A Delicate Balance: Tax Competition Versus Cooperation

Tax administrators want to maximise the amount of revenue collected without stifling the county’s competitiveness as a business destination. How should ASEAN countries navigate changing international conditions to meet this goal?

By Rebecca Tan – As Benjamin Franklin once famously said, “In this world, nothing can be said to be certain—except death and taxes.” While this statement holds true even today, taxpayers—particularly the wealthy ones who pay the most tax—are increasingly mobile and can minimise their tax burden by shifting their wealth offshore.

This mobility leaves tax authorities in a bind: how do they collect sufficient taxes to ensure the provision of public services without driving away the biggest tax payers? Tax authorities are often sandwiched between the policy makers who want more tax revenues collected and the taxpayers who want to minimise their tax.

Speaking at the Singapore Management University-Tax Academy (SMU-TA) Centre for Excellence in Taxation (CET) inaugural conference on 17 September, 2015, Tan Sri Datuk Wira Dr. Mohd Shukor Mahfar, CEO and Director General of the Inland Revenue Board of Malaysia, noted this dilemma.

“Of course we would like to increase the tax revenue, but at the same time, we cannot kill the goose that lays the golden egg by hurting the business community,” Dr. Mohd Shukor Mahfar said.

Two ways to ‘attract geese’

One way governments around the world have tried to attract international business is through tax competition, having a low tax rate to encourage more business activity in the country. However, cutting taxes may sometimes mean that they do not have sufficient revenues to implement redistributive social policies, leading to growing inequality.

“It’s really sobering to look not only at inequality but the economic mobility numbers,” said Eric M. Zolt, Michael H. Schill Distinguished Professor of Law at the University of California-Los Angeles, speaking at the same panel discussion. “In the United States, parent’s income will explain 40 percent of the variation of a child’s predicted income, a figure that is just 10-25 percent in Canada or Scandinavian countries.”

A race to the bottom on tax incentives could be a “dangerous vicious cycle” to get into, he cautioned.

“To solve the problem of inequality and economic mobility, governments need to invest their revenue not only in physical structure but also human capital.”

Echoing Professor Zolt’s sentiments, Dr. Yip Chun Seng, principal economist (fiscal policy) at the Singapore Ministry of Finance, suggested that developed economies should not rely too heavily on tax incentives to grow their economy. Instead, another way to ‘attract geese’ would be to provide the right kind of environment.

“For more mature economies, the kind that Singapore aspires to or is already arriving at, the role of incentives has to fade into the background. Instead, institutions, innovation and infrastructure become terribly important,” he said.

Co-operation instead of competition

At the other end of the equation, tax authorities are trying to raise their revenues by ensuring that taxes are paid when they are due.

To help reduce tax evasion by multinational companies, the Organisation for Economic Co-operation and Development (OECD) has proposed to standardise international tax rules and promote greater disclosure surrounding cross-border transactions. Called the base erosion and profit shifting (BEPS) project, the initiative consists 15 action items that are progressively being rolled out.

Action item 6, which focuses on preventing the abuse of tax treaties, has particular relevance to the Association of Southeast Asian Nations (ASEAN), said University of Sydney’s Professor Graeme Cooper in his talk following the panel discussion.

“Some ASEAN member states—Indonesia, the Philippines and Singapore, for example—have a huge number of tax treaties. BEPS action item 6 inserts limitations on a source country’s tax system, and so there is a lot at stake for ASEAN,” Professor Cooper explained.

However, the implementation of action item 6 has not been straightforward, he said, adding that more contentious portions of action item 6 have also been scaled back. Professor Cooper noted that the structural limitation of benefits clause, which initially included a long list of conditions that would deny treaty benefits, has since been subsumed under the less stringent notion of minimum standards.

“As a result, action item 6 is becoming less ambitious and is likely to result in proposals that are modest and innocuous,” Professor Cooper said. “It may end up that the post-BEPS world looks similar to the world we are living in at the moment.”

Focus on building capacity and trust

If measures such as BEPS are unlikely to have a huge impact on ASEAN, what alternatives do governments have in trying to balance the conflicting goals of increasing tax revenue while promoting business activity at the same time?
Providing certainty, clarity and consistency is one way forward, said panel chair Professor Jeffrey Owens, director of the Vienna University of Economics and Business (WU) Global Tax Policy Centre, faculty member at the Institute for Austrian and International Tax Law, and chairman of the SMU-TA CET Technical Advisory Panel.

“If you get those things right, that in itself provides quite an attractive environment,” Professor Owens said.

This drew agreement from Ms. Selena Ling, head of treasury research & strategy at Overseas-Chinese Banking Corporation (OCBC), who said that tax is just one tool in the government’s big multi-tool box, and tax policy needs to be situated more broadly within revenue strategy.

“At the end of the day, you’re talking about tax revenues versus expenditures. I think the key word is actually trust—trust that the tax authorities are collecting and spending in a way that is transparent, accountable and adding to clear socioeconomic objectives,” Ms. Ling concluded.