What’s at Stake in the Sovereignty Debate?: International Tax and the Nation-State

[Professor Diane Ring is Professor of Law at Boston College Law School]

The international tax problems of today are typically beyond the scope of a single nation to solve. However, the prospect of multinational problem solving, often under the auspices of an international organization, unleashes objections grounded in sovereignty.  Despite widespread reliance on sovereignty arguments, little attention has been directed at what is meant by sovereignty and what place it has in international tax policy.  This article contends that a loss of tax sovereignty undermines both significant functional roles played by a nation-state (revenue and fiscal policy) and important normative governance values (accountability and democratic legitimacy).  Whether these limitations are severe enough to demand that a sovereign state recall its taxing powers from an international body (or not surrender them initially) depends on the nature of the powers in question and the necessity for a coordinated global response.

To establish the foundation for the article’s analysis, Part I defines sovereignty and develops the nexus between sovereignty and taxation. Generally sovereignty envisions a state with territory, government and a people — where the state demonstrates control over the territory and people, and demonstrates independence from other states. Developments in the twentieth century expanded this concept to require attention to legitimacy and responsibility.  For example, post World War II the international community began to emphasize not just the sovereign state’s rights but its responsibilities including the duty to protect and promote citizen welfare.

The consideration of tax sovereignty in the remainder of Part I draws upon the basic vision of sovereignty and the expanded ideas of legitimacy and responsibility.  The article argues that tax sovereignty has a valuable functional role for governments and an important role in preserving norms crucial to democratic governance.  First, states need revenue to perform their general welfare and governance functions.  Second, states use taxing powers to manage fiscal policy.  What else, beyond these functional roles, is at risk when states surrender taxing powers? Four important norms: (1) democratic accountability of government; (2) democratic legitimacy; (3) benefit of multiple sovereigns, and (4) competing claims of tax sovereignty.  The first two points derive from an understanding of state sovereignty grounded in democratic legitimacy.

Government accountability serves as a cornerstone of legitimate democracy.  Research regarding the Swiss cantons indicates that the more direct (i.e. accountable) the democratic process, the higher taxpayer compliance in the canton.  Democratic legitimacy depends on another, more elusive element, the “demos.”  The demos (a political community with a significant shared sense of commitment whether through common history, destiny or identity) plays a vital role in creating a legitimate, sustainable democracy.  But an effective demos has been difficult to achieve above the national level and this reality undermines the legitimacy of supra-state decisions.
Even if we could resolve the democracy questions inherent in decision making at a more global level, we still might prefer local decision making because it fosters unique societies, it encourages alternative solutions, and it avoids the inherent risk of a global state. Ultimately, however, tax sovereignty provides the potential for conflict between sovereigns. What if one state justifies its tax policies as an act of sovereign power, while another state argues that those very policies infringe upon its sovereign right to design tax rules beneficial to its own citizens?  No clear resolution to the quandary exists, but the case studies provide a context for this question and the implications for inter-nation equity.

Part II examines the use of sovereignty arguments in three case studies.  In first the case (the OECD harmful tax competition project), tax sovereignty captures concerns over fiscal policy, democratic legitimacy, and inter-nation equity when states clash in designing tax rules to their advantage.  Even though critics of the OECD plan used sovereignty-based arguments to advance their own agendas, their sovereignty message nonetheless resonated with some legislators and others.  The second case study (tax voting and harmonization in the EU) involves tax sovereignty among states with a unique relationship.  Concerns over fiscal control and revenue arise, as well as explicit questions of democratic legitimacy and the value of multiple sovereigns.  Finally, the third case study (the United States’ conflict with the WTO about export sales regimes) documents the tax sovereignty debate after a state has surrendered a certain taxing powers to an international body.

Drawing upon the case studies, Part III examines how sovereignty claims are manipulated in tax debates, how states think about sovereignty in taxation, and what their decisions suggest about the future of international tax and the prospects for international cooperation. As an exercise in exploring tax sovereignty the article concludes with a question – What if the EU were to invite the United States to join the EU on tax policy, or alternatively, to pursue joint rate setting and collection of income (with spending to remain at the national level)?  Although the prognosis for cooperation seems highly doubtful, consideration of this question helps illuminate tax sovereignty and the reality that tax policy implicates two very contentious issues – size of government and allocation of tax burdens – both of which are political questions embedded in the democratic process.