policymakers will try to increase direct taxation while business interest groups will try to block/soften such initiatives. If business interest groups are highly coordinated, they will have substantial

394  Handbook on the politics of taxation Table 25.1

Business coordination and tax policy Patterns of business coordination

Policymakers’ preferences

Low (decentralized)

High (centralized)

Conservative

I. No policy change is likely – if

II. Tax cuts are likely – indirect

(austerity >

fiscal space is contracted, indirect

taxes are likely to increase

redistribution)

taxes are likely to increase

Progressive

III. Progressive tax reforms

IV. Partial policy changes are

(redistribution >

are more likely – including tax

likely – personal income taxes and

austerity)

loopholes to protect powerful

indirect taxes are likely to increase

business sectors

organizational resources available to block or soften policymakers’ attempts to implement progressive tax reforms. Following this line of argumentation, progressive tax reforms seem to be more feasible in contexts where business interest groups are only moderately coordinated or not coordinated at all. In these contexts, the business community’s response to progressive governments’ tax agenda is usually weaker (or at least fragmented) because either they are not well integrated to policymaking boards or they cannot release enough organizational and financial resources for political action (or these resources are not uniformly distributed across different industries). Consequently, business interest groups are not able to block progressive policymakers’ initiatives. They are probably only able to palliate potential negative impacts on certain industries (e.g., those industries with most resources available for lobbying). Table 25.1 illustrates the interaction between policymakers’ preferences and patterns of business coordination. It shows that progressive tax reforms are more likely (see quadrant III) in contexts where: (1) policymakers have clear progressive fiscal preferences – i.e., they strictly prefer redistribution over austerity, and (2) business interest groups are not highly coordinated. Obviously, this is only possible under the assumption that policymakers have strong political support to pass legislation in congress. In contexts where pivotal policymakers have clear conservative fiscal preferences and business interest groups are highly coordinated, we can expect direct taxes to be cut and indirect taxes to be raised (see Table 25.1, quadrant II). Status quo would prevail where policymakers are fiscally conservative and business interest groups are not highly coordinated (see quadrant I) – unless policymakers face serious fiscal constraints. In that case, indirect taxes are likely to increase (Kato, 2003; Lierse & Seelkopf, 2016; Kemmerling, 2017). Table 25.1 also shows that, no matter the type of policymaker, highly coordinated business interest groups would successfully block or soften any attempts to increase direct taxation. In these scenarios, policymakers (no matter their policy preferences) would need to increase indirect (e.g., value-added tax (VAT)) and non-traditional taxes (e.g., gasoline or financial transaction taxes) to fund their expenditures. Recent research shows that this effect seems to be reinforced in countries where labour informality is prevalent because tax bases are narrow (Castañeda & Doyle, 2019). In these contexts, business interest groups would successfully transfer the burden of taxation to the middle and working classes. In sum, the discussion above provides an analytical framework to argue that the patterns of business coordination could shape tax policy change. Beyond issues of preferences aggregation or institutional design, it seems that there are models of coordination for collective action that make business interest groups more successful than politicians in the policymaking process.

Business interest groups and tax policy  395 These models of business coordination also explain when business interest groups are more effective than other special interest groups in transferring the tax burden to non-organized or less-organized groups of citizens.

3.

AN EXAMPLE: BUSINESS AND TAXATION IN LATIN AMERICA

Business interest groups have consistently been crucial actors in the fiscal policymaking process in Latin America. Despite their indisputable political influence, literature on the political influence of business interest groups in Latin America is rather limited. Seminal works in the field focused on the role of business elites in authoritarian regimes and the relationship between authoritarianism and corporatism (Malloy, 1976; Schmitter, 1974). These studies usually explain the role of business interest groups from a structural perspective, are more focused on the state–business relationship, and pay little attention to the politics of the policymaking process (Cardoso & Faletto, 1979; Evans, 1979). More recently, some scholars have distanced themselves from these structural views. They rather focus on the political role of business elites during the regional transition to democracy and the implementation of market-friendly policies (Bartlett, 1973; Malloy, 1976; Durand & Silva, 1998; Kingstone, 2010). These studies focus on the strategies that business interest groups used to navigate the recurring crises of the industrialization strategy in the region and their capacity to adapt to new political and economic models in the late twentieth century. Other scholars investigate the mechanisms that business interest groups use to influence the policymaking process and the organizational factors that enable them to shape public policy. For example, Flores-Macías (2014, 2019), Fairfield (2015a), Castañeda (2017), and Castañeda and Doyle (2019) offer new insights about the bargaining process between governments and business interest groups in the definition of tax policies in the region. They identify various sources of business political power and discuss their consequences for tax policy outcomes. Fairfield (2015a) argues that “business interests shape policy decisions when either instrumental power or structural power is strong” (Fairfield, 2019, p. 180). She also argues that “the more types of power and the more sources of power business enjoys, the more significant and consistent business influence will be” (Fairfield, 2019, p. 180). In the meantime, Castañeda (2017) argues that direct taxation is lower when business interest groups are better organized, even when policymakers prefer to make taxation more progressive. In fact, Castañeda (2017) provides empirical evidence that indirect taxation increases when business interest groups are highly coordinated. Similarly, Castañeda and Doyle (2019) present a novel analytical model to explain how the interaction between business interest groups and the informal labour market shapes the ability of left-leaning governments to introduce progressive tax policies. Flores-Macías (2014) also provides empirical evidence that governments’ ability to implement progressive tax reforms depends on the organizational attributes of business interest groups. From a political economy perspective, all these works help us to understand how business interest groups influence the policymaking process in the region. Based on this scholarship, we can also assess how recent transformations in the relationship between governments and business interest groups (i.e., the transition from a corporatist-like model to a more pluralist model of interaction) has had a great impact on tax policy in the region. As a result of the emergence and consolidation of new actors (e.g., economic con-

396  Handbook on the politics of taxation glomerates and family-owned business groups), the fiscal policymaking process is now more complex, which prevents governments – even those with strong progressive agendas – to implement structural and equitable tax reforms. In fact, the increasing number of business veto players makes redistribution via taxation less feasible. On the one hand, the consolidation of a more pluralist model of business representation poses serious difficulties for democratic representation because political power is now concentrated in a small number of firms or conglomerates. On the other hand, business interest groups are less interested in discussing broad policy issues (e.g., economy-wide industrial policies or national development strategies) and focus their attention on narrow, industry-specific, or particularistic policy domains (e.g., consumer or anti-trust regulation). Before the 1990s, business interest groups were mostly represented by sectoral and peak business associations. Only some non-organized business sectors or individual firms had access to the policymaking process. Business–government relations fitted almost perfectly within the definition of societal-corporatism (Schmitter, 1974; Cohen & Pavoncello, 1987; Kingstone, 2010). The ability of business interest groups to influence economic policies was quite constrained by the attributes of their relationship with the state. Therefore, sectoral and peak business associations prevailed as the main tool for political influence. The collapse of the state-led industrialization process in the late 1980s and the subsequent implementation of structural adjustment policies had strong consequences on business interest groups in Latin America. Indeed, several studies have shown that traditional business associations effectively lost political influence (Haggard & Kaufman, 1995; Viguera, 1996; Giacalone, 1997; Kingstone, 2010). In sum, business interest groups were somewhat unified before the market reforms and substantially less unified after them. The process of fragmentation of business interest groups and the decline of peak business associations opened space for the political consolidation of conglomerates. Indeed, the transition towards a more pluralist model of business coordination made business conglomerates – also known as diversified business groups or large corporations made up of different businesses that operate in various industries or sectors6 – more politically powerful. This process has also changed business community’s policy preferences. They seem to be now less concerned about nationwide development or economic policies, and more focused on less-salient policy issues like taxation or financial regulation (Schneider, 2013; Jones & Lluch, 2015). Indeed, diversified conglomerates seem to have a completely different relationship with the state: (1) they have new (different) channels to influence the policymaking process; (2) they are less tied to ideological or policy agendas – they are, indeed, more politically pragmatic (Culpepper, 2011); and (3) they are also more autonomous from the state. One can confidently argue that, before the 1990s, the ability of business interest groups to influence policies relied mainly on their structural power (Malloy, 1976; Schneider, 2004). After the broad implementation of market-friendly reforms, the political influence of business interest groups mostly relies on their instrumental power and their capacity to solve internal coordination problems. Business conglomerates seem now more concerned about policy issues that are only relevant to their economic activity. Unlike “corporatist” peak business associations, the goals of their political action are rather selective. Their political action is focused on promoting very specific industrial or tax policies rather than pushing for economy-wide development strategies or macroeconomic policies. This makes instrumental power critical for business influence (Culpepper, 2011).

Business interest groups and tax policy  397 Besides, emergent conglomerates do not behave like conventional agenda setters. On the contrary, they promote and defend their particularistic interests by funding friendly politicians (especially those with leadership positions in relevant legislative committees or policymaking forums) or by hiring highly specialized lobbyists. Conglomerates have adjusted their political strategies to more democratic institutional designs. Consequently, their portfolio of political investments is also highly diversified (Schneider, 2004, 2013). Unlike conventional peak business associations, they have cultivated alternative channels of access to policymakers in the legislative and executive branches of government. Peak business associations continue to lobby on behalf of their members and actively participate in policy forums (Schneider, 2010). However, they are not the only actors involved in the policy-bargaining process and they are certainly not the most relevant. On one hand, conglomerates have more specific policy targets (industry-specific policies or tax regulations) and invest more resources in professional lobbying or networking activities. On the other hand, lobbying is now cheaper and even small business interest groups can buy access by funding electoral campaigns or providing policy expertise to legislators. The growing fragmentation of business interest groups has also increased the level of competition among them. More lobbyists and firms are competing for the attention of cabinet ministers and legislators. At the same time, economic legislation is becoming more and more complex. Therefore, only business interest groups with substantial amounts of resources, networks, and technical capacity can successfully influence policies. In this environment, only a few conglomerates and firms can be major players in the policymaking process. In a highly competitive lobbying environment, only conglomerates with highly diversified political investment portfolios have the resources to block government initiatives or move legislation forward. It is also easier for them to avoid internal coordination problems and pursue consistent political strategies. The case of tax policymaking illustrates this argument quite well. The lack of fiscal space has been a major constraint for macroeconomic balance in Latin America since the debt crisis in the early 1980s. Most governments in the region have implemented substantial tax reforms aimed to increase tax revenues since the early 1990s (Focanti et al., 2016; Castañeda, 2017; Castañeda & Doyle, 2019). However, most of these reforms have had a limited impact on total tax revenue (Focanti et al., 2016, table 3).7 Corporate income taxation is still quite low (relative to Organisation for Economic Co-operation and Development (OECD) countries) and the average top marginal corporate tax rates have decreased substantially (Fairfield & Jorratt De Luis, 2016; OECD, 2020). At the same time, raising personal income taxation has proven to be challenging given the high levels of labour informality in the region. For example, personal income tax revenues only accounted for 2.2 per cent of the regional gross domestic product – 9.7 per cent of total tax revenue – in 2017; meanwhile, personal income taxation corresponds to about 8.3 per cent of gross domestic product – 23.9 per cent of total tax revenue – in OECD countries (OECD, 2020). Given these fiscal constraints, most of the recent fiscal effort in the region comes from considerable increases in indirect taxation – average VAT revenue was about 6 per cent of regional gross domestic product in 2018. Unsurprisingly, VAT and other indirect taxes on goods and services have definitively become the most preferred tax policy tool for governments in the region (Tanzi, 2013). The political influence of business interest groups could partially explain the limitations of tax policy as a tool for redistribution. As mentioned above, it is increasingly difficult to imple-

398  Handbook on the politics of taxation ment structural tax reforms in the region not only because legislative bargaining is now more complex, but also because more business actors are involved in the process. Governments and legislators now negotiate tax policies with many business interest groups. Unlike the previous model in which business interest groups and governments negotiated substantial or high-salience agendas (Fairfield, 2015b; Castañeda, 2017), now business interest groups lobby for industry-specific tax exemptions, sector-targeted tax deductions, or specific preferential treatments for capital income. Consequently, only well-coordinated groups with privileged access to policymaking networks or sufficient resources to fund lobbying and media strategies can accomplish their goals. Meanwhile, not well-coordinated and under-resourced business interest groups are exposed to increasing tax burdens. With fewer resources than business conglomerates and other special interest groups, non-organized (or poorly organized) citizens are often defeated in the legislative arena and must pay the cost of increasing tax burdens. The political influence of business depends on their ability to coordinate across several layers of their organizational structure. As I argued above, only well-coordinated business interest groups can display a great deal of instrumental power. Large and highly diversified business interest groups in Latin America have more resources for policy bargaining and are much more cohesive than other business or non-business interest groups. Consequently, they are much more effective in protecting their economic interests and transferring the costs of taxation to less-organized and less-resourced groups. Highly diversified business interest groups have been quite successful in blocking major initiatives to increase corporate taxation (Fairfield, 2015b) and using their political capability to promote indirect taxation as the main policy tool to increase government revenues (Focanti et al., 2016; Castañeda, 2017; Castañeda & Doyle, 2019). Examples are multifold. Chilean business groups have systematically undermined tax reforms proposed by right and left governments in the past 15 years (Fairfield, 2015b; Arenas de Mesa, 2016). Similarly, sectoral business interest groups have repeatedly blocked the legislative approval of an urgently needed structural tax reform in Colombia (Arenas de Mesa, 2016; Castañeda, 2018). In sum, corporate lobbying and competition among business interest groups is more intense in the current political and economic environment. In contexts of increasing electoral fragmentation and weakened political parties, well-resourced business interest groups find it very easy (and cheap) to influence policymakers and promote policies that are beneficial for their constituency but are quite detrimental for income redistribution. This new pluralist-like model of business influence in politics not only concentrates more political power around the business community but also within the business community itself.

4. CONCLUSION This chapter explores the circumstances under which business interest groups are more likely to impose their tax policy preferences. It contends that progressive tax reforms seem to be more feasible in contexts where business interest groups are not well coordinated. In these contexts, business interest groups’ reaction to government action is usually weaker either because they are not well integrated to policymaking boards or because they do not have enough organizational and financial resources for political action. Consequently, business interest groups are not able to block progressive policymakers’ initiatives. They are probably

Business interest groups and tax policy  399 only able to palliate potential negative impacts on certain industries (i.e., those industries with most resources available for lobbying). Therefore, one can reasonably argue that the patterns of business coordination shape tax policy change. Beyond issues of preferences formation and aggregation, this chapter shows that there are certain models of coordination that make business interest groups more successful than politicians in shaping tax policy. This also explains why business interest groups are usually very effective in transferring the burden of taxation to non-organized or less-organized groups of citizens. The changing nature of business interest groups in Latin America constitutes a very useful example to illustrate the complexities of tax politics and the role of business interest groups as political actors. It also illustrates well why the preponderance of business interest groups makes it very difficult to use tax policy as a tool for income redistribution. The case of Latin America shows us that using taxation as a useful policy tool to promote redistribution and reduce inequality seems to be unfeasible in contexts where the social contract between citizens and the state is fragile, and economic elites are politically over-represented or have privileged access to the policymaking process. This chapter also shows that the case of Latin America is useful to understand the role of special interest groups in tax (fiscal) policymaking. As I show above, much of fiscal policymaking literature focuses on the effect of institutions on policy outcomes. The role of special interest groups is rarely the centre of the debate. Many scholars recognize the crucial role that firms and business organizations play in fiscal policymaking but such a role is rarely studied systematically (Smith, 2014) and there have been only a few attempts to understand the mechanisms that effectively translate business influence into specific tax policy outcomes. Using the case of recent tax reforms in Latin America, this chapter not only highlights the importance of business interest groups in tax policymaking. It also presents a theory of tax policy change. It shows that policymakers’ policy preferences are not the central factor shaping tax policy. In fact, the analytical framework presented above shows that tax policy change is mostly a function of the domestic patterns of business coordination. In particular, the empirical evidence presented above illustrates how specific models of business coordination are more successful than policymakers in shaping domestic tax structures. These insights are in direct dialogue with literature on varieties of capitalism (Hall & Soskice, 2001; Rueda & Pontusson, 2000; Rueda, 2007; Martin & Swank, 2004). According to this literature, variation in the model of business organization explains the nature of the bargaining process, and consequently, the attributes of public policy. This literature also argues that more business coordination and policy integration could potentially produce positive outcomes such as widespread welfare and social policies (Martin & Swank, 2004). However, they do not pay much attention to the effects of business coordination on tax policy and financial regulation. The chapter tries to fill this gap by presenting empirical evidence that regressive tax structures are more common in contexts where business interests are highly coordinated. In those contexts, the tax burden is relatively low, and the relative weight of indirect taxes is much greater than corporate and personal income taxes. In other words, business interest groups successfully transfer the burden of taxation to non-organized (or at least, less-organized) groups of citizens. This is obviously not a specific attribute of “Latin American capitalism” (Schneider, 2013). As the most recent literature on inequality and taxation has demonstrated,

400  Handbook on the politics of taxation one could describe similar processes in more developed economies in Western Europe and North America (Saez & Zucman, 2019). Further research could focus on finding better ways to understand the internal conflicts within the business community. As I noted in this chapter, the existing body of literature usually understands business interest groups as some sort of homogenous unit of analysis, with similar preferences and similar sources of political power. However, there are substantial differences in the ways in which large firms and SMEs participate in the policymaking process and the efficacy of their political action. Most of the existing body of literature explains how large firms influence policies. However, we know very little about the role of SMEs in shaping tax policies and the limitations they face as political actors. This is a particularly relevant issue in low- and medium-income economies where the average firm size is smaller, and the levels of informality are much higher. A second possible avenue of further research should definitively focus on understanding business interest groups’ tax policy preferences. Once again, scholarship on business politics usually assumes the business community is only concerned about corporate taxation and the costs of tax compliance. However, there are good reasons to conjecture that it also has specific preferences about labour, personal income, and wealth taxation. In fact, it is reasonable to expect that firms and conglomerates of firms operating under different scenarios would have quite different preferences about both direct and indirect taxation.

NOTES 1. The global average of corporate tax rates decreased almost 10 percentage points between 1991 and 2016 (Toplensky, 2018; Saez & Zucman, 2019). In Latin America, the top marginal corporate tax rates fell from 37.4 per cent in 1990 to 27.8 per cent in 2015 (CIAT, 2020). 2. It is worth noting that recent scholarship (e.g., Christensen & Hearson, 2019) has found that, as a consequence of the 2007–2009 financial crisis, the issue of corporate tax avoidance has become more salient and there have been unprecedent changes in international tax cooperation. 3. In both cases, keeping large fiscal deficits or increasing government debt are usually not credible policy options because they are not sustainable in the long run (Alesina et al., 2011). 4. Scandinavian countries are often portrayed as models on how to square concerns for efficiency and equity. However, the welfare system is based on high taxes on labour and consumption, and relatively low corporate income taxation – in comparison with other OECD countries (Andersen, 2008). Therefore, a high level of business coordination coincides with an extensive welfare system that is not funded by firms. In fact, the welfare system is mostly funded with taxes on labour income, and “it has been possible to adjust taxation of capital income and corporations to lower levels in order to match rates observed in competing countries while maintaining relatively high tax rates (and progressive elements) on labour income” (Andersen, 2008, p. 60). 5. The definition of the minimum-wage target is perhaps one of the best examples of cooperative engagement between employers, labour, and government in contemporary democracies. Minimum-wage policies not only shape macroeconomic and social conditions at the national level, but they also affect the costs of production for most firms. Unlike sector-coordination or decentralized systems of business coordination, business interest groups play an essential role for the definition of minimum-wage targets in centralized-coordination systems. In these cases, encompassing business associations and powerful economic conglomerates are central players in the bargaining process and their participation guarantees some degree of policy stability (Schneider, 2013). 6. These conglomerates usually hold a stake in several smaller firms with separate corporate governance structures in order to minimize market risks and to take advantage of diversification. 7. Also see OECD (2020).

Business interest groups and tax policy  401

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Index

accountability 9, 157, 276, 326, 329 Addis Ababa Action Agenda 330, 333 Addis Tax Initiative 330 Afghanistan 41, 330 Africa 40, 68, 70–71, 75, 122, 128, 132–4, 171, 179, 323, 347–8 see also individual countries African Tax Administration Forum 256, 348 agriculture 106, 138, 326 Ahrens, L. 232, 235 aid see tax aid aid curse 326–7, 331, 333 Aidt, T. S. 52, 238 Airbnb 339 Aizenman, J. 120 alcohol taxation 4–5, 104 Alexander, R. 132 Alibaba 347 Allen, M. P. 41 Allingham, M. G. 356 Alm, J. 361–2, 364 Altshuler, R. 234 Altunbas, Y. 122 Amazon 281, 287, 289, 340–41 Andersen, M. S. 215 Andersson, P. F. 49, 51, 53, 106, 120 Andorra 265 Angelopoulos, K. 86 Antigua 266 Appel, H. 91, 236 Apple 281, 287, 289, 338, 341, 344 Paradise Papers 253, 287, 344 Arbex, M. 360 Ardant, G. 39 Argentina 70, 151 aristocracy 19, 21–2, 24–5 arm’s length principle 249, 251, 254 Artana, D. 136 austerity 98, 136, 253, 256, 261, 268, 364, 389, 394 Australia 12, 69–70, 131, 138, 154–5, 158, 194, 362, 366, 380 Austria 12, 55, 66, 155, 173, 284, 297–8, 345 authoritarianism 1, 116, 327 autocracies 11, 17, 19–20, 24, 49, 67–8, 99, 114–18, 122–3, 148, 170, 183, 327, 332 automatic exchange of information 293–300, 302–4

B2W 347 Bahamas 167, 301, 303 Baidu 347 bailouts 287, 296, 310, 316, 377 Baines, J. 340 Bak, A, K. 140 Balima, W. H. 327 Ballard-Rosa, C. 100 Bangladesh 77 banking secrecy see secrecy bankruptcy 149, 295 Barbados 266 bargaining power 120, 123, 152, 156 Barnes, L. 53, 105 Barnett, K. 194 Bartels, L. M. 296 Bartelson, J. 32 Barzel, Y. 20 base erosion 345 see also Base Erosion and Profit Shifting Base Erosion and Profit Shifting 254, 256, 260–61, 264, 268–72, 281, 340–41, 344–5, 349 Basinger, S. 232 Baskaran, T. 122 Bassinger, S. 234 Bastiaens, I. 326, 330–33 Bates, R. H. 121 Bathel, F. 233 Baturo, A. 236 Baumgartner, F. R. 92 Baumol, W. J. 66 Baybeck, B. 232 Beck, N. 232 Becker, G. S. 356 Beiser-McGrath, L. F. 218 Belgium 12, 155, 287 bellicist thesis 32–41, 70, 74–5 Beramendi, P. 105, 149, 151, 159 Berens, S. 183, 382 Bermuda 303, 349 Bernauer, T. 218 Besley, T. 38, 49 Betz, H.-G. 239 Biden, J. 271–2, 289 big data 340 Bigsten, A. 122 Bird, R. 152, 158, 326, 328 Blair, T. 133

405

406  Handbook on the politics of taxation Blockmans, W. 19 Boix, C. 53, 116 Bolton, P. 150 Borick, C. P. 218 Boston Tea Party 114 Botea, R. 41 Bott, K. M. 362, 364–5 Boudreau, C. 376 Bourdieu, P. 248 Box, G. E. P. 85 Brambor, T. 49 Braun, R. 32 Brazil 12, 70, 73, 133, 138, 155, 158, 303, 332, 341, 346–7, 349, 377, 379–80 Bretton Woods system 166, 244 British Virgin Islands 303 Brockmann, H. 199 Broz, J. L. 214 Bruner, D. M. 359–60 Buchanan, J. 266 bureaucratization 24–6, 39, 91 Burgers, I. 270 Bush, G. W. 252, 266, 268 business interest groups 388–400 business models 129, 338–40, 342 business power 8, 296, 389–95 Büttner, T. 261 Buttrick, S. 230 Campbell, J. L. 41 Canada 12, 70, 98, 131, 155, 158, 360 Canard, N.-F. 118 Cao, X. 213, 215, 232–3, 236–7, 239 cap-and-trade 208, 211 capital flight 7–9, 294, 296, 298, 324 capital taxation 6, 9, 26, 84–6, 88, 103, 167, 169–70, 234, 383, 388 capitalism 1, 67, 98–9, 109, 317–18, 399 carbon taxation 131, 134, 208–10, 212–22, 257, 277 Carneiro, R. 38 Castañeda, N. 395 causal mechanisms 32–9, 52–3, 65, 67, 90, 114, 174, 239, 389 Cayman Islands 167, 303 Centeno, M. A. 40–41 centralization 22–3, 38, 89, 157 Chan, E. 362 Cheibub, J. A. 116, 120 Chile 154, 380, 398 China 18, 24–6, 39, 136, 158, 180–81, 303, 325, 332, 341–2, 346–7, 349 Christensen, J. 91 Christensen, R. C. 256, 286 Christians, A. 261, 270

Citizens for Tax Justice 267 climate change 10, 139, 208–10, 215–17, 219–22, 244, 315, 318 Clinton, B. 296 Cockfield, A. J. 261, 270, 341 Cold War 325 Colombia 120, 375, 398 colonialism 3, 5, 10, 64–77, 120–22, 244, 249, 323, 328 Common Consolidated Corporate Tax Base 281, 286 common reporting standard 293–4, 297–300, 302–4 Community of Andean Nations 249 Comparative Manifesto Project 216 comparative politics 3, 82, 88, 98–100, 104, 107, 109, 167, 208, 213–17, 221, 229, 288 constructivism 90, 245, 248, 253, 256, 271, 289, 293, 319 consumption taxes 4–6, 8–10, 36, 42, 47–8, 50, 53–4, 58–9, 64–6, 82–9, 92–3, 99–101, 104–9, 120, 128, 156, 170–73, 193, 197–8, 203, 209–10, 217, 229–30, 236, 238, 340, 382–3, 388 coordinated market economies 234–5 corporate income taxes 6, 11, 54–5, 57–9, 64, 67–8, 71–2, 76, 82, 133, 155, 171, 173, 230, 257, 276–7, 281, 328, 396 corporate taxation 5–6, 100, 103, 105, 157, 167, 170, 173, 230, 233–6, 252, 254–6, 277–83, 285–9, 296, 329, 340–45, 388, 397–8, 400 in the digital economy see digital economy OECD governance of 260–73 corporatism 51, 86, 88, 98, 102–3, 170, 235, 393, 395–6 Correlates of War project 32 corruption 23–5, 149, 326, 329 Costa Rica 136, 380 Cottarelli, C. 329 Country-by-Country Reporting 280–81, 286 COVID-19 pandemic 7, 128, 134, 140, 254, 277, 289 Cox, R. H. 91 Cox, R. W. 247–8 Crasnic, L. 167, 304 Crawford, R. 137 credit 1, 109 Cukierman, A. 119 Culpepper, P. D. 316 Czech Republic 12, 196 D’Arcy, M. 39, 120 D’Attoma, J. 359–60 Daude, C. 132 Daunton, M. 92

Index  407 Davidovic, D. 218 decentralization 22–3, 89, 113 see also fiscal decentralization Dehejia, V. H. 283–4 democracy 17, 19–22, 26, 47–51, 53–6, 65–7, 75–6, 87, 99, 102, 105, 113–17, 120, 122, 152, 185–6, 214, 238, 317, 323–4, 326–7, 333, 367, 395 democratization 3, 20, 49, 59, 64, 76, 106, 114, 121, 123, 183 Denmark 12, 87, 91, 100–101, 103, 211–12, 316, 378, 392 developing countries 6, 9–11, 13, 64, 116–17, 129, 135–6, 140, 148, 175, 194, 198, 237–8, 244–5, 249, 251, 254–7, 269–70, 323–33, 346–50, 358, 379, 381, 383, 392 Devereux, M. P. 85 dictatorships 116, 119, 121 diffusion of tax policy 83, 91, 211, 229–39 digital economy 9–11, 238, 254, 256, 261, 270–71, 281, 287, 338–50 Digital Services Tax 272, 342, 344–6, 349 digitalization 255, 257, 264, 338–41, 348–9 Dincecco, M. 39–40, 49, 105 direct taxation 1, 5–6, 12, 21, 23, 41, 48–9, 59, 68, 76, 123, 170–72, 198, 238, 276–7, 281–4, 393, 395, 400 Directive on Administrative Cooperation 281, 298 discrimination 130, 132, 139, 192–201, 276, 282–3, 293 distributional perspective 99–103 see also redistribution Dolphin, G. 214, 221 Dominican Republic 132, 136 double taxation 9, 233, 245–56, 260, 262, 266, 270, 276, 279–80, 282, 345 Doyle, D. 395 Duncan, D. 230 easy-to-collect taxes 6 Eccleston, R. 107 e-commerce 280, 340–41 see also digital economy; individual companies economic competition 229, 231, 233, 237–8, 320 economic growth 10, 19–20, 26, 66, 109, 114, 118, 122, 128–9, 134–6, 181, 312–13, 316, 318, 390 Ecuador 135 education 4, 10, 41, 50, 52, 98, 146 Eggenberger, K. 295 Ehrhart, H. 117, 326 El Salvador 136

emerging economies 77, 245, 257, 338, 341, 346–8, 374 Emmenegger, P. 50–51, 187, 239, 295, 297 empires 10, 17–18, 24, 26, 68, 70–71, 73, 76–7 see also colonialism Enachescu, J. 360 environmental concerns 4, 128–9, 134, 138–9, 179, 200, 208–22, 239, 267, 277 see also climate change; pollution equal treatment principle 6–7 Estonia 11, 345 Eurodad 287 European Court of Justice 277, 279, 282, 285, 288–9 European Economic Community 103, 183, 277–8 European integration 277–81, 288, 315 European Parliament 276, 286, 289, 311, 319 European Social Survey 218 European Union 5, 9, 116, 194, 211–13, 220, 230, 232, 237, 252, 255, 261, 271–2, 293, 297–8, 340, 342–6, 348–9, 391 financial transactions tax 5, 11, 188, 197, 289, 309–20, 394 politics of taxation in 276–89 taxing financial transactions in 309–20 European Values Survey 364 Europeanization 102 Eurozone crisis 280, 315 expenditures 4, 98, 102, 115, 119, 146, 149–56, 194, 200–201, 212, 324, 327, 380, 394 military 200 public 33, 41, 115, 367 social 382–3 tax 105, 115, 128–40, 194–5, 362 welfare 53 experimental economies 199 externalities 147, 208, 220 Eyraud, L. 153 Facebook 338–9, 341 Fairbrother, M. 218 Fairfield, T. 395 Falleti, T. G. 152 Fauvelle-Aymer, C. 116 Federal Reserve 295 federalism 89, 132, 147–50, 152, 157 First Generation of Fiscal Federalism 147, 150, 153, 159 Second Generation of Fiscal Federalism 150, 153, 159 feminism 194–5 Fernández-Albertos, J. 376 field experiments 13, 355–8, 361–4, 366

408  Handbook on the politics of taxation financial crisis 5, 100, 109, 170, 183, 230, 239, 244–5, 253, 255–7, 268, 270, 277, 280, 285–7, 296, 299, 302, 309–10, 314–15, 317–18, 333, 343, 355, 364, 377, 388, 390 financial transactions tax 5, 11, 188, 197, 289, 309–20, 394 Finland 211, 345 Finseraas, H. 183 First Generation of Fiscal Federalism 147, 150, 153, 159 first movers 250, 389, 393 fiscal bargains 8–10, 326, 389 fiscal contracts 12, 18, 50, 70–72, 75–7, 86, 89, 115–16, 120–21, 128, 327, 375, 382 fiscal decentralization 132, 146–60 fiscal illusion 139 Fjeldstad, O. 329 flat taxes 5–7, 91, 109, 212, 230, 236, 239 Flipkart 347 Flores-Macias, G. A. 395 Foreign Account Tax Compliance Act 254–5, 268, 294, 296–9 foreign direct investment 136, 139–40, 233 foreign financial institutions 294, 296 fossil fuels 134, 138–9, 212, 215–16, 218, 221 France 10–12, 20, 25, 35–6, 39, 66, 71, 73, 120, 131, 138, 193, 217, 219, 297, 311, 316, 342, 344–7, 349, 380 Franzese, R. 232 fraud 55, 280–81, 295, 329, 331, 340 free trade 6, 53, 105–6, 166 free-riding 37, 220, 265, 376, 391 Friedman, M. 266 G7 251–2, 254, 256, 302 G20 5, 128, 132, 244, 253–4, 256, 263–4, 268–9, 272, 298, 302, 310, 315, 328, 338, 341–2, 345, 347–8, 350 G24 256, 347–8 G77 347 Gabor, D. 315, 317 Game Theory 250 Ganghof, S. 85, 92 Garcia, F. 361–2 Garcia, M. M. 117 GDP see gross domestic product Gelepithis, M. 183 gender 10–11, 22, 179, 192–203, 330, 359–60 general sales tax 5, 54, 64, 66, 68, 72 Genschel, P. 283–5 Germany 12, 71, 91–3, 106, 132, 138–9, 154–5, 158, 192, 195, 197, 200, 212, 218, 284, 297, 316, 319, 330, 344–5, 392 Gerry, C. J. 115 Gerschewski, J. 118

Gilardi, F. 232, 235 Gilet Jaunes movement 138, 209, 217, 219 global financial crisis see financial crisis Global Forum on Transparency and Exchange of Information 298 global governance OECD model of 260–73 politics and history of 244–57 Global Tax Expenditures Database 128, 131–2, 134 global warming see climate change globalization 9, 68, 77, 85–6, 91, 103, 166–9, 171, 174, 182–3, 185–6, 220–21, 233, 244, 260, 264, 276, 301, 332 Goenaga, A. 37, 42 Goldscheid, R. 47 Goldstein, J. 91 Goodspeed, T. J. 234 Google 338–9, 341 Gray, J. 236 Greece 12, 20–22, 24, 131, 316, 365 green taxation 11, 104, 208–22 greenhouse gas emissions 208, 210, 217, 219–20 see also carbon taxation gross domestic product 17–19, 24, 26, 33–4, 65, 73, 98, 100–101, 113, 117–18, 122, 139, 181, 184–6, 323–4, 326, 331, 379, 397 Grown, C. 194 growth models 98–9, 105, 107–9 Guatemala 380 Gur, N. 121–2 Gwaindepi, A. 75–6 Haffert, L. 36, 106, 183 Hager, S. B. 340 Haidt, J. 92 Hakelberg, L. 167, 230, 261, 296 Hall, P. 90 Hallerberg, M. 232, 234 hard law 249–50, 254 Hardiman, N. 318 hard-to-collect taxes 6, 327 see also income taxes; VAT harmful tax competition 251–3, 265–9, 271, 279, 281, 286 Harring, N. 218 Hays, J. C. 88, 232 healthcare 4, 146 Hearson, M. 167, 256, 347 hedge funds 312, 319–20 Hegemonic Stability Theory 247 hegemony 247, 253, 257 Helmdag, J. 232 Heraclitus of Ephesus 32 Herbst, J. 40

Index  409 Hertel-Fernandez, A. 35 Heuermann, D. F. 139 history 244–57 Holland, A. C. 382 Holzinger, K. 215, 284 Hong Kong 265 Howard, C. 136 humanitarianism 325 Hungary 12 hut taxes 69, 72, 74, 76 ideational approaches 90–93 ideology 24, 47–8, 51–4, 57–8, 132, 140, 169, 218, 232, 235–6, 253, 296, 376 Ikea 287 implicit bias 90, 193, 195, 197–8 Inclusive Framework 254, 256, 260–61, 268–71, 347, 349–50 income inequality 10, 376 income taxes 1, 5, 7, 10, 26, 35–6, 47–50, 52, 57–60, 83–4, 88–9, 100, 108, 117, 174, 198, 230, 232, 283–4, 312, 327, 332, 377, 382 corporate 6, 11, 54–5, 57–9, 64, 67–8, 71–2, 76, 82, 133, 155, 171, 173, 230, 257, 276–7, 281, 328, 396 see also corporate taxation personal 6, 11, 41, 50–51, 53–5, 57, 59, 64, 66–8, 71–3, 77, 82, 117, 155, 173, 175, 181, 184–6, 194, 198, 230, 257, 276–7, 328, 374, 382, 397 India 71, 77, 132, 151, 180–81, 332, 341–2, 346–9 Indiamart 339 indirect taxation 1, 5–6, 21, 23, 48, 82, 88, 91, 98, 170–71, 198, 238, 276–8, 281, 288, 323, 329, 397 see also VAT Indonesia 113, 132 Industrial Revolution 18–19, 25, 40–41 industrialization 41, 48, 50–51, 65–6, 105, 392, 395–6 inequality 6, 10, 52, 93, 100, 130, 136–7, 149, 171, 178–88, 198, 301, 303, 323, 328, 330, 362, 376, 379, 394, 397, 399–400 information asymmetries 178, 185, 187 information exchange 252, 254–5, 268, 270, 284, 296, 299, 302 infrastructure 4, 19, 41, 50, 74 inheritance taxes 5, 7, 35, 53–5, 57–8, 64, 66–8, 70–71, 73–4, 98, 171–2, 182, 187 intellectual property 4, 135, 264, 339, 346 interest groups 51, 84, 86–8, 93, 102, 114, 135, 185, 215, 221, 247–8, 341, 388–400 interest rates 49

Internal Revenue Service 294, 296–7 International Conference on Financing for Development 329–30 International Consortium for International Journalism 344 International Energy Agency 263 International Labour Organization 76 International Monetary Fund 9, 12, 52, 74, 194, 232, 237, 310, 328–9 international organizations 6, 9–11, 52, 131, 133, 148, 211, 220, 230–33, 235–9, 260, 263, 286, 302, 323 see also multinational enterprises international relations 3, 220, 245–6, 257 international taxation 6, 9, 71, 83, 134–5, 140, 229–30, 244, 246, 248–50, 253, 256–7, 260–64, 266, 269–71, 281, 287, 289, 302–3, 323, 338, 340–43, 345–9 Iraq War 325 Ireland 12, 135, 284, 287, 314–15, 344, 349, 380 Italy 12, 24–5, 297, 311, 316, 342, 344, 360, 364–5, 392 iTunes 339 Jacquemet, N. 361 Jagers, S. C. 218 Japan 109, 154, 328 Jensen, P. S. 52, 238 Jersey 303, 344 Jinjarak, Y. 120 Jio 347 joint-decision trap 282–5, 287–8, 298, 311, 320 Jumia 347 Juncker Commission 343–4 Kalaitzake, M. 317 Kaldor, N. 328 Kane, J. 39 Kastner, L. 316–17 Kato, J. 92 Keen, M. 236–7 Kemmerling, A. 93 Kenny, K. W. 200 Kenny, L. W. 115, 117 Kenya 73, 192 Keohane, R. O. 91 Kerceski, S. M. 238 Keynesianism 90–91, 313 Kiser, E. 20, 39, 238 Klofat, A. 234 Koessler, A. K. 360–61, 366 Korpi, W. 382 Krasner, S. D. 250 Krever, R. 270 Kuhn, T. 90

410  Handbook on the politics of taxation Kuitto, K. 232 Kumar, M. S. 233–4 Kuo, A. 376 Kyoto Protocol 217, 220 laboratory experiments 360, 365 Lachapelle, E. 214 laissez-faire economists 313 Latin America 40, 70–71, 86, 89, 116, 128, 132–3, 159, 179, 231, 237, 249, 374–5, 377–83, 389, 395–9 Le Maire, B. 346 League of Nations 244–5, 250–51, 254, 261–2 legitimacy 9, 20–21, 37, 42, 115–18, 122, 134, 253, 260–72, 287, 297–9, 302–4, 315, 350, 355, 362–7 Lehman Brothers 309–10 Levi, M. 37, 119, 326 Levi, S. 218, 221 Lichtenstein 265 Lien, D.-H. D. 121 Lierse, H. 117, 120 Limberg, J. 7, 100, 184, 230, 239 Linos, K. 231–2 Lips, W. 287 lobbying 8, 129, 132–4, 140, 150–51, 174–5, 215, 221, 253, 267, 294–5, 310, 315–20, 388, 390–91, 394, 397–9 Lockwood, B. 236–7 López-Luzuriaga, A. 365 Lott, J. R. 200 Lusinyan, L. 153 Luttig, M. 183–4 Luxembourg 253, 284, 287, 297–8, 344, 349 LuxLeaks 253, 287 MacArthur, D. 328 machine learning 340 MacKenzie, S. A. 376 macro-economic policy 90 Macron, E. 342, 344 Madagascar 135 Madison, J. 147 Mahdavi, S. 117 Mail.Ru 347 majoritarian electoral systems 87–9, 103 Maliniak, D. 214 Malta 212 Mann, M. 18 Mares, I. 50, 52 Marshall Plan 250, 263 Martin, C. J. 35, 87, 103, 105, 392 Martinez-Vazquez, J. 158 Marx, P. 187, 239 Mascagni, G. 333

Masciandaro, D. 317 Masclet, D. 365, 367 Mascussen, M. 263 McCaffery, E. 194 Mechanical Turk 339 median voter theory 178, 183–8 Mehrotra, A. K. 26 Meiselman, B. S. 365 Meltzer, A. H. 48, 55, 99 Mertens, D. 106–7 Metinsoy, S. 318 Mexico 131, 377, 379–80 Mickiewicz, T 115 Mikesell, J. 157–8 Mildenberger, M. 215 military expenditures 200 Millennium Development Goals 325, 329 model tax convention 260, 262, 264–5 modern tax introduction 25–6, 47, 64, 70–72 Monti, M. 286 Morgan, K. 35–6 Morocco 193 Morone, A. 364 Morrison, K. M. 121 mortgage interest deduction 104, 138 Mosquera, I. J. 270 Mossin, J. 356 Mozambique 330 Mulligan, C. B. 116 multilevel tax administration 146, 157 multinational enterprises 134–5, 166, 175, 248–9, 252–4, 262, 264–8, 271, 281, 287, 289, 343–8 see also international organizations; individual companies Musgrave, R. A. 4, 147 Nemore, F. 364 neoliberalism 8, 91, 109, 137, 230, 233, 235–6, 244 NERI Institute 314 Netflix 339 Netherlands 11–12, 73, 131, 138, 193, 314, 316, 344 Neumark, F. 278 Neumayer, E. 232–3 New Zealand 70, 91, 131, 378 Ngo Njib, M. M. 117 Niger 135 Nigeria 198, 347 Nike 287 Nistotskaya, M. 39, 120 non-governmental organizations 256, 267, 286–8 North, D. C. 20, 37, 47 North Korea 1

Index  411 Norway 12, 173, 211, 362, 364–6 Nuclear Energy Agency 263 Oates, L. 363 Oates, W. E. 147–8 Obama, B. 294, 296–8, 310 Occupy Wall Street 374 O’Donnell, G. 159 OECD 26, 82, 99–101, 109, 128, 132–3, 135, 137–9, 151, 153–4, 156–7, 168, 172–3, 183, 185, 211, 233–6, 244–5, 247, 249–57, 281, 286–7, 289, 293–4, 297–300, 302–4, 328, 338, 341–50, 374, 377–82, 397 common reporting standard 293–4, 297–300, 302–4 governance of international corporate taxation 260–73 structure and processes 262–4 offshore financial centers 264–5, 267–8, 270, 304, 312 oil 325, 327 Olson, M. 115, 153 Onu, D. 363 Orenstein, M. A. 236 Organisation for Economic Co-operation and Development see OECD Ottawa Taxation Framework Conditions 341 overtaxation 23, 148, 248–51 Owens, J. 267 Oxfam 265, 267, 287 Pakistan 77, 362–3 Palan, R. 264 Palme, J. 382 Panama 302 Panama Papers 253, 287 Papua New Guinea 132 Paradise Papers 253, 287, 344 Paris Agreement 216–18, 220–21 Passarelli, F. 317 patent boxes 135 patents 135, 264 patrimonialism 22 payroll taxes 82, 84, 88–9, 388 see also social security Peacock, A. 37 pensions 4, 130, 137, 195, 312 Perez-Truglia, R. 363 personal income taxes 6, 11, 41, 50–51, 53–5, 57, 59, 64, 66–8, 71–3, 77, 82, 117, 155, 173, 175, 181, 184–6, 194, 198, 230, 257, 276–7, 328, 374, 382, 397 Persson, T. 38, 49, 120, 148, 150 Peru 380 Peter, K. S. 184, 230

Philippines 132, 135 Piketty, T. 108, 178 Plümper, T. 232, 235 Poggi, G. 19 polarization 119, 136, 287 policy diffusion 83, 91, 211, 229–39 policy learning and emulation 236 political economy 11, 18, 42, 48, 53–4, 77, 82–5, 88, 90, 92, 98, 100, 104, 106, 109, 129, 132–3, 146, 150, 159, 208–9, 211, 217, 221, 244, 246, 248, 256–7, 260, 264–5, 272, 277, 288, 348, 367, 389, 395 political institutions 18, 22, 35, 47–60, 87–91, 93, 103, 214, 221, 231, 234–5, 326, 375, 382–3 political regimes 2, 8, 56, 75, 93, 113–23, 214 regime types 67, 114–18, 121–3, 132, 140, 170, 323, 332 political science 2–4, 9, 11–13, 64–8, 113, 123, 146, 150, 166–7, 169–70, 174, 178, 187–8, 201–3, 208–9, 211, 214, 220–21, 231, 244–6, 288, 338, 374 political stability 113, 118–20, 390 poll taxes 21, 69, 72 polluter-pays principle 211 pollution 4, 208–12, 214, 216–17 population density 40 populism 239, 244, 261, 268, 343–4, 380 poverty 130, 136, 315, 318, 330, 333 power 10, 19, 24, 38, 50, 88, 104, 120, 133, 140, 149, 188, 247–8, 250, 253, 255–6, 289, 310, 316, 318–19, 330, 346, 396, 398 business power 8, 296, 389–95 in global tax politics 294–9 power resource theory 104, 169 Prasad, M. 35–6, 92, 106 preferential tax regimes 265 premodern taxation 17–26, 66 Prichard, W. 331, 333, 347 privatization 22–3 Profeta, P. 116 profit shifting 343–5 see also Base Erosion and Profit Shifting progressive taxation 5–7, 10, 12, 26, 35–6, 42, 48, 52, 54, 59, 67, 82, 84–5, 99–100, 102, 117, 120, 183–4, 194, 196–7, 374–82, 388, 394 property taxes 1, 5, 47, 49, 54, 58–9, 82, 98, 113, 173, 182 proportional representation 47, 51, 53, 87, 89, 102–3, 123, 178, 214, 323 protection rackets 37–9 protectionism 105, 244 Przeworski, A. 85 public choice theory 119, 147–8 public expenditures 33, 41, 115, 367

412  Handbook on the politics of taxation public opinion 90, 133, 187, 215, 221, 271, 377, 379–80, 388, 392 purchasing power 349 Qualified Intermediary Program 295–6 Queralt, D. 40, 50, 52 Quinn, D. 233–4 Rabe, B. G. 218 Radaelli, C. M. 285 Randazzo, A. 92 Rapaport, O. 232 rational choice theory 19, 99, 245–7, 252 redistribution 4–5, 7, 10–11, 34, 36, 48, 51–2, 66–7, 76, 84, 87–8, 99–100, 104–5, 108, 114, 117, 136, 149–50, 178–85, 187, 254, 330, 349, 375, 380–81, 396–7, 399 Regime Theory 247 regressive taxation 10, 48, 53, 85–7, 89, 92, 99–103, 109, 217, 376, 399 Reinke, R. 316 remittances 324–5 rent-seeking 132, 135, 140 research and development 4, 130, 135–6 residence states 249, 342, 348 resistance in global tax politics 299–304 resource allocation 4, 6, 36, 48, 89, 138 Richard, S. F. 48, 55, 99 Rixen, T. 167, 246, 252 Robin Hood Tax 314–15 Rodden, J. 149, 153 Rogers, M. 105, 159 Roland, G. 150, 287 Rome Treaty 276, 281 Römgens, I. 287 Ross, M. L. 116, 121 Ruding, O. 279 Rudra, N. 326, 330, 332 rule of law 4, 8 Russia 21, 155, 158, 234, 332, 347 Sadiq, K. 270 Saint-Amans, P. 346 Sakamoto, T. 85–6 Samuelson, P. A. 147–8 Sanders, B. 374 Sandmo, A. 356 Savings Tax Directive 284, 286, 297 Scabrosetti, S. 116 Scartascini, C. 365 Schäfer, D. 312 Schaffer, L. M. 215, 218 Scharpf, F. 282 Scheve, K. 7, 26, 35–6, 42, 52, 100, 184 Schmidt-Catran, A. W. 183

Schmidtke, H. 237 Schneider, B. R. 382 Schulmeister, S. 312 Schulz, D. 106, 183 Schumpeter, J. 64 Second Generation of Fiscal Federalism 150, 153, 159 secrecy 293–7, 299–304 sectoral conflict 99, 104–6, 109 Seelkopf, L. 47, 117, 120, 238, 330–33 self-interest 38, 115, 150, 263, 374–6 Seligman, E. 51 sex see gender shadow banking 312 Shipan, C. R. 232 Shoup Mission 328 Siebrits, K. 75–6 Sierra Leone 198 Simmons, B. 230–31 sin taxes 4–5, 104 Singapore 265 Skovgaard, J. 213, 215 Slater, D. 122 Slovakia 316 Slovenia 316 social contract 37–9, 41, 75, 192, 245, 399 social distribution 134, 136–8 social expenditures 382–3 social justice 91, 289 social media 363, 367 social security 4, 11, 54, 64, 67–8, 71–2, 82–7, 89, 92, 100, 104, 122, 129, 173, 181, 184, 188, 325, 374 soft law 249–50, 263, 279, 285 source states 249, 342, 348 South Africa 10, 75, 131, 155, 346–7 South Korea 131–2, 136 sovereignty 9, 38, 149, 152, 244–6, 248–9, 251–7, 262, 264–5, 269–70, 284, 293, 296, 302 Spain 12, 21, 70, 73, 155, 158, 173, 180, 196, 297, 316, 342, 344–5, 376 special economic zones 134, 136 special interest groups 84, 86–8, 133, 215, 388–9, 395, 398–9 Srinivasan, T. N. 356 stamp duty 5, 311–12 Starbucks 281, 287, 289 Stasavage, D. 7, 26, 35–6, 42, 52, 100, 184 state building 1, 3, 9, 37–40, 122 Steinmo, S. 87–92, 105, 132, 170, 230, 236 Stepan, A. 129, 140, 152 Stewart, M. 333 Stotsky, J. 193–4 Strezhneva, M. 315

Index  413 subcentral governments 146, 148–9, 151–3 see also fiscal decentralization subcentral taxation 146, 151–9 suffrage 47–8, 50, 52, 54–6, 59–60, 67–8, 114, 200 see also voting behavior Sustainable Development Goals 139, 323, 325, 330 Svendsen, G. T. 216 Swank, D. 170, 230, 232–4, 236–7, 239, 392 Sweden 12, 51, 88–9, 105, 173, 180, 196–7, 211, 218, 311, 316, 360, 392 Switzerland 12, 51, 134, 138, 155, 158, 167, 173, 187, 192, 195, 217–18, 235, 239, 253, 265, 284, 293, 295–300, 302, 360, 366 Syria 299–300 Tabellini, G. 120, 148, 150 Taiwan 136 “tampon tax” 192–3, 198 Tanzania 140, 198, 330 Tanzi, V. 233, 236 tax administration 17–18, 21–6, 39, 59–60, 67–9, 76, 118, 146, 151, 157–9, 203, 256, 269, 326, 329, 340, 348, 365 tax aid 71, 323–4, 328, 330–33 aid curse 326–7, 331, 333 tax assignment 146–7, 151, 153, 155, 159 tax avoidance 7, 136, 166, 175, 245–6, 248, 251–7, 262, 264, 267–8, 271, 277, 280–81, 287–9, 296, 303, 340–41, 343–4, 348 tax benefits see tax expenditures tax breaks see tax expenditures tax competition 6, 9, 11, 83, 85–6, 129, 133–6, 149–50, 166–75, 230–31, 233, 235, 238, 245–7, 253, 256–7, 263–4, 269, 276, 283–4, 344, 348–9 harmful 251–3, 265–9, 271, 279, 281, 286 tax compliance 115, 117, 175, 199–200, 355–67, 400 tax credits 130, 133, 137, 195, 388 tax deferrals 130, 139 tax evasion 7, 20, 199, 238, 245, 248, 252–3, 255–6, 261, 264, 277, 280–81, 287, 293–304, 323, 348, 356, 360, 363–5 tax expenditures 105, 115, 128–40, 194–5, 362 tax experiments 355, 360, 364 tax farming 23 tax harmonization 266, 277–9, 284–5, 288 tax havens 71, 166, 169, 230, 246, 251–3, 256, 263–8, 284, 286–7, 293–4, 296, 299, 303–4, 343, 349 tax holidays 135 see also tax expenditures tax incentives see tax expenditures

Tax Justice Network 256, 267, 286–7 tax mixes 11, 53–4, 56, 58, 82–93, 99, 102, 107, 153, 212, 383 tax planning 136, 261, 263–4, 268–71, 281 tax policy diffusion 83, 91, 211, 229–39 tax preferences 49, 51, 374–84, 393 tax progressivity see progressive taxation tax relief see tax expenditures tax revenue 98, 100–102, 155, 184, 186, 209–10, 284, 344–5, 376 in developing countries 323–33 tax state 1, 3–4, 6, 9, 11, 21, 47, 82, 114, 166–7, 169–70, 174, 229, 238, 251 colonial 64–77 see also colonialism size and structure of 98–109 tax structure 17–18, 21, 23, 25–6, 76, 114, 116–17, 120, 123, 128, 130, 155, 173, 181, 236, 238, 329, 388–9, 393, 399 tax subsidies see tax expenditures taxation 374 capital 6, 9, 26, 84–6, 88, 103, 167, 169–70, 234, 383, 388 carbon 131, 134, 208–10, 212–22, 257, 277 consumption 4–6, 8–10, 36, 42, 47–8, 50, 53–4, 58–9, 64–6, 82–9, 92–3, 99–101, 104–9, 120, 128, 156, 170–73, 193, 197–8, 203, 209–10, 217, 229–30, 236, 238, 340, 382–3, 388 corporate see corporate income taxes; corporate taxation definition of 4, 209 direct 1, 5–6, 12, 21, 23, 41, 48–9, 59, 68, 76, 123, 170–72, 198, 238, 276–7, 281–4, 393, 395, 400 double 9, 233, 245–56, 260, 262, 266, 270, 276, 279–80, 282, 345 drivers of 8–9 flat 5–7, 91, 109, 212, 230, 236, 239 general sales 5, 54, 64, 66, 68, 72 green 11, 104, 208–22 income see income taxes indirect 1, 5–6, 21, 23, 48, 82, 88, 91, 98, 170–71, 198, 238, 276–8, 281, 288, 323, 329, 397 see also VAT inheritance 5, 7, 35, 53–5, 57–8, 64, 66–8, 70–71, 73–4, 98, 171–2, 182, 187 nuts and bolts of 4–8 payroll 82, 84, 88–9, 388 see also social security poll 21, 69, 72 premodern 17–26, 66

414  Handbook on the politics of taxation progressive 5–7, 10, 12, 26, 35–6, 42, 48, 52, 54, 59, 67, 82, 84–5, 99–100, 102, 117, 120, 183–4, 194, 196–7, 374–82, 388, 394 property 1, 5, 47, 49, 54, 58–9, 82, 98, 113, 173, 182 subcentral 146, 151–9 “tampon” 192–3, 198 trade 11, 33, 47, 50, 54, 68, 71, 74, 76, 116–17, 325–8, 332–3 turnover 276–8 value-added see VAT wealth 1, 5, 7, 98, 170–75, 182, 197–8 Taylor, B. D. 41 technology 33, 135, 157, 166, 210, 326, 329, 331, 339, 347 Tencent 347 Teorell, J. 32 terrorism 268 Therkildsen, O. 140 Thiemann, M. 261 Thies, C. G. 119 think tanks 263, 314 Thornton, J. 122 Tiebout, C. 147–8 Tierney, M. J. 330–31 Tilly, C. 19, 32, 34, 37–41, 119 Timmons, J. F. 86, 88, 116–17 Timofeev, A. 158 tobacco taxation 4–5, 104 Tobin, J. 310 Tocqueville, A. D. 147 Tolbert, C. J. 89–90 trade taxes 11, 33, 47, 50, 54, 68, 71, 74, 76, 116–17, 325–8, 332–3 trade unions 6, 87, 93, 103, 170 trademarks 137, 264 transparency 115, 131–2, 134, 138–40, 235, 252, 264–5, 267–70, 280, 286–7, 293–5, 298–9, 303–4, 323, 329–30, 333, 391 Transparency International 287 Treaty of Rome 276, 281 Treaty of Westphalia 293 Treaty on the Functioning of the European Union 276 triangulation 137 Troiano, U. 363 Trondal, J. 263 Trump, D. 342 Turkey 299–300 turnover taxes 276–8 Twitter 340 UBS scandal 253–4, 296 Uganda 72

Umit, R. 218 unemployment 4, 51, 93, 102, 146, 195, 197, 375, 377 Union Bank of Switzerland 295 United Arab Emirates 167 United Kingdom 10, 12, 20, 22, 25, 39, 52–4, 70–71, 73, 75, 88–90, 93, 98, 105, 120, 131, 133, 155, 193–4, 249–50, 252, 297, 311–12, 314–16, 319, 330, 342, 345, 360, 362–3, 366, 380, 392 United Nations 244, 249–50, 294, 328–30, 347 United Nations Conference on Trade and Development 323 United States 12, 26, 35, 41, 70, 75, 87, 89–90, 92, 98, 103, 105–6, 128, 131–3, 136–8, 151, 154–5, 157–8, 179–80, 184, 195, 197, 200, 218, 230, 232–5, 247–50, 252–6, 262, 268, 284, 289, 294–9, 302, 304, 309, 316, 328, 330, 338, 340–49, 356, 360, 362–3, 365–6, 374, 376, 391–2 Uppsala Conflict Data Program 32 urbanization 49, 65 Uruguay 47 value chains 7, 260, 345, 347 value creation 339–40, 345 value-added tax see VAT Van den Bergh, J. C. 220 Van Rompuy, P. 153 VAT 5–7, 9, 11, 50, 52, 54, 64–5, 68, 73, 82–3, 86, 90, 92–3, 98, 101, 103–4, 106–7, 120, 128, 130–32, 155, 182–3, 192, 198, 229–30, 232, 236–8, 277–81, 288, 323, 325, 327–9, 332, 340, 374, 394, 397 Vella, J. 312–13 Venezuela 69 venture capital 339–40 vertical fiscal imbalances 153, 155 Vestager, M. 287, 344 veto players 53, 89, 170, 253, 276, 282, 311, 345, 396 Vietnam 41 Volden, C. 232 von Hagen-Jamar, A. 37, 42 von Haldenwang, C. 117 von Schiller, A. 382 voting behavior 19–20, 49–50, 52, 185 see also suffrage median voter theory 178, 183–8 Wagner, A. 65 Wallerstein, M. 85 Wang, Y. 39–40 war 3, 7, 19–20, 26, 32–42, 48, 64–8, 74–6, 100, 106, 238, 377

Index  415 Ward, H. 213, 215, 232, 239 Warren, E. 374 Washington Consensus 328 Wasserfallen, F. 232, 235, 284 wealth taxes 1, 5, 7, 98, 170–75, 182, 197–8 Weber, M. 19, 22 Weingast, B. R. 20, 37, 47, 148 welfare expenditures 53 welfare state 2, 8–9, 41–2, 51–2, 86–7, 89, 91, 98–106, 108, 133, 136–7, 139, 178, 181, 195, 200, 286, 364, 374–5, 378, 381–2 West African Economic and Monetary Union 232, 237 Weyland, K. G. 231 whistleblowers 359, 365, 367 Wibbels, E. 151 Wilensky, H. 92

Wilson, C. E. 87 Winer, S. L. 115, 117 Wiseman, J. 37 Woodward, R. 261 World Bank 12, 135–6, 185, 328–9 World Commission on Environment and Development 211 World Trade Organization 220, 244, 329 Yandex 347 yellow vest movement 138, 209, 217, 219 Yogo, U. T. 117 Zalando 339 Zimbabwe 195, 198 Zolt, E. M. 328