Introduction 149 I. The Canon 156 II. Setting the Stage 161 Marketization 161 Fragmentation 168 III. A Paradigm Shift 174 A. The Costs of Jurisdiction Shopping 177 B. The Availability of Different Legal Regimes 193 C. Targeted Audience 197 Conclusion 205 Introduction
In a recent article in the New York Times, entitled "For the Wealthiest, a Private Tax System That Saves Them Billions," the following argument was made:
[T]he very richest Americans have financed a sophisticated and astonishingly effective apparatus for shielding their fortunes. Some call it the "income defense industry," consisting of a high-priced phalanx of lawyers, estate planners, lobbyists and antitax activists who exploit and defend a dizzying array of tax maneuvers, virtually none of them available to taxpayers of more modest means.... [T]he wealthy have used their influence to steadily whittle away at the government's ability to tax them. The effect has been to create a kind of private tax system, catering to only several thousand Americans. (1) Although taxpayers have always avoided taxes, the current era of globalization has made it easier for some to achieve this goal. The decentralized international regime, where states compete for residents, investments, and businesses, is particularly amenable to the use of loopholes, especially by the ultra-rich. (2) The marketized and fragmentized nature of the competition between states, which allows (some) taxpayers to essentially design their own tax system by picking and choosing from among specific rules, has produced unprecedented opportunities for avoiding taxes through legal planning. Thus, despite growing inequality and renewed interest in policies aimed at reducing the gap between the rich and the poor, the ability of the former to avoid taxation seriously undermines the ability of states to redistribute via tax rules. (3)
My claim is that this reality challenges the conventional view of the tax and transfer system as the most efficient way to attain redistribution. I show that the electivity of legal regimes under globalization (i.e., the ability of individuals and businesses to choose the laws applicable to them or to avoid application of a particular legal regime altogether) radically diminishes the effectiveness of redistribution through the tax system. This, I argue, makes other rules an attractive avenue for redistribution.
One of the fundamental debates in the literature is how a state can best redistribute income among its subjects. The canonical preference for the tax and transfer system argues that tax laws are more efficient than other areas of law in redistributing income; (4) some assert, in contrast, that redistribution can be efficiently achieved in many other legal spheres, particularly private law. (5) The objection to redistribution through nontax rules is grounded in two key arguments. First, nontax rules are arguably both over-inclusive and under-inclusive. Unlike tax and transfer rules, which directly target income, nontax rules cannot be as precisely tailored to the redistribution goal. Second, unlike other areas of law (such as private law), tax laws do not create what is known as a "double distortion" problem. (6) Although all laws that redistribute income involve a labor-leisure distortion, nontax rules (or "legal rules" as they have been termed) arguably entail additional distortions. And since tax laws redistribute income in a less costly way than other legal instruments, redistribution via the tax and transfer system provides more resources to the poor, the argument goes. Thus, for example, whereas high taxes will distort people's incentives to work rather than engage in leisurely activities, tort rules favoring poor fishermen over rich yacht owners will distort the latter's incentives not only to produce income rather than engage in leisure but also to take the optimal level of precaution. (7) Together, these two arguments form the canonical claim for redistribution via tax and transfer rules and against redistribution in the framework of other areas of law. (8)
Contrary to conventional wisdom, the Article asserts that global tax competition shakes the case against using nontax rules for redistribution. (9) The electivity of legal regimes currently impacts tax more than it does other areas of law. This raises doubts about the tenets of the over-inclusiveness and under-inclusiveness argument and undermines the double-distortion argument against using nontax rules to effect redistribution.
Globalization has transformed the state-citizen relationship by turning states into market players competing for residents (individuals and businesses), for factors of production, and for tax revenues. Instead of powerful sovereigns with the capacity to make and enforce mandatory rules, impose taxes, and set redistribution, states are increasingly becoming actors in a competitive global market, where their ability to govern is shaped by supply and demand. With the increased mobility of residents and factors of production, the state no longer functions as a regime that imposes whatever rules it deems necessary but as a regime that is elective to a large extent. Consequently, individuals and businesses have the ability to choose from a broad range of legal regimes, while states are pressured to offer competitive deals of desired public goods and services (including competitive regulation) at an attractive price. Redistribution has thus become a price that some states can afford to impose on high-ability individuals and businesses. This competitive market reality dramatically weakens states' ability to redistribute, by pushing them to lower the "prices" they charge.
Moreover, individuals and businesses are not limited to shopping for one "pre-packaged" legal regime under the sovereignty of a single state, but they can also buy, a la carte, fractions of regimes under the sovereignty of different states. In other words, the state-subject relationship has not only been marketized but also fragmented: individuals and businesses can detach their residency from the location of their investments, manufacturing plants, and any other business activities and subject each to separate jurisdictions. Even more significant for the purposes of this Article is that they do not have to actually physically relocate themselves or their resources and activities in order to be subject to rules of another jurisdiction, nor do they have to comply with all the rules of any particular jurisdiction as a package deal. Rather, in many cases, they can bind themselves to specific rules of a certain jurisdiction (and avoid the rules of another jurisdiction) by way of choice-of-law rules. Therefore, the public goods and services as well as the rules, in and of themselves, are market choices for taxpayers. The result is that as a practical matter, wealthy individuals and businesses can, to some degree, put together their own legal regime and thereby minimize the price they pay for each of its components. From a state's perspective, the price it charges for each of the unbundled rules, products, and services it offers (including the redistributive component of that price) must be competitive relative to the prices charged by other states for the same products and services.
Under the conventional approach, selecting the most effective legal tool for redistribution is a matter of internal optimization for the closed-economy state. Under the current fragmented and competitive global regime, however, redistribution has become a process of price-setting by a competitive actor (the state) seeking to optimize the (redistributive) price it charges for the legal rules it offers. In this market reality, the best tool for redistribution is the rule for which the highest price can be charged. Thus, given the electivity of taxpayers' choice of jurisdiction, the price (i.e., the redistributive component) of each individual tax or nontax rule should be determined by the elasticity of taxpayers' choice of jurisdiction--i.e., how variations in these prices will impact that choice. Elasticity, the Article will explain, is a function of the availability of alternative choices in other jurisdictions as well as the costs of opting for these alternatives.
In the framework of the Article's discussion, two considerations will be offered for determining the optimal rules for attaining redistribution. The first is a given rule's opting-out potential. (10) The different areas of law vary in their criteria for the applicability of their rules. Choice-of-law rules, which govern the applicability of legal jurisdictions, make opting in and opting out ofjurisdictions more or less costly. Some choice-of-law rules are easily contended with (or evaded). For example, the rules relating to contracts essentially enable individuals to freely choose which rule will apply to their contractual relationships. Other rules, such as those applying to property law, tend to more closely bind to a specific territorial location (e.g., the locus of the asset) and are therefore costlier to plan around. Consequently, such rules are better mechanisms for achieving redistribution, provided that the cost of redistribution does not push individuals to move their factors of production (e.g., their investments in land) to another--more welcoming--location. In short, the effectiveness of rules as a means of redistribution is negatively correlated with how costly it is to avoid them. All other things being equal, then, for any given rule, a state can impose a redistributive price that reflects the cost of opting out of that rule. Accordingly, assuming a country seeks to redistribute income, it would be more efficient to do so through rules that are costlier to avoid. (11)
Despite the efforts made by many states to counter international tax planning, tax laws are still highly susceptible to jurisdiction shopping. If other legal areas are less elastic in...