Automatic Information Exchange and Domestic Tax Policy

The previous section has shown that AEI did have the expected effects on international portfolioflows: tax evaders shift their portfolios out of tax havens.

But does international cooperation in the form of AEI also curb the pressures of tax competition? If residence countries receive full and high-quality information on their taxpayers’foreign funds, the threat of capitalflight, which led them to lower their tax rates in the past, disappears. Will this effect reverse the trend of ever-lower (portfolio) capital tax rates, which has marked the era of neoliberalism over the last 35 years (Swank 2006)? Researching the effects of AEI on domestic tax policy has not previously been undertaken. Our research on this issue charters into new territory.

Our theoretical argument is the following: once governments are freed from competitive pressure through AEI, they should be free to raise taxes in accordance with domestic political demands again. For example, left governments are gener-ally in favour of higher taxes on capital (e.g. Basinger and Hallerberg 2004) and could seize the opportunity offered by financial transparency. Similarly, heavy budget deficits (e.g. Lierse and Seelkopf 2016) or voter demand for compensatory

fairness (Limberg 2019; Scheve and Stasavage 2016) could lead governments to increase taxes on portfolio capital. Figure 7.1 illustrates our argument.

To submit this argument to an empirical test, we pursue two different strategies.

In afirst step, we leverage the differential success of thefight against tax evasion and avoidance described in Section 7.3 in a quasi-experiment. While there is adequate cooperation against portfolio capital tax evasion, avoidance of corporate profits taxes by MNCs mostly continues unhinged. Since the relevant domestic political determinants of tax rates are identical for business profits and portfolio capital, the difference in the effectiveness of cooperation should lead to a diver-gence in the respective tax rates.

Indeed, comparing the development of average tax rates in OECD countries on dividends at the shareholder level, an appropriate indicator for taxes on portfolio capital, with the statutory tax rate on retained corporate profits provides initial evidence for this theory (see Figure 7.2). Whereas dividend taxes increase after 2009, the year the G-20 countries credibly committed that‘the era of banking secrecy is over’(G-20 2009), corporate profits taxes continue to decrease. In a comprehensive difference-in-difference analysis, we estimate the average tax rate on dividends in OECD countries to be 4.5 percentage points higher in 2017 than it would have been absent international tax cooperation (Hakelberg and Rixen 2020).⁷

There is, however, substantial variation around this trend. Belgium, for instance, raised the tax rate on dividend payments from 15 per cent in 2008 to 30 per cent in 2018, Hungary lowered it from 35 per cent to 15 per cent and Sweden kept it constant at 30 per cent. This cannot be explained by financial secrecy alone. Furthermore, the binary approach of the diff-in-diff analysis disre-gards that some countries were subjected to a more significant increase infinancial transparency than others. The US, for example, does not reciprocate information sharing, which implies that jurisdictions for whomfinancial services provided by the US are pivotal saw a lesser increase in transparency.

Therefore, our second empirical strategy aimed at investigating the variation across countries in more detail. In Ahrens et al. (2020a), and in line with the general theoretical model presented above, we argue that the variation in coun-tries’ reactions to increased transparency depends on domestic factors.

Transparency alone is not sufficient to motivate governments to increase tax rates. Transparency instead is anenabler because it complicates tax evasion by households, effectively giving governments leeway to increase tax rates as they see fit. However, governments may or may not use this leeway depending on domestic factors such as the ideological colour of governments, absence or presence of compensatory fairness arguments among voters as well as budget constraints.

⁷ We control for important potential confounders—like the occurrence of afinancial crisis that may affect tax rates on dividends differently from tax rates on profits, and the top rate on personal income that may be linked to dividend taxes but not corporate taxes.

35

30

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20

15

Mean tax rate

Full sample

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

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Corporate profits Dividends 15

Mean tax rate

Excluding Norway and Finland

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Figure 7.2 Average tax rates imposed on dividends and corporate profits in OECD countries (%, taxable income).

Note: Data is from OECD (2019b). Specifically, we obtain data on corporation taxes from the OECD tax database’s table II.1, where we use the indicator‘combined corporate income tax rate,’which compiles member states’ ‘combined central and sub-central (statutory) corporate income tax rate given by the central government rate (less deductions for sub-national taxes) plus the sub-central rate.’

Data on dividend taxes comes from the database’s table II.4, where we use the item‘net personal tax,’

which‘shows the net top statutory rate to be paid at the shareholder level, taking account of all types of reliefs and gross-up provisions at the shareholder level’. We excluded Norway and Finland in the empirical analysis. Due to the peculiarities of the dual income tax their tax policies during the 2000s included very extreme policy shifts. Nevertheless, our results hold if both countries are included. See Hakelberg and Rixen (2019) for details.

Such domestic factors are thedriversof tax policy decisions. Our main argument is that primarily those governments who experience domestic pressure to increase rates use the room to manoeuvre introduced byfinancial transparency.

The most critical domestic factor that drives tax increases is the budgetary situation of a government (Lierse and Seelkopf 2016). Financial transparency makes it more likely that higher taxes on capital income actually lead to higher tax revenue because evasion is less likely. Governments facing budget constraints should thus have an incentive to increase taxes on capital income when their investment environments become more transparent. Ahrens et al. (2020a) there-fore expect an effect of budget constraints, on dividend tax rates, that depends on the level offinancial transparency. In the same vein, we expect conditional effects of government partisanship, compensatory fairness demands (Limberg 2019;

Plümper et al. 2009) and the mismatch between the taxation of labour and capital (Ganghof 2006).

To test the argument, Ahrens et al. (2020a) first develop a novel financial transparency indicator, which measures financial transparency in the invest-ment networks of 35 OECD countries between 2001 and 2018. The resulting Investment Network Transparency Score (INTS) reveals a strong upward trend in transparency, reflecting the gradual replacement of banking secrecy with increasingly effective methods of information exchange. We use this indicator in multiple regression analyses to determine its conditional impact on tax rate reforms.

The results show that financial transparency does not have an independent effect on the taxation of dividends. As expected, the effect of transparency is conditional on a domestic factor, namely the budget balance. There is a significant interaction betweenfinancial transparency and budget balance. Negative budget balance in combination with high transparency motivates cabinets to increase taxes on dividends, which confirms the expectations. For the other domestic factors, there are no significant independent or interaction effects. The absence of an interaction between transparency and fairness concerns comes as a theor-etically interesting surprise. However, the main results fit with our theoretical arguments. No government raises dividend tax rates just because of an increase in financial transparency. It seems that high financial transparency gives national governments the room to raise taxes on portfolio capital if they need revenue because of budget constraints.