Money on the Table?: Responding to Cross-Border Tax Arbitrage

I. INTRODUCTION In the international taxation literature, one cannot so much as scan an opening paragraph without substantial danger of "learning" once again that we live in an age of globalization, worldwide capital mobility, increasing inter-dependency, and (with suitable drumroll) threats to national sovereignty. Tedium aside, however, these claims have the virtue, at least-except for the last of them-of being unmistakably true. Why isn't national sovereignty endangered (or at least not unmistakably so) by global economic integration? If one defines it as national autarky, then presumably it is endangered-if only because, as the people of North Korea and Myanmar might attest, the global trends make autarky ever more unappealing. Suppose, however, that one instead defines sovereignty in a conventional international law sense, as embracing political independence, territorial integrity, exclusive jurisdiction over one's territory and residents, and freedom from intervention by foreign sovereigns.' Then the fact that countries have ever more extensive strategic interactions and ability to affect each other is not a violation of sovereignty; rather, it is part of the context in which they exercise sovereignty. Even if countries have less latitude to make policy in disregard of outside competitive pressures or emerging worldwide uniformities, this might be viewed as merely influencing how they may choose to exercise their sovereignty. Still, a debate about global economic trends in relation to sovereignty is too semantic to hold much ultimate interest. A more rewarding topic is how the trends affect countries' strategic interactions. Harmonization and competition are two wellknown modes of interaction between countries' legal systems, sometimes viewed as IMAGE FORMULA6polar opposites, but often overlapping. For example, a race to the bottom may involve effective harmonization through competition. In evaluating the consequences of countries' strategic interactions, two key norms to keep in mind are national welfare and worldwide welfare. When the two norms offer consistent counsel, countries may find it easy to achieve mutual gain through cooperation. Even when the two norms seem to conflict, they can, in theory, be reconciled through policies that aim at maximizing worldwide welfare, but offer compensation to the losers. However, this Coase Theorem truism is subject to the usual problem of transaction costs, such as those with the underlying prisoner's dilemmas, where cooperation is best for the group but not for anyone acting in isolation. National and worldwide welfare also may be pushed apart by bargaining problems in a bilateral monopoly, wherein each actor seeks to capture as much as possible of the surplus that is available through cooperation, even at the risk of destroying it all. International income taxation provides a good illustration of how national and worldwide welfare may interrelate in practice. Countries frequently tax income on both a source and a residence basis, reflecting their power and accepted legal jurisdiction both in personam and in rem. Given these dual claims, if an American invests in France or vice versa, both countries may feel entitled to tax the same income at their full statutory rates. However, such a "double tax" may lead to inefficient deterrence of cross-border investment, to the detriment of the government and people of both countries. Coordination of the two countries' tax claims may help mitigate this result. Countries around the world have therefore agreed, through a web of bilateral treaties, to coordinate their competing claims via "source country priority." Many countries, including the United States, do this by offering foreign tax credits that effectively rebate the tax on what they deem to be foreign source income, to the extent not in excess of the domestic tax on such income.2 Implicit in the allowance of foreign tax credits is the view that other countries' taxes on the outbound investments of one's residents are relevant to one's own policy choice regarding taxation of these investments. …