THE RIGHT AND THE GOOD: TAXING RIGHTS, VALUE CREATION, AND THE RHETORIC OF INTERNATIONAL TAXATION.

• Author: Elkins, David

1. INTRODUCTION 194 II. CONTRACTUAL RIGHTS 202 III. NEO-LOCKEAN RIGHTS 211 A. The Neo-Lockean Claim 211 B. Analyzing the Neo-Lockean Claim: Presence 215 C. Analyzing the Neo-Lockean 216 Claim: Factor Prices D. Analyzing the Neo-Lockean Claim: Uncompensated Contribution 220 E. Quantifying the Contribution of Social Capital: The Domestic Arena 222 F. Quantifying the Contribution of Social Capital: The International Arena 225 IV. THE GOOD 229 V. CONCLUSIONS: WHAT'S REALLY GOING ON? 235 I. INTRODUCTION

   In the discourse of international taxation, it has become commonplace to assert that the international tax regime established in the wake of the First World War is ill-adapted to the needs of the modern era. Scholars and policy makers alike have averred that globalization has rendered the traditional norms obsolete and that the structure needs to be revised in view of the economic reality of the 21st century. (1) However, as much as it purports to be aware of the irrelevance of key elements in the 100-year-old structure, the literature overwhelmingly fails to question its underlying principles. Instead it tends to accept those principles dogmatically and simply suggest new ways of applying them in light of changed circumstances.

   One of the principles of the traditional international tax regime is territoriality, the tenet that countries have the right to tax income derived from within their sovereign territory. (2) Originally described as economic allegiance on the basis of acquisition of wealth, (3) the principle of territoriality worked reasonably well as long as the means of production and the goods that they produced were primarily tangible and there existed substantial legal and practical barriers to the free movement of people, capital, and goods. While taxpayers have always sought to structure their activities so as to alleviate their tax burden, countries that hosted international investment nevertheless had the capacity to tax effectively the wealth produced within their territory.

   With the rise of the multinational enterprise (MNE), whose means of production are widely scattered and yet fully integrated and who can often move capital from one jurisdiction to another at the click of a button or the shuffling of some papers, host countries have found it increasingly difficult to impose an effective tax on MNEs operating within their territory. In particular, MNEs have proven extraordinarily adept at manipulating legal and accounting rules so as to understate the profits that they earn in the host country. (4) The methods that MNEs employ to accomplish this end are many and varied. Among the most common are paying deductible interest or royalties to related corporations in other jurisdictions, overpaying related foreign corporations for goods or services purchased from them, or undercharging related foreign corporations for goods or services it sells to them. (5) In one well-publicized example, Starbucks operated in the United Kingdom for a number of years, during which time it reported receipts amounting to several billion pounds and yet paid no income tax. (6) According to press reports, Starbucks used two primary means to divert its income outside of the relatively high-tax United Kingdom. First, it purchased coffee beans via a subsidiary in Switzerland, roasted them in the Netherlands, and resold them at a much higher price to its U.K. affiliate. Second, the U.K. affiliate paid a royalty to a related corporation in the Netherlands, which apparently then paid royalties to another related corporation in Switzerland. The high cost of the beans and the royalty payments reduced the taxable income of the U.K. operation to zero. (7)

   Other MNEs engage in even more aggressive versions of this tax planning technique. For instance, consider Google's maneuver, known in the trade as a "Double Irish Dutch Sandwich." (8) Profits from Google's overseas operations, regardless of where its consumers are located, are booked in an Irish subsidiary. This subsidiary then pays a royalty to a Dutch subsidiary, which in turn pays a royalty to another subsidiary registered in Ireland but headquartered in Bermuda. Finally, the Irish/Bermudian subsidiary pays a royalty to a subsidiary both registered and headquartered in Bermuda. The purpose of the roundabout maneuver is to avoid withholding taxes--because Ireland and Holland are both members of the European Union, royalties between corporations resident in these two countries are exempt from withholding--as the income finds its way to Bermuda, a country that imposes no corporate income tax. (9)

   Practice has shown that it is extraordinarily difficult for host countries acting on their own to confront these and other tax planning techniques and to enforce their claim to a share of the wealth created within their borders. (10) As a consequence, governments, multinational organizations, and scholars have in recent decades begun exploring methods of international cooperation to ensure that host countries can effectively impose tax on MNEs operating within their territories. Perhaps the most radical among them is a scheme of formulary apportionment, under which an MNE's total profits would be allocated to the countries in which it operates in accordance with a formula that supposedly quantifies the extent of its operations in each country. Each host country would then be free to tax whatever income was allocated to it without regard to intrafirm transactions. (11) The OECD, which has hitherto refrained from endorsing formulary apportionment, (12) has nevertheless taken what some consider the first step toward adopting such an approach when, within the framework of its BEPS project, it recommended that MNEs be required to report how much of their income they earned in each jurisdiction ("country-by-country reporting"). (13) Instead of formulary apportionment, the OECD has recommended or considered a number of other measures, including strengthening of the arm's length transfer price doctrine, (14) the imposition of effective worldwide taxation of income by home countries, (15) the imposition of a global minimum tax, (16) and limiting the deduction of interest. (17)

   All of these proposals are explicitly premised on the assumption that taxing rights should follow wealth creation, that is, that the international tax regime should be structured so that host countries can effectively tax the income that is generated within their territories. (18) The debate within the academic literature and in policy discussions at both the national and international levels focuses on how best to implement that principle. (19) All agree that the traditional rules, instituted a century ago in a much different economic environment, have proven ineffective. The only question is what should replace them.

   Left unaddressed in the current debate is the question of whether the principle itself--that taxing power should follow the creation of wealth--itself has any credence. Perhaps it too is a relic of a bygone era. Perhaps it never had any credence, and the rapid globalization of recent decades has served to expose that fact. Note that I am not referring here to the capacity of individual countries or even of the international community acting in concert successfully to implement the principle of territoriality given the challenges of globalization, digitali-zation, and so forth. One who laments the passing of territoriality as a practical option in light of the power of large MNEs to avoid taxation in the countries that host their investments implicitly agrees that effective taxation of domestic-source income is a valuable, albeit unachievable goal. The question that this Article will consider is deeper: whether allocation of taxing rights in accordance with wealth creation, assuming it could be achieved, is a goal that the international tax regime should pursue and, if it is not, why the idea that taxing rights should follow wealth creation plays such a central role in the international tax discourse.

   In examining the principle that taxing power should follow wealth creation, this Article will rely upon the dichotomy, familiar in moral philosophy, between the right and the good. (20) In the context of international taxation, the right refers to a host country's deontological claim to receive a portion of the income produced within its borders. The good refers to the claim that host countries need revenue from MNEs to fund public goods. Although the literature often conflates these two claims, they are conceptually distinct and require separate analysis. I will argue that what actually motivates countries is not the right but rather a particular conception of the good in which the needs and desires of their own citizens and residents take precedence over those of other countries. However, for both political and psychological reasons they frame their position either in terms of the right or in terms of a more universal good, and this confusion pervades the academic literature as well.

   Within the realm of the right, we must make a further distinction between two different types of right-based claims. A host country may assert that MNEs who choose to operate within its territory take upon themselves an implicit contractual obligation to pay tax as delineated in the host country's laws. When the host country imposes an income tax, MNEs are, in effect, contractually obligated to pay the host country a percentage of the income generated by their economic activity in the host country. Alternatively, the host country may assert a neo-Lockean claim to a commensurate share of the wealth that its social capital--in the broadest sense of the term--helped to create. Part II will discuss the contractual claim. Part III will consider the neo-Lockean claim.

   Part IV will consider the good. It will sketch and then examine an argument leading from the proposition that tax revenues are necessary for the promotion of...