Sunday, 11 March 2012

Countries don't help each other to tax, and they should.

Despite the compelling idea that a central mark of statehood is the power of the sovereign to impose taxation, it is surprising how little states help each other to tax.  Tax information exchange is virtually the only way to impose income taxation coherently in a world of footloose capital.   Yet while countries have cooperated to some extent in signing some bilateral and some multilateral information sharing covenants, in most cases they seem to do very little sharing of necessary information.

This is mostly because of the onerous identification requirements countries have imposed on themselves before they will divulge taxpayer information to each other, even under an agreement to do so.  Under the current status quo, the government that seeks information can typically only obtain it by requesting it on a case by case basis, i.e., by identifying a specific taxpayer suspected of specific tax avoidance or evasion activity.  This is hard to do when the major difficulty of mobile capital that information sharing is meant to resolve is the impossibility states face in finding out about taxpayer's offshore assets.  Worse, even when identification is possible, the other state can deny the request if local laws prohibit disclosure of taxpayer information.

That makes specific request-based information exchange "a charade," in which countries appear to agree in principle but in practice do little but defect.   The result is, countries don't help each other very much at all, and so all continue to struggle to tax effectively.

The best way to fix this problem is automatic or spontaneous information exchange.  This would mean that countries would as a matter of routine gather information about the home countries of anyone receiving income from sources within their jurisdictions, and report that this income was received to the recipients' home countries.  In simple form this means that governments would require payors of income, such as banks (paying interest on savings accounts) and mutual funds (paying dividends to shareholders), to let the government know when they make payments to their payees (such as on a form 1099), and in so doing take note of the residence of these payees.  Governments then would sort the payments by residence of the payees and send periodic reports to the home countries to apprise them that the payment has been made.

Not only is this not difficult to do, it is not untested.  Canada and the U.S. have this arrangement, and it has been called "the best existing example of what an automatic exchange of information protocol would look like."  It's a strange arrangement, in that it only requires U.S. payors to report payments made to Canadians: for now, U.S. banks are not required to report any payments made to non-Canadian foreign payees if no U.S. tax is owed (typically the case).  In turn, the U.S. government apparently only turns the pertinent info over to Canada, and not to any other country even if it has such information (possible under an odd twist to the disclosure rule that permits banks to simply collect and report residence information on all payees, rather than segregate the Canadian accounts and only turn those over).

There is no good reason not to extend this rule to all foreigners, and the only reason the U.S. has not done so is political malfunction--each time some legislator sensibly suggests that the rule be expanded to all foreigners (which happens periodically), the idea is discarded amongst cries (by lobbyists and their representatives in Congress) that the U.S. ought not to be in the business of helping other countries enforce their tax systems, that such aiding and abetting would hurt U.S. banks by subjecting them to standards more strident than their foreign competitors.

Thus the consensus seems to be that every country has an inviolable right to tax, but no country has any obligation to help the others exercise that right, and indeed, a country that does do that is only hurting itself.  That is an odd status quo.  The Canada-U.S. arrangement (along with some other similar arrangements like the European savings directive) suggests that there is something fundamentally untrue about the status quo story.  Countries can help each other, and they should help each other, and it is likely even the case that they must help each other, if any of them are to continue to have anything that resembles a coherent income tax system going forward.

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