Bilateralism or multilateralism? The political economy of avoiding international double taxation
| Author | Thomas Rixen |
| DOI | 10.1177/1354066109346891 |
| Published date | 01 December 2010 |
| Date | 01 December 2010 |
| Subject Matter | Articles |
European Journal of
International Relations
16(4) 589–614
© The Author(s) 2010
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DOI: 10.1177/1354066109346891
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Article
Corresponding author:
Thomas Rixen, Social Science Research Center Berlin (WZB), Germany.
Email: rixen@wzb.eu
Bilateralism
or multilateralism? The
political economy of avoiding
international double taxation
Thomas Rixen
Social Science Research Center Berlin (WZB), Germany
Abstract
Why do states cooperate bilaterally or multilaterally? This article addresses the issue
using the example of international double tax avoidance. It is argued that double tax
avoidance exhibits the strategic structure of a coordination game with a distributive
conflict. The distribution of tax revenues depends on the asymmetry of investment flows
between treaty partners. Since investment flows are defined dyadically, bilateral bargaining
can best accommodate countries’ concerns for the distribution of tax revenues and
other economic benefits connected to the tax base. Moreover, because there are no
serious externality problems with bilateral agreement, this solution is also viable. At
the same time, there is a need for a multilateral organization to disseminate information
and shared practices in the form of a model convention that provides a focal point
for bilateral negotiations. This solution minimizes transaction costs. Since agreements
are self-enforcing in coordination games there is no need for third-party enforcement.
Instead, the Mutual Agreement Procedure (MAP) is a device to address problems of
incomplete contracting.
Keywords
bilateralism, coordination, distribution, multilateralism, rational institutional design, taxation
Introduction
Economic activities are increasingly globalized, but the power to tax remains bound to the
nation-state. One of the problems resulting from this incongruity is double taxation, which
stems from an overlap of jurisdiction to tax between a residence state — the country where
a taxpayer lives — and a source state — the country where the taxpayer’s income was
generated. If both countries exert to the full their power to tax, then the tax burden for
590 European Journal of International Relations 16(4)
international investments is higher than for national investments causing an inefficient
allocation of capital. In order to prevent this, governments engage in efforts to avoid dou-
ble taxation.1 The institutional form of international double tax avoidance exhibits several
features that are in need of explanation.
The most remarkable feature is the fact that double tax agreements (DTAs) are pre-
dominantly bilateral (Vann, 1991; Whalley, 2001: 17–18).2 This bilateralism contrasts
with many other international regimes in the economic sphere. Most prominent among
these is the GATT/WTO — a multilateral regime with a commitment to achieving pro-
gressive, coordinated trade liberalization in simultaneous negotiations. In a classic model
Mundell (1957) shows that the free flow of goods and the resultant common prices for
them lead to factor prices being equalized across countries. Likewise, free factor flows
and common factor prices lead to equal goods prices. What can be achieved with goods
flows can also be achieved with factor flows. As Whalley (2001: 17–18) has pointed out,
Mundell’s factor–goods equivalence could be taken to suggest that the institutional form
of the tax and trade regimes (which deal with factor and goods flows, respectively)
should be similar or the same. So the puzzle is: why is the regime of international double
tax avoidance not multilateral?
Posing the question in this way is somewhat imprecise, because there actually are
some multilateral elements of tax cooperation. The OECD, as a multilateral organization,
deals with double tax avoidance and other issues of international taxation. It publishes a
so-called model convention (MC) that is negotiated and agreed upon by its member
countries. The OECD MC is non-binding. In practice, however, nearly all of the bilateral
tax treaties are based upon this instrument (Vann, 1991: 99). Thus, more precisely stated,
the question is why there is no binding multilateral agreement. What is the MC’s function
in international tax cooperation? How can one account for the coexistence of binding
bilateral treaties and this multilateral document that serves as a template for them?
When turning to theories of international cooperation for potential answers, one
finds that the institutional choice between bilateralism and multilateralism has hardly
been addressed. For one, cooperation theory has an inherent analytical bias towards
multilateralism and generally disregards the antipode to this institutional form, namely,
bilateralism (Odell, 2000: 13).3 Even work that explicitly focuses on the institutional
form of cooperation fails to contrast multilateralism with bilateralism (cf. Ruggie,
1993). The disregard of bilateralism in international relations (IR) theory cannot be
explained with the empirical irrelevance of this category — the United Nations treaty
database collected 5130 bilateral treaties adopted from 1990 to 1999 (United Nations,
2003).4 Second, and more important for the research question at hand, research was also
largely blind towards the specific advantages of an institutional form (Caporaso, 1993:
62). When do states cooperate bilaterally? What are the relative benefits and costs of
bilateral compared to multilateral cooperation? Cooperation theory not only disregards
bilateralism, it also does not systematically investigate the choice between bilateralism
and multilateralism.
This leads to an incomplete understanding of cooperation, including multilateral
cooperation. As I demonstrate, states consciously choose between the two institutional
forms and often design institutions with a mix of both bilateral and multilateral elements.
A straightforward classification of a regime as bilateral or multilateral is not always pos-
sible. In many regimes, cooperation exhibits bilateral and multilateral elements which
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