Tax integration under NAFTA: Resolving the conflict between economic and sovereignty interests

Stanford Journal of International Law

Volumn 34, Issue 1, 1998, Pages 39-68

  Cockheld, Arthur J ^a,b,c  

^a STANFORD LAW SCHOOL   (United States)

^b QUEEN S UNIVERSITY   (Canada)

^c UNIVERSITY OF WESTERN ONTARIO   (Canada)

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[No Author keywords available]

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EID: 11544274995     PISSN: 07315082     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (180)

1. North American Free Trade Agreement, Dec. 8-17, 1992, U.S.-Mex.-Can., 32 I.L.M. 605 (1993) [hereinafter NAFTA].
2. A "double movement" propels modem society. On the one hand, as market forces expand they increasingly constrain governmental policymaking, while on the other hand, people react to the socially disruptive effects of these market forces by demanding protectionist measures. See KARL POLANYI, THE GREAT TRANSFORMATION: THE POLITICAL AND ECONOMIC ORIGINS OF OUR TIME 138 (1957).
3. I use the term "tax integration" to mean the development of tax policy mechanisms that reflect the growing economic integration among countries participating in free trade agreements.
4. Beginning in 1967, the member states of the European Community instituted a common VAT system. The tax rates of the European VATs were harmonized on December 31, 1992; a minimum VAT rate of 15% is required, with reduced VAT rates of at least 5% for certain goods and services. For a description of recent European Union efforts with respect to VAT harmonization, see Sijbren Cnossen, Coordination of Sales Taxes in Federal Countries and Common Markets, 9 CONN. J. INT'L L. 741 (1994).
5. See Commission of the European Communities, Report of the Committee of Independent Experts on Company Taxation, TAX NOTES INT'L, Sept 2, 1992, at 36-15, available in LEXIS, Taxana Library, TNI File [hereinafter Ruding Committee].
6. See INDUSTRY CANADA, ECONOMIC INTEGRATION IN NORTH AMERICA: TRENDS IN FOREIGN DIRECT INVESTMENT AND THE TOP 1,000 FIRMS 9 (1994) [hereinafter INDUSTRY CANADA]. Data taken was for 1991.
7. For example, NAFTA will eliminate tariffs on virtually all goods traded among the Member States. See JON R. JOHNSON, THE NORTH AMERICAN FREE TRADE AGREEMENT: A COMPREHENSIVE GUIDE 26 (1994). In addition, NAFTA contains a number of provisions to facilitate investment among the Member States, including national treatment, or nondiscrimination against investors and investments from other Member States, and most favored nation treatment For a description of these provisions, see GARY C. HUFBAUER & JEFFREY J. SCHOTT, NAFTA: AN ASSESSMENT 80 (1993); see also NAFTA AND INVESTMENT (Seymour J. Rubin & Dean C. Alexander eds., 1995).
8. For example, NAFTA will eliminate tariffs on virtually all goods traded among the Member States. See JON R. JOHNSON, THE NORTH AMERICAN FREE TRADE AGREEMENT: A COMPREHENSIVE GUIDE 26 (1994). In addition, NAFTA contains a number of provisions to facilitate investment among the Member States, including national treatment, or nondiscrimination against investors and investments from other Member States, and most favored nation treatment For a description of these provisions, see GARY C. HUFBAUER & JEFFREY J. SCHOTT, NAFTA: AN ASSESSMENT 80 (1993); see also NAFTA AND INVESTMENT (Seymour J. Rubin & Dean C. Alexander eds., 1995).
9. For example, NAFTA will eliminate tariffs on virtually all goods traded among the Member States. See JON R. JOHNSON, THE NORTH AMERICAN FREE TRADE AGREEMENT: A COMPREHENSIVE GUIDE 26 (1994). In addition, NAFTA contains a number of provisions to facilitate investment among the Member States, including national treatment, or nondiscrimination against investors and investments from other Member States, and most favored nation treatment For a description of these provisions, see GARY C. HUFBAUER & JEFFREY J. SCHOTT, NAFTA: AN ASSESSMENT 80 (1993); see also NAFTA AND INVESTMENT (Seymour J. Rubin & Dean C. Alexander eds., 1995).
10. See generally ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT, TAXING PROFITS IN A GLOBAL ECONOMY: DOMESTIG AND INTERNATIONAL ISSUES 12 (1991) [hereinafter OECD].
11. See, e.g., Lawrence H. Summers, Taxation in a Small World, in TAX POLICY IN THE TWENTY-FIRST CENTURY 64, 75 (Herbert Stein ed., 1988) ("The only judgment confirmed by historical trends is that as long as the world remains at peace, economic integration will continue. As the example of the American states and the European Common Market demonstrate, increased economic integration can promote growth and prosperity... [yet] must inevitably limit national sovereignty.").
12. For a description of the effect of tax distortion, see Ruding Committee, supra note 5, ch. 4.
13. See id. Foreign portfolio investment, which is extremely mobile, is sensitive to tax changes which alter after-tax rates of return. Economists continue to debate, however, the extent to which capital movement is influenced by taxation. A number of economic studies have focused on the impact of U.S. tax reform in 1986 on capital flows to and from the United States in an attempt to separate the impact of taxation on capital movement from that of nontax factors. See, e.g., Alan J. Auerbach & Kevin Hassett, Taxation and Foreign Direct Investment in the United States: a Reconsideration of the Evidence, in STUDIES IN INTERNATIONAL TAXATION 119, 137 (Alberto Giovannini et al. eds., 1993) (disputing the attribution of increased foreign direct investment in the United States after the mid-1980s to the 1986 tax reform); Joosung Jun, U.S. Tax Policy and Direct Investment Abroad, in TAXATION IN THE GLOBAL ECONOMY 55, 71 (Assaf Razin & Joel Slemrod eds., 1990) (concluding that U.S. tax policy may not significantly affect foreign direct investment financed by retained earnings abroad, but that it does have an influence on outward foreign direct investment financed by transfers from a domestic parent corporation); Joel Slemrod, The Impact of the Tax Reform Act of 1986 on Foreign Direct Investment to and from the United States, in Do TAXES MATTER? 169, 192 (Joel Slemrod ed., 1990) (indicating that several aspects of foreign direct investment flows are consistent with the effect of the 1986 tax reform on tax incentives).
14. See id. Foreign portfolio investment, which is extremely mobile, is sensitive to tax changes which alter after-tax rates of return. Economists continue to debate, however, the extent to which capital movement is influenced by taxation. A number of economic studies have focused on the impact of U.S. tax reform in 1986 on capital flows to and from the United States in an attempt to separate the impact of taxation on capital movement from that of nontax factors. See, e.g., Alan J. Auerbach & Kevin Hassett, Taxation and Foreign Direct Investment in the United States: a Reconsideration of the Evidence, in STUDIES IN INTERNATIONAL TAXATION 119, 137 (Alberto Giovannini et al. eds., 1993) (disputing the attribution of increased foreign direct investment in the United States after the mid-1980s to the 1986 tax reform); Joosung Jun, U.S. Tax Policy and Direct Investment Abroad, in TAXATION IN THE GLOBAL ECONOMY 55, 71 (Assaf Razin & Joel Slemrod eds., 1990) (concluding that U.S. tax policy may not significantly affect foreign direct investment financed by retained earnings abroad, but that it does have an influence on outward foreign direct investment financed by transfers from a domestic parent corporation); Joel Slemrod, The Impact of the Tax Reform Act of 1986 on Foreign Direct Investment to and from the United States, in Do TAXES MATTER? 169, 192 (Joel Slemrod ed., 1990) (indicating that several aspects of foreign direct investment flows are consistent with the effect of the 1986 tax reform on tax incentives).
15. See id. Foreign portfolio investment, which is extremely mobile, is sensitive to tax changes which alter after-tax rates of return. Economists continue to debate, however, the extent to which capital movement is influenced by taxation. A number of economic studies have focused on the impact of U.S. tax reform in 1986 on capital flows to and from the United States in an attempt to separate the impact of taxation on capital movement from that of nontax factors. See, e.g., Alan J. Auerbach & Kevin Hassett, Taxation and Foreign Direct Investment in the United States: a Reconsideration of the Evidence, in STUDIES IN INTERNATIONAL TAXATION 119, 137 (Alberto Giovannini et al. eds., 1993) (disputing the attribution of increased foreign direct investment in the United States after the mid-1980s to the 1986 tax reform); Joosung Jun, U.S. Tax Policy and Direct Investment Abroad, in TAXATION IN THE GLOBAL ECONOMY 55, 71 (Assaf Razin & Joel Slemrod eds., 1990) (concluding that U.S. tax policy may not significantly affect foreign direct investment financed by retained earnings abroad, but that it does have an influence on outward foreign direct investment financed by transfers from a domestic parent corporation); Joel Slemrod, The Impact of the Tax Reform Act of 1986 on Foreign Direct Investment to and from the United States, in Do TAXES MATTER? 169, 192 (Joel Slemrod ed., 1990) (indicating that several aspects of foreign direct investment flows are consistent with the effect of the 1986 tax reform on tax incentives).
16. See Ruding Committee, supra note 5, ch. 10.
17. For example, the World Competitiveness Report, published by the World Economic Forum, lists eight principal factors for assessing the investment climate of a country: (1) overall economic strength; (2) barriers to international trade and investment flows; (3) government policies; (4) quality of financial services; (5) infrastructure; (6) management skills; (7) scientific and technological capacity; and (8) human resources. See INVESTMENT CANADA RESEARCH AND POLICY STAFF, INTERNATIONAL INVESTMENT AND COMPETTTWENESS 49 (1992) (excerpting the World Competitiveness Report) [hereinafter INVESTMENT CANADA].
18. See Ruding Committee, supra note 5, ch. 10. The Ruding Committee found that a general lowering of corporate income tax rates by the member states of the European Community was consistent with, but not necessarily proof of, international tax competition.
19. See, e.g., Robin Boadway, The Theory and Measurement of Effective Tax Rates, in THE IMPACT OF TAXATION ON BUSINESS ACTIVITY 60 (Jack M. Mintz & Douglas D. Purvis eds., 1985). Marginal effective tax rates encompass income tax rates and depreciation schedules as well as nontax factors such as inflation and interest rates in order to establish the tax burden that an investor considers when making an investment decision. The rates are termed "marginal" because they are calculated on marginal investments, or projects that are expected to earn a rate of return just sufficient to persuade an investor that a project is worth undertaking.
20. Most limitations result from attempts to oversimplify the tax regimes under study in order to keep the studies manageable, as well as to ease the comparative process. For example, these studies typically aggregate businesses in broad categories such as "manufacturing," "construction," or "retail trade." Households are sometimes aggregated by average personal tax rate or highest marginal tax rates, or assumptions are made concerning tax free investments. Similarly, broad arrays of capital goods are shoehorned into vague categories such as "industrial buildings," "machines," and "inventories." For a description of these limitations, see OECD, supra note 8, at 92. See also Lawrence J. Kotlikoff, Comment, in THE IMPACT OF TAXATION ON BUSINESS ACTIVITY 102 (Jack M. Mintz & Douglas D. Purvis eds., 1985) ("One comes away from this recipe book with the distinct feeling that effective tax rates, like sausage, are best enjoyed in their final form, and that one can quickly lose one's appetite by looking at the details of preparation.").
21. See Kenneth J. McKenzie & Jack M. Mintz, Tax Effects on the Cost of Capital, in CANADA-U.S. TAX COMPARISONS 189, 209 tbl. 5.2 (John B. Shoven & John Whalley eds., 1992) (showing a convergence in the cross-industry marginal effective tax rates of Canada and the United States and stating that in 1990 Canada's industry-aggregate marginal effective tax rate was 28.9%, while in the United States it was 20.4%, with most industry-specific results revealing closer rates); see also John B. Shoven & Michael Topper, The Cost of Capital in Canada, the United States, and Japan, in CANADA-U.S TAX COMPARISONS 217, 232-34 (John B. Shoven & John Whalley eds., 1992) (employing a different approach than most marginal effective tax rate studies, which do not incorporate risk analysis to conclude that the cost of capital in Canada and the United States is very similar and arguing that investment location decisions are driven by factors other than tax considerations).
22. See Kenneth J. McKenzie & Jack M. Mintz, Tax Effects on the Cost of Capital, in CANADA-U.S. TAX COMPARISONS 189, 209 tbl. 5.2 (John B. Shoven & John Whalley eds., 1992) (showing a convergence in the cross-industry marginal effective tax rates of Canada and the United States and stating that in 1990 Canada's industry-aggregate marginal effective tax rate was 28.9%, while in the United States it was 20.4%, with most industry-specific results revealing closer rates); see also John B. Shoven & Michael Topper, The Cost of Capital in Canada, the United States, and Japan, in CANADA-U.S TAX COMPARISONS 217, 232-34 (John B. Shoven & John Whalley eds., 1992) (employing a different approach than most marginal effective tax rate studies, which do not incorporate risk analysis to conclude that the cost of capital in Canada and the United States is very similar and arguing that investment location decisions are driven by factors other than tax considerations).
23. See DUANJIE CHEN & KENNETH J. MCKENZIE, THE IMPACT OF TAXATION ON CAPITAL MARKETS: AN INTERNATIONAL COMPARISON OF EFFECTIVE TAX RATES ON CAPITAL 15 tbl. 2 (1997) (indicating that for investments in manufacturing capital, the marginal effective tax rates for Canada and the United States are comparable, although Mexico imposes a lesser burden); see also MAHMOOD IQBAL, A TAX COMPARISON OF LARGE MANUFACTURING INDUSTRIES IN CANADA, THE UNITED STATES AND MEXICO 12 (1994) (using a cash flow approach, which provides average tax rate results, to conclude that overall corporate tax burdens for manufacturing activities are similar among the NAFTA Member States); JACK M. MINTZ & THOMAS TSIOPOULOS, LATIN AMERICAN TAXATION OF FOREIGN DIRECT INVESTMENT IN A GLOBAL ECONOMY (1996) (finding that marginal effective corporate tax rates for manufacturing investments in the NAFTA Member States are comparable, with Canada imposing the highest burden and Mexico the lowest, while, for services, Mexico imposes the highest tax burden of any Member State).
24. See DUANJIE CHEN & KENNETH J. MCKENZIE, THE IMPACT OF TAXATION ON CAPITAL MARKETS: AN INTERNATIONAL COMPARISON OF EFFECTIVE TAX RATES ON CAPITAL 15 tbl. 2 (1997) (indicating that for investments in manufacturing capital, the marginal effective tax rates for Canada and the United States are comparable, although Mexico imposes a lesser burden); see also MAHMOOD IQBAL, A TAX COMPARISON OF LARGE MANUFACTURING INDUSTRIES IN CANADA, THE UNITED STATES AND MEXICO 12 (1994) (using a cash flow approach, which provides average tax rate results, to conclude that overall corporate tax burdens for manufacturing activities are similar among the NAFTA Member States); JACK M. MINTZ & THOMAS TSIOPOULOS, LATIN AMERICAN TAXATION OF FOREIGN DIRECT INVESTMENT IN A GLOBAL ECONOMY (1996) (finding that marginal effective corporate tax rates for manufacturing investments in the NAFTA Member States are comparable, with Canada imposing the highest burden and Mexico the lowest, while, for services, Mexico imposes the highest tax burden of any Member State).
25. See DUANJIE CHEN & KENNETH J. MCKENZIE, THE IMPACT OF TAXATION ON CAPITAL MARKETS: AN INTERNATIONAL COMPARISON OF EFFECTIVE TAX RATES ON CAPITAL 15 tbl. 2 (1997) (indicating that for investments in manufacturing capital, the marginal effective tax rates for Canada and the United States are comparable, although Mexico imposes a lesser burden); see also MAHMOOD IQBAL, A TAX COMPARISON OF LARGE MANUFACTURING INDUSTRIES IN CANADA, THE UNITED STATES AND MEXICO 12 (1994) (using a cash flow approach, which provides average tax rate results, to conclude that overall corporate tax burdens for manufacturing activities are similar among the NAFTA Member States); JACK M. MINTZ & THOMAS TSIOPOULOS, LATIN AMERICAN TAXATION OF FOREIGN DIRECT INVESTMENT IN A GLOBAL ECONOMY (1996) (finding that marginal effective corporate tax rates for manufacturing investments in the NAFTA Member States are comparable, with Canada imposing the highest burden and Mexico the lowest, while, for services, Mexico imposes the highest tax burden of any Member State).
26. See generally INTERNATIONAL REGULATORY COMPETITION AND COORDINATION 38-41 (William Bratton et al. eds., 1996) [hereinafter Bratton et al.] (describing competition for mobile factors such as capital).
27. Tax competition may also generate certain economic benefits. See infra notes 46-50 and accompanying text.
28. Early work in this field was conducted by Professor Charles Tiebout, who created a model of the market for local public goods. The Tiebout model suggested that regulatory bodies would be disciplined by the public, who would "vote with their feet" if they did not approve of government policies by moving to a jurisdiction with a more favorable regulatory approach. In other words, there would be competition for voters (and taxpayers) between jurisdictions, each of which would try to achieve the optimally efficient size. The jurisdiction that best reflected the public preference (i.e., the correct mix of tax and the provision of public goods) would attract the most voters and hence the most tax review. See Charles M. Tiebout, A Pure Theory of Local Expenditure, 64 J. POL. ECON. 416 (1956). The literature that has developed around this public choice theory concentrates on whether or not competition between tax regimes results in the suboptimal provision of goods. Others have criticized the extension of public choice theory to the international sphere. See, e.g., Peggy B. Musgrave & Richard A. Musgrave, Fiscal Coordination and Competition in an International Setting, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETTTTVENESS 59, 63 (1990).
29. Early work in this field was conducted by Professor Charles Tiebout, who created a model of the market for local public goods. The Tiebout model suggested that regulatory bodies would be disciplined by the public, who would "vote with their feet" if they did not approve of government policies by moving to a jurisdiction with a more favorable regulatory approach. In other words, there would be competition for voters (and taxpayers) between jurisdictions, each of which would try to achieve the optimally efficient size. The jurisdiction that best reflected the public preference (i.e., the correct mix of tax and the provision of public goods) would attract the most voters and hence the most tax review. See Charles M. Tiebout, A Pure Theory of Local Expenditure, 64 J. POL. ECON. 416 (1956). The literature that has developed around this public choice theory concentrates on whether or not competition between tax regimes results in the suboptimal provision of goods. Others have criticized the extension of public choice theory to the international sphere. See, e.g., Peggy B. Musgrave & Richard A. Musgrave, Fiscal Coordination and Competition in an International Setting, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETTTTVENESS 59, 63 (1990).
30. The convergence of interest and inflation rates in Europe was a principal cause of this harmonization. The Ruding Committee was concerned with thwarting the development of future tax incentives designed to attract international investment. See Ruding Committee, supra note 5, ch. 10.
31. The United States accounts for 88% of North America's GDP, while Canada accounts for 9% and Mexico 3%. See INDUSTRY CANADA, supra note 6, at 9.
32. See ROBERT E. HALL, THE INTERNATIONAL CONSEQUENCES OF THE LEADING CONSUMPTION TAX PROPOSALS 18 (CEPR Publication No. 447, 1995).
33. According to one commentator: Until recently, international taxation has been an arcane subspecies among American tax lawyers, and international considerations have rarely influenced the thrust of tax reform .... Such a provincial approach to tax policy may have been appropriate in an earlier era, but the increasing economic integration of the world requires a more global approach to tax policy. The emphasis in recent American tax reform debates on competitiveness is only a precursor to a time in which international considerations will play a pervasive role in shaping tax policies. Lawrence H. Summers, Taxation in a Small World, in TAX POLICY IN THE TWENTY-FIRST CENTURY 64, 64 (1988). Likewise: In the past, the United States has sometimes acted unilaterally in setting tax regulations and given little thought as to how die world would follow along. But now I think we recognize that an incompatible American tax policy may harm not only our own businesses in the international arena but also may allow other countries to take unfair advan tage of our tax system. James A. Baker III, The Momentum of Tax Reform, in TAX POLICY IN THE TWENTY-FIRST CENTURY 1, 6 (1988); but see Robert J. Patrick, Jr., Comments on U.S. Tax Structures and Competitiveness, 41 NAT'L TAX J. 343, 343 (1988) ("[T]here is virtually nothing in the legislative history of the 1986 Tax Act that indicates that concerns about international trade and investment had anything to do with the legislation.").
34. According to one commentator: Until recently, international taxation has been an arcane subspecies among American tax lawyers, and international considerations have rarely influenced the thrust of tax reform .... Such a provincial approach to tax policy may have been appropriate in an earlier era, but the increasing economic integration of the world requires a more global approach to tax policy. The emphasis in recent American tax reform debates on competitiveness is only a precursor to a time in which international considerations will play a pervasive role in shaping tax policies. Lawrence H. Summers, Taxation in a Small World, in TAX POLICY IN THE TWENTY-FIRST CENTURY 64, 64 (1988). Likewise: In the past, the United States has sometimes acted unilaterally in setting tax regulations and given little thought as to how die world would follow along. But now I think we recognize that an incompatible American tax policy may harm not only our own businesses in the international arena but also may allow other countries to take unfair advan tage of our tax system. James A. Baker III, The Momentum of Tax Reform, in TAX POLICY IN THE TWENTY-FIRST CENTURY 1, 6 (1988); but see Robert J. Patrick, Jr., Comments on U.S. Tax Structures and Competitiveness, 41 NAT'L TAX J. 343, 343 (1988) ("[T]here is virtually nothing in the legislative history of the 1986 Tax Act that indicates that concerns about international trade and investment had anything to do with the legislation.").
35. According to one commentator: Until recently, international taxation has been an arcane subspecies among American tax lawyers, and international considerations have rarely influenced the thrust of tax reform .... Such a provincial approach to tax policy may have been appropriate in an earlier era, but the increasing economic integration of the world requires a more global approach to tax policy. The emphasis in recent American tax reform debates on competitiveness is only a precursor to a time in which international considerations will play a pervasive role in shaping tax policies. Lawrence H. Summers, Taxation in a Small World, in TAX POLICY IN THE TWENTY-FIRST CENTURY 64, 64 (1988). Likewise: In the past, the United States has sometimes acted unilaterally in setting tax regulations and given little thought as to how die world would follow along. But now I think we recognize that an incompatible American tax policy may harm not only our own businesses in the international arena but also may allow other countries to take unfair advan tage of our tax system. James A. Baker III, The Momentum of Tax Reform, in TAX POLICY IN THE TWENTY-FIRST CENTURY 1, 6 (1988); but see Robert J. Patrick, Jr., Comments on U.S. Tax Structures and Competitiveness, 41 NAT'L TAX J. 343, 343 (1988) ("[T]here is virtually nothing in the legislative history of the 1986 Tax Act that indicates that concerns about international trade and investment had anything to do with the legislation.").
36. use the term "regulatory emulation" to mean "the process whereby regulators change their policies as a result of observing the regulatory policies pursued by other countries." STEPHEN WOOLCOCK, THE SINGLE EUROPEAN MARKET: CENTRALIZATION OR COMPETITION AMONG NATIONAL RULES 15 (1994).
37. See McKenzie & Mintz, supra note 17, at 207 (noting that the convergence may not have been deliberate).
38. See John Whalley, Foreign Responses to U.S. Tax Reform, in Do TAXES MATTER? 286, 294, 307 (Joel Slemrod ed., 1990). Whalley explains that although discussion of Canadian corporate income tax reform actually began prior to the American initiatives, the final version of the Canadian reform reflected concerns regarding Canada's ability to maintain an attractive tax climate for capital and the fear that, with lower U.S. corporate income tax rates, increased debt financing in Canada by multinationals would erode Canadian tax revenue.
39. For comments concerning the NAFTA Member States' tax reforms in the 1980s, see infra text accompanying note 108.
40. See, e.g., Luis Manuel Perez de Acha, Mexico Amends Tax Legislation to Reflect Increased Global Trade, NAFTA, 44 TAX NOTES INT'L L (1994).
41. Canada and the United States abandoned a number of tax incentives in the 1980s. See infra note 107 and accompanying text.
42. See, e.g., Arthur J. Cockfield, The Impact of U.S. Consumption Tax Reform on Canada, 4 NAFTA L. REV. (forthcoming Winter 1998) (discussing how implementation of a consumption tax by the United States could significantly reduce the tax burden it imposes on marginal investments, thus forcing Canada to adjust its tax policy in order to remain competitive). For a description of the impact of consumption-based tax proposals on U.S. marginal effective tax rates on investments, see ALAN J. AUERBACH, TAX REFORM, CAPITAL ALLOCATION, EFFICIENCY AND GROWTH 23 (CEPR Publication No. 444, 1995) (concluding that all such proposals would lower the investment tax wedge facing new investments, resulting in a rise in the after-tax return on marginal investments).
43. See, e.g., Arthur J. Cockfield, The Impact of U.S. Consumption Tax Reform on Canada, 4 NAFTA L. REV. (forthcoming Winter 1998) (discussing how implementation of a consumption tax by the United States could significantly reduce the tax burden it imposes on marginal investments, thus forcing Canada to adjust its tax policy in order to remain competitive). For a description of the impact of consumption-based tax proposals on U.S. marginal effective tax rates on investments, see ALAN J. AUERBACH, TAX REFORM, CAPITAL ALLOCATION, EFFICIENCY AND GROWTH 23 (CEPR Publication No. 444, 1995) (concluding that all such proposals would lower the investment tax wedge facing new investments, resulting in a rise in the after-tax return on marginal investments).
44. See, e.g., Joel Slemrod, Free Trade Taxation and Protectionist Taxation, 2 INT'L TAX & PUB. FIN. 471, 471 (1995) ("[A]lthough international trade theory has been applied principally to policy instruments such as tariffs, quotas, and dumping, tax policy can have at least as large an effect on the flow of goods across countries, the location of productive activity, and the gains from trade as these trade policy instruments.").
45. NAFTA does not prohibit this type of tax subsidization. For a discussion of tax subsidies under NAFTA, see Paul R. McDaniel, Formulary Taxation in the North American Free Trade Zone, 49 TAX L. REV. 691, 715-719 (1994).
46. See id. at 718.
47. To be sure, tax competition can influence purchasing patterns before exchange rates adjust to tax changes. See, e.g., Michael J. McIntyre, Commentary, The Design of Tax Rules for the North American Free Trade Alliance, 49 TAX L. REV. 769, 783 (1994) (describing how millions of Canadians flooded across the U.S. border to purchase goods after the Canadian government introduced the federal Goods and Services Tax in 1991).
48. Excise Tax Act, R.S.C. (1985) (Can.).
49. For an explanation of how exchange rates adjust to offset price effects of corporate income taxes and rebated indirect taxes, see Jane G. Gravelle, International Tax Competition: Does It Make a Difference for Tax Policy?, 39 NAT'L TAX J. 375 (1986). However, it has been noted that nonuniform indirect taxes (i.e., different tax rates on different commodities) will distort the pattern of production and trade. These "[d]istortions will arise under either the destination or origin-based System if there are nonuniform taxes, but only under origin-based taxes will the locational pattern of production be disturbed." See Joel Slemrod, Tax Cacophony and the Benefits of Free Trade, in 1 FAIR TRADE AND HARMONIZATION: PREREQUISITES FOR FREE TRADE? 283, 283 (Jagdish Bhagwati & Robert E. Hudec eds., 1996).
50. For an explanation of how exchange rates adjust to offset price effects of corporate income taxes and rebated indirect taxes, see Jane G. Gravelle, International Tax Competition: Does It Make a Difference for Tax Policy?, 39 NAT'L TAX J. 375 (1986). However, it has been noted that nonuniform indirect taxes (i.e., different tax rates on different commodities) will distort the pattern of production and trade. These "[d]istortions will arise under either the destination or origin-based System if there are nonuniform taxes, but only under origin-based taxes will the locational pattern of production be disturbed." See Joel Slemrod, Tax Cacophony and the Benefits of Free Trade, in 1 FAIR TRADE AND HARMONIZATION: PREREQUISITES FOR FREE TRADE? 283, 283 (Jagdish Bhagwati & Robert E. Hudec eds., 1996).
51. Nevertheless, discriminatory treatment against goods and services from other NAFTA parties continues to a certain extent under NAFTA. For a review of significant GATT panels dealing with this alleged discriminatory treatment by Canada and the United States, see Trade Related Aspects of International Taxation, A New WTO Code of Conduct?, 30 J. WORLD TRADE L. 161, 188-93 (1996).
52. See NAFTA, supra note 1, annex 311 (explaining how goods must be marked to identify their country of origin).
53. See Malcolm Gammie, The Taxation of Inward Direct Investment in North America Following the Free Trade Agreement, 49 TAX L. REV. 615, 650 (1994).
54. For example, almost 70% of trade in manufactured products between Canada and the United States consists of non-arm's length intrafirm trade. See ALAN M. RUGMAN, MULTINATIONALS AND CANADA-UNITED STATES FREE TRADE 3 (1990). The amount of U.S.-Canada related party transactions reached US$166 billion in 1993. See ROBERT TURNER, STUDY ON TRANSFER PRICING (Technical Committee on Business Taxation Working Paper No. 2 96-10, 1996).
55. For example, almost 70% of trade in manufactured products between Canada and the United States consists of non-arm's length intrafirm trade. See ALAN M. RUGMAN, MULTINATIONALS AND CANADA-UNITED STATES FREE TRADE 3 (1990). The amount of U.S.-Canada related party transactions reached US$166 billion in 1993. See ROBERT TURNER, STUDY ON TRANSFER PRICING (Technical Committee on Business Taxation Working Paper No. 2 96-10, 1996).
56. For example, the adoption of new international transfer pricing rules by the IRS has caused some concern among tax practitioners in Canada, where tax authorities issued a statement indicating that they would not necessarily agree to abide by U.S. decisions under the new rules. See Robert Brown & Michael Alexander, Sovereignty in the Modern Age, 20 CAN.-U.S. L.J. 273, 281 (1994).
57. See Robin Boadway & Neil Bruce, Pressures for the Harmonization of Income Tax Between Canada and the United States, in CANADA-U.S. TAX COMPARISONS 26 (John B. Shoven & John Whalley eds., 1992).
58. But see Ruding Committee, supra note 5, ch. 3 (indicating that the country of shareholder residence should give the tax credit).
59. See Charles E. McLure, Tax Competition: Is What's Good for the Private Goose also Good for the Public Gander?, 39 NAT'L TAX J. 341-48 (1986).
60. Jeanne-Mey Sun & Jacques Pelkmann, Regulatory Competition in the Single Market, 33 J. COMMON MARKET STUD. 67, 83 (1995).
61. But see Musgrave & Musgrave, supra note 21, at 63-70 (arguing that market forces alone cannot secure an efficient and equitable allocation of economic resources in the international arena).
62. For a discussion of the costs and benefits of competition among rules, see WOOLCOCK, supra note 26, at 16-21.
63. See supra notes 34-35 and accompanying text.
64. For a discussion on the transposition of arguments for free trade into the international tax policy arena, see Slemrod, supra note 33, at 472-80.
65. It has been noted that globalization encompasses contradictory trends. On the one hand, the unaccountable forces of globalization are partially beyond the control of state regulation while, on the other hand, the state often pulls in the opposite direction by using a variety of government interventions to create a competitive edge. See James H. Mittelman, The Dynamics of Globalization, in GLOBALIZATION CRITICAL REFLECTIONS 16 (James H. Mittelman ed., 1996).
66. For a general review of sovereignty issues under globalization, see SASKIA SASSEN, LOSING CONTROL? SOVEREIGNTY IN AN AGE OF GLOBALIZATION (1996).
67. Alex Easson, Taxing International Income (1997) (unpublished manuscript on file with the Stanford Journal of International Law). I use the term "sovereignty" to mean "the basic internal legal status of a state that is not subject, within its territorial jurisdiction, to the governmental, executive, legislative or territorial jurisdiction of a foreign state or to foreign law other than public international law." Helmut Steinberger, Sovereignty, in 10 ENCYCLOPEDIA OF PUBLIC INTERNATIONAL LAW 408 (1981).
68. Alex Easson, Taxing International Income (1997) (unpublished manuscript on file with the Stanford Journal of International Law). I use the term "sovereignty" to mean "the basic internal legal status of a state that is not subject, within its territorial jurisdiction, to the governmental, executive, legislative or territorial jurisdiction of a foreign state or to foreign law other than public international law." Helmut Steinberger, Sovereignty, in 10 ENCYCLOPEDIA OF PUBLIC INTERNATIONAL LAW 408 (1981).
69. See Treaty Establishing the European Economic Community, Mar. 25, 1957, 298 U.N.T.S. 11 [hereinafter Treaty of Rome].
70. For a discussion of this movement, see generally Joseph H.H. Weiler, The Transformation of Europe, 100 YALE L. J. 2403 (1991).
71. For a description of recent VAT harmonization efforts, see INTERNATIONAL BUREAU OF FISCAL DOCUMENTATION, SUPPLEMENTARY SERVICE TO EUROPEAN TAXATION § 8 (1997) [hereinafter SUPPLEMENTARY SERVICE].
72. The three measures adopted by the European Council are: (1) the Parent-Subsidiary Directive, which deals with the tax treatment of cross-border dividend payments between parent and subsidiary corporations; (2) the Merger Directive, aimed at the deferral of capital gains taxation related to the restructuring of companies; and (3) the Convention on the Elimination of Double Taxation, which deals with the adjustment of profits of associated enterprises. For a description of these measures, see id. § 1.1.
73. The committee, chaired by Onno Ruding, was appointed to prepare guidelines for the European Commission regarding company taxation. See Ruding Committee, supra note 5. Elaborate analysis of European integration has been conducted elsewhere. See, e.g., INTEGRATION THROUGH LAW (Mauro Cappelleti et al. eds., 1986).
74. Article 220 of the Treaty refers implicitly to direct taxation by indicating that the European member states should enter into negotiations to abolish double taxation within the European Union. See Jan E. Brinkmann & Andreas O. Riecker, European Company Taxation: The Ruding Committee Reports Give Harmonization Efforts a New Impetus, 27 INT'L LAW 1061, 1063 (1993). The Ruding Committee noted additional provisions in the Treaty of Rome which implicitly call for the harmonization of taxes, including the removal of all restrictions on the movement of capital (Article 67), the freedom of establishment of firms (Article 52) and the conditions of competition (Article 101). See Ruding Committee, supra note 5, ch. 1.
75. Frederick M. Abbott, Integration Without Institutions: The NAFTA Mutation of the EC Model and the Future of the GATT Regime, 40 AM. J. COMP. L. 917, 936 (1992).
76. For example, each Member State should adopt sanitary and phytosanitary measures that match stipulated guidelines. SeeNAFTA, supra note 1, art. 713(1).
77. Abbott, supra note 61, at 917.
78. See id. at 917.
79. For example, the European Commission has indicated that it favors a number of business tax proposals issued by the Ruding Committee and is creating draft legislation to deal with these proposals. See SUPPLEMENTARY SERVICE, supra note 57, at 9 § A.
80. Canada's entrance to NAFTA has been characterized as "defensive," since by deciding to participate it avoided the costs associated with being excluded from the agreement See Ronald J. Wonnacott, Canada's Role in NAFTA: To What Degree Has It Been Defensive?, in MEXICO AND THE NORTH AMERICAN FREE TRADE AGREEMENT: WHO WILL BENEFIT? 163 (Victor Bulmer-Thomas et al. eds., 1994). The Mexican impetus for initiating the negotiation of NAFTA was primarily motivated by economic reasons. The United States, in turn, desired to gain greater efficiencies, but also had noneconomic goals, like limiting illegal immigration from Mexico and improving Mexican environmental standards. See FREDERICK M. ABBOTT, LAW AND POLICY OF REGIONAL INTEGRATION: THE NAFTA AND WESTERN HEMISPHERIC INTEGRATION IN THE WORLD TRADE ORGANIZATION SYSTEM 15-19 (1995).
81. Canada's entrance to NAFTA has been characterized as "defensive," since by deciding to participate it avoided the costs associated with being excluded from the agreement See Ronald J. Wonnacott, Canada's Role in NAFTA: To What Degree Has It Been Defensive?, in MEXICO AND THE NORTH AMERICAN FREE TRADE AGREEMENT: WHO WILL BENEFIT? 163 (Victor Bulmer-Thomas et al. eds., 1994). The Mexican impetus for initiating the negotiation of NAFTA was primarily motivated by economic reasons. The United States, in turn, desired to gain greater efficiencies, but also had noneconomic goals, like limiting illegal immigration from Mexico and improving Mexican environmental standards. See FREDERICK M. ABBOTT, LAW AND POLICY OF REGIONAL INTEGRATION: THE NAFTA AND WESTERN HEMISPHERIC INTEGRATION IN THE WORLD TRADE ORGANIZATION SYSTEM 15-19 (1995).
82. The negotiators of NAFTA took great care to avoid granting to any centralized body the power to make decisions that would directly bind the Member States. See Abbott, supra note 61, at 936.
83. But see Leo Panitch, Rethinking the Role of the State, in GLOBALIZATION: CRITICAL REFLECTIONS 96 (James H. Mittelman ed., 1996) (NAFTA "will function as an economic constitution, setting the basic rules governing the private property rights that all governments must respect and the types of economic policies that all governments must eschew.").
84. See JOHNSON, supra note 7, at 487, 521-25.
85. In fact, the European Court of Justice has in recent years struck down domestic tax provisions based mainly on the right of establishment and the principle of freedom of movement of workers. See Gammie, supra note 41, at 639-40. The European Court of Justice can even ensure that each European member state follows certain community-wide standards for human rights, a development that would be shocking to most North Americans. See, e.g., Joseph H.H. Weiler, The Jurisprudence of Human Rights in the European Union: Integration and Disintegration, Values and Processes (1997) (unpublished manuscript, on file with the Stanford Journal of International Law).
86. The Commission consists of individuals appointed by the governments of the member states and proposes legislation to the European Council. The European Council then consults with the European Parliament to decide whether or not to issue a directive or a regulation. A directive instructs the governments of the member states to enact domestic laws while a regulation is a supranational legislative measure that binds the citizens of the member states directly.
87. Loyalty to the concept of a united Europe, as well as to the centralized institutions, may have developed as the European member states learned to effectively cooperate through decades of enhanced political voice. &e Weiler, supra note 56, at 2465-66.
88. See George J. Church, Where He Rings True: Free Trade Isn't Always Fair, TIME, Mar. 4, 1996, at 28 (citing a Time/CNN poll indicating 51% of respondents believed effects of free trade were "mostly bad" for workers); see also Jackie Calmes, Satisfaction with Today Hides a Fear of Tomorrow, WALL ST. J., Mar. 8, 1996, at R2 (citing a Wall Street Journal/NBC News Poll in which 59% of respondents opined that free trade agreements cost jobs in the United States).
89. See George J. Church, Where He Rings True: Free Trade Isn't Always Fair, TIME, Mar. 4, 1996, at 28 (citing a Time/CNN poll indicating 51% of respondents believed effects of free trade were "mostly bad" for workers); see also Jackie Calmes, Satisfaction with Today Hides a Fear of Tomorrow, WALL ST. J., Mar. 8, 1996, at R2 (citing a Wall Street Journal/NBC News Poll in which 59% of respondents opined that free trade agreements cost jobs in the United States).
90. See infra notes 86-90 and accompanying text.
91. See Bratton et al., supra note 19, at 31-38.
92. See Maarten J. Ellis, Direct Taxation in the European Community: An Irresistible Force Meets an Immovable Object?, 28 WAKE FOREST L. REV. 51, 56 (1993).
93. See generally Craig A. Hart, The European Community's Value-Added Tax System: Analysis of the New Transitional Regime and Prospects for Further Harmonization, 12 INT'L TAX & BUS. LAW. 1, 5-8 (1994). See also Gianni Forlani, Fiscal Harmonization in the European Union, in INTERNATIONAL TAX PLANNING 173 (Dennis Campbell ed., 1995) (explaining that the removal of border checks created a fear that differences in indirect taxation would lead to a risk of fraud, distortion of competition, and income transfers).
94. See generally Craig A. Hart, The European Community's Value-Added Tax System: Analysis of the New Transitional Regime and Prospects for Further Harmonization, 12 INT'L TAX & BUS. LAW. 1, 5-8 (1994). See also Gianni Forlani, Fiscal Harmonization in the European Union, in INTERNATIONAL TAX PLANNING 173 (Dennis Campbell ed., 1995) (explaining that the removal of border checks created a fear that differences in indirect taxation would lead to a risk of fraud, distortion of competition, and income transfers).
95. See Sun & Pelkmann, supra note 47, at 88.
96. See WOOLCOCK, supra note 26, at 39.
97. The Commission indicated that a number of proposals went beyond the scope of the subsidiarity principle, and that more discussion was required on the tax rates, tax bases, and tax structures to be applied to corporations before further harmonization. See John Goldsworth, European Community: EC Commission Reviews Ruding Committee Report, Suggests Member State Consultations, 5 TAX NOTES INT'L 177, 178 (1992). It is understandable that the European member states would be reluctant to give up control over their business income tax systems in light of the restrictions that have been placed on their indirect tax policies as well as the potential loss of currency control with the European Monetary Union looming on the (distant) horizon.
98. Most European member states tax their commodities on a destination basis (i.e., goods and services are taxed on the basis of location of consumption or destination). The European Commission has proposed moving toward taxing commodities on the origin principle (i.e., goods and services are taxed on the basis of their place of production or origin). The European member states have thus far resisted switching systems since they worry that an origin-based VAT creates advantages for firms based in a country with lower VAT rates (e.g., a firm subject to a VAT rate of 15% would sell its product both domestically and throughout the community at this rate, while another firm subject to a higher VAT rate would sell the same product at the higher rate). See Hart, supra note 77, at 7-8. In July 1996, the European Commission released a document entitled A Common System of VAT: A Programme for the Single Market, which creates a gradual phasing in of a system of taxation based on the origin principle. The new system is not likely to enter into force before the year 2000. See SUPPLEMENTARY SERVICE, supra note 57, at 2, 9. The Commission recently revisited the need for greater uniformity in corporate business tax systems of the European member states in a report released in 1996. See EC Update, 36 EUROPEAN TAXATION 12 (1996), at EC-45.
99. Most European member states tax their commodities on a destination basis (i.e., goods and services are taxed on the basis of location of consumption or destination). The European Commission has proposed moving toward taxing commodities on the origin principle (i.e., goods and services are taxed on the basis of their place of production or origin). The European member states have thus far resisted switching systems since they worry that an origin-based VAT creates advantages for firms based in a country with lower VAT rates (e.g., a firm subject to a VAT rate of 15% would sell its product both domestically and throughout the community at this rate, while another firm subject to a higher VAT rate would sell the same product at the higher rate). See Hart, supra note 77, at 7-8. In July 1996, the European Commission released a document entitled A Common System of VAT: A Programme for the Single Market, which creates a gradual phasing in of a system of taxation based on the origin principle. The new system is not likely to enter into force before the year 2000. See SUPPLEMENTARY SERVICE, supra note 57, at 2, 9. The Commission recently revisited the need for greater uniformity in corporate business tax systems of the European member states in a report released in 1996. See EC Update, 36 EUROPEAN TAXATION 12 (1996), at EC-45.
100. See A. JAVIER TREVINO, THE SOGIOLOGY OF LAW: CLASSICAL AND CONTEMPORARY PERSPECTIVES 439-49 (1996) (discussing the manner in which legal modifications follow social modifications and the ways that legal changes can instigate social changes).
101. See POLANYI, supra note 2, at 88-89 (describing the social forces which encouraged the laissez-faire market society in England from the 1790s onward and the social forces that opposed the commodification of land and labor; ultimately the interaction of these two forces led to the creation of new forms of the state). Some theorists argue that globalization will inevitably cause a convergence of values among countries and erode the usefulness of the nation-state. See, e.g., MALCOLM WATERS, GLOBALIZATION 12 (1995) (suggesting that each society will converge on a "single set of axial principles for its social organization," including values oriented toward individualization, universahsm, secularity, and rationalism).
102. Legal theorists tend to conceive of sovereignty as the ability of a nation-state to pursue its preferences in an autonomous manner. See supra note 54.
103. For a discussion of the historical development of the modern conception of sovereignty, see Marc Williams, Rethinking Sovereignty, in GLOBALIZATION: THEORY AND PRACTICE 109 (E. Kofman & G. Youngs eds., 1996) (explaining that although emphasis is frequently placed on the political aspects of sovereignty, it must also be viewed as both a norm and a practice or institution).
104. See, e.g., Andrew F. Cooper, Questions of Sovereignty: Canada and the Widening International Agenda, 50 BEHIND THE HEADLINES 10 (1993) ("The move to continental free trade was part of a much wider process towards globalism. Opponents of these deals not only dispute their economic benefits but contend that even if some benefits did emerge from this market-oriented approach, they would come at a very high social/cultural price.").
105. A 1988 Canadian federal election concerning free trade with the United States created an acrimonious national debate over the sovereignty implications of greater ties with the United States. The federal government at the time ensured the people of Canada that "cultural industries" would be protected under the new deal. See, e.g., Donald S. Macdonald, The Canadian Cultural Industries Exemption under Canada-U.S. Trade Law, 20 CAN.-U.S. L. J. 253, 260 (1994). The Mexican debate concerning the loss of sovereignty was perhaps less vocal: Criticism to [sic] NAFTA has been mute, timid or deliberately silenced by the government. There are nevertheless a number of areas where concerns have been repeatedly expressed. The most important is the issue of sovereignty. Concerns range from the denunciation that Mexico is surrendering its oil resources to US interests, that the country is giving up its regulatory powers necessary to design development, industrial and agricultural policies, to the outright conviction that Mexico is, by virtue of NAFTA, falling under the political and strategic influence of Washington. Adolfo Anguilar Zinser, Is There an Alternative? The Political Restraints of NAFTA, in MEXICO AND THE NORTH AMERICAN FREE TRADE AGREEMENT: WHO WILL BENEFIT? 119, 123 (Victor-Bulmer-Thomas et al. eds., 1994).
106. A 1988 Canadian federal election concerning free trade with the United States created an acrimonious national debate over the sovereignty implications of greater ties with the United States. The federal government at the time ensured the people of Canada that "cultural industries" would be protected under the new deal. See, e.g., Donald S. Macdonald, The Canadian Cultural Industries Exemption under Canada-U.S. Trade Law, 20 CAN.-U.S. L. J. 253, 260 (1994). The Mexican debate concerning the loss of sovereignty was perhaps less vocal: Criticism to [sic] NAFTA has been mute, timid or deliberately silenced by the government. There are nevertheless a number of areas where concerns have been repeatedly expressed. The most important is the issue of sovereignty. Concerns range from the denunciation that Mexico is surrendering its oil resources to US interests, that the country is giving up its regulatory powers necessary to design development, industrial and agricultural policies, to the outright conviction that Mexico is, by virtue of NAFTA, falling under the political and strategic influence of Washington. Adolfo Anguilar Zinser, Is There an Alternative? The Political Restraints of NAFTA, in MEXICO AND THE NORTH AMERICAN FREE TRADE AGREEMENT: WHO WILL BENEFIT? 119, 123 (Victor-Bulmer-Thomas et al. eds., 1994).
107. Canada is the United States' largest trade partner, with approximately US$100 billion in exports to Canada and US$111 billion in imports from Canada in 1993. Mexico is the third largest trade partner of the United States (behind Canada and Japan) with approximately US$41 billion in exports to Mexico and US$39 billion in imports from Mexico. The European Union, in aggregate, was the third largest exporter to the United States (after Canada and Japan) and the second largest importer (after Canada). See ABBOTT, supra note 66, at 121 n.7.
108. 90 A white paper on foreign policy issued by the Canadian federal government on February 7, 1995, called Canada in the World, warns that Canada must participate fully in economic globalization, while ensuring that government policies are tailored strictly to the national interest See Andrew Cohen, Canada in the World: The Return of the National Interest, 52 BEHIND THE HEADLINES 3 (1995) ("At root, though, Canada in the World marks a retreat for this country. It is a dilution - even a denial - of those principles which have driven Canada's foreign policy for a half-century.").
109. 90 A white paper on foreign policy issued by the Canadian federal government on February 7, 1995, called Canada in the World, warns that Canada must participate fully in economic globalization, while ensuring that government policies are tailored strictly to the national interest See Andrew Cohen, Canada in the World: The Return of the National Interest, 52 BEHIND THE HEADLINES 3 (1995) ("At root, though, Canada in the World marks a retreat for this country. It is a dilution - even a denial - of those principles which have driven Canada's foreign policy for a half-century.").
110. It has been argued that the global economy (which provides a huge supply of low-skilled foreign workers) is the principal cause of income inequality in the United States, since it reduces die wages of low-skilled workers. See, e.g., L.C. THUROW, THE FUTURE OF CAPITALISM (1996). But see PAUL KRUGMAN, POP INTERNATIONALISM (1996) (arguing that technology, not global competition, is the principal cause of American income inequality).
111. It has been argued that the global economy (which provides a huge supply of low-skilled foreign workers) is the principal cause of income inequality in the United States, since it reduces die wages of low-skilled workers. See, e.g., L.C. THUROW, THE FUTURE OF CAPITALISM (1996). But see PAUL KRUGMAN, POP INTERNATIONALISM (1996) (arguing that technology, not global competition, is the principal cause of American income inequality).
112. See, e.g., NAFTA Panels Challenged by Coalition, FIN. TIMES, Jan. 17, 1997, at 6 (reporting that the American Coalition for Competitive Trade filed a complaint with the U.S. Court of Appeals on January 16, 1997, claiming that the supranational panels created under NAFTA are usurping the authority of the U.S. judiciary).
113. Similarly, U.S. tax reform debates continue to pay little attention to international issues. To be sure, die recent "flat tax" debate in the United States involved a discussion of the impact that a flat tax would have on the country's ability to attract and maintain foreign capital investment. The vast majority of the debate, however, revolved around domestic issues. For example, the Kemp Commission's report included only two pages that were exclusively devoted to international issues relating to the movement toward a broad consumption-based tax. See The National Commission on Economic Growth and Tax Reform, Unleashing America's Potential, A ProGrowth, Pro-Family Tax System for the 21st Century, 70 TAX NOTES 413 (1996).
114. As one commentator observed: In the immediate future, America will remain preoccupied by ... its own democratic logic at home. In the long run, its growing association with Mexico and Canada will require of it a tolerance of diversity in political style and national culture functioning outside the moral dynamic and purpose of its own national life. Marc Pachter, American Identity: A Political Compact, in IDENTITIES IN NORTH AMERICA: THE SEARCH FOR COMMUNITY 39 (Robert L. Earle & John D. Wirth eds., 1995).
115. Despite the apparent similarities between Canada and the United States, Canadians like to think of themselves as having needs distinct from those of Americans. For example, they tend to believe in a system of government that preserves a generous social safety net through measures such as universal health care and a variety of other benefits. Still, Canada and the United States are similar in most macroeconomic aspects. For example, both countries are mature industrial economies that provide a relatively high level of wealth to most citizens. The nature of the Mexican economy differs from that of the Canadian and United States economies, since it generally produces low value added and low skill-intensive components for export The table shows that Canada and the United States have similar global standard of living rankings (ranking first and second in the world, respectively) while Mexico has less wealth and less government institutional support for social needs. Political differences also exist among the Member States. Canada and the United States have a strong historical commitment to a multiparty system of democratic government while Mexico has been ruled for the past 70 years by one party. Further, the legal systems of Canada and the United States are based on common law principles, whereas Mexico has adopted the civil law system. SeeJOHNSON, supra note 7, at 2-4.
116. See RALPH H. FELSON & MICHAEL W. GORDON, INTERNATIONAL BUSINESS TRANSACTIONS 411 (1995).
117. SeeJOYCE HOEBING ET AL., NAFTA AND SOVEREIGNTY: TRADE-OFFS FOR CANADA, MEXICO AND THE UNITED STATES (1996) (describing the sovereignty concerns expressed by each Member State prior to the implementation of NAFTA).
118. This convergence is not expected to lead to the type of union seen in Europe: Given the distinct histories and trajectories of three very large federal states, and their disparities in economic power, the model of a federated, European-style community with a capital "C" is unlikely to apply to North America. Yet as we sort out the distorting perspectives of history and unexamined stereotypes, it is plausible to envision a loosely structured and largely informal community with a small "c." IDENTITIES IN NORTH AMERICA: THE SEARCH FOR COMMUNITY 197 (Robert L. Earle & John D. Wirth eds., 1995).
119. International tax policy principles generally assist the development of cross-border tax measures. Although the content of these principles is debated, there is consensus that they should generally promote economic efficiency and international equity. See generally Hugh J. Ault, Corporate Integration, Tax Treaties and the Division of the International Tax Base: Principles and Practices, 27 TAX L. REV. 565 (1992); Easson, supra note 54; R.A. Green, The Future of Source-Based Taxation of the Income of Multinational Enterprises, 79 CORNELL L. REV. 18 (1993); Klaus Vogel, Worldwide vs. Source Taxation of Income: A Review and Reevaluation of Arguments, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETITIVENESS (1990). Despite this consensus, however, international tax policy has properly been characterized as "rudderless." See Stephen Utz, Tax Harmonization in Europe and America, 9 CONN. J. INT'L L. 767, 769 (1994).
120. International tax policy principles generally assist the development of cross-border tax measures. Although the content of these principles is debated, there is consensus that they should generally promote economic efficiency and international equity. See generally Hugh J. Ault, Corporate Integration, Tax Treaties and the Division of the International Tax Base: Principles and Practices, 27 TAX L. REV. 565 (1992); Easson, supra note 54; R.A. Green, The Future of Source-Based Taxation of the Income of Multinational Enterprises, 79 CORNELL L. REV. 18 (1993); Klaus Vogel, Worldwide vs. Source Taxation of Income: A Review and Reevaluation of Arguments, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETITIVENESS (1990). Despite this consensus, however, international tax policy has properly been characterized as "rudderless." See Stephen Utz, Tax Harmonization in Europe and America, 9 CONN. J. INT'L L. 767, 769 (1994).
121. International tax policy principles generally assist the development of cross-border tax measures. Although the content of these principles is debated, there is consensus that they should generally promote economic efficiency and international equity. See generally Hugh J. Ault, Corporate Integration, Tax Treaties and the Division of the International Tax Base: Principles and Practices, 27 TAX L. REV. 565 (1992); Easson, supra note 54; R.A. Green, The Future of Source-Based Taxation of the Income of Multinational Enterprises, 79 CORNELL L. REV. 18 (1993); Klaus Vogel, Worldwide vs. Source Taxation of Income: A Review and Reevaluation of Arguments, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETITIVENESS (1990). Despite this consensus, however, international tax policy has properly been characterized as "rudderless." See Stephen Utz, Tax Harmonization in Europe and America, 9 CONN. J. INT'L L. 767, 769 (1994).
122. International tax policy principles generally assist the development of cross-border tax measures. Although the content of these principles is debated, there is consensus that they should generally promote economic efficiency and international equity. See generally Hugh J. Ault, Corporate Integration, Tax Treaties and the Division of the International Tax Base: Principles and Practices, 27 TAX L. REV. 565 (1992); Easson, supra note 54; R.A. Green, The Future of Source-Based Taxation of the Income of Multinational Enterprises, 79 CORNELL L. REV. 18 (1993); Klaus Vogel, Worldwide vs. Source Taxation of Income: A Review and Reevaluation of Arguments, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETITIVENESS (1990). Despite this consensus, however, international tax policy has properly been characterized as "rudderless." See Stephen Utz, Tax Harmonization in Europe and America, 9 CONN. J. INT'L L. 767, 769 (1994).
123. See supra text accompanying notes 27-30.
124. The five principal goals of modern tax treaties are: (1) the elimination of double taxation; (2) the elimination of discrimination through national treatment; (3) the prevention of tax evasion; (4) the removal of administrative obstacles to international business and investment; and (5) the equitable allocation of tax revenues between the contracting parties. See VERN KRISHNA, CANADIAN INTTERNATIONAL TAXATION 10-6 (1995). NAFTA generally leaves taxation up to the tax treaties; it establishes that "[n]othing in [NAFTA] shall affect the rights and obligations of any [of the Member States] under any tax convention" and that the tax treaty provision will prevail in the event of any inconsistency between a NAFTA provision and a tax treaty provision. NAFTA, supra note 1, art. 2103(2), 32 I.L.M. at 700. See also Income Tax Convention, Sept. 18, 1992, U.S.-Mex., Tax Treaties (CCH) ¶ 5,903 [hereinafter U.S.-Mexico Treaty]; Income Tax Convention, Apr. 8, 1991, Can.-Mex., Tax Treaties (CCH) ¶ 34,687 [hereinafter Canada-Mexico Treaty]; Income Tax Convention, Sept 26, 1980, U.S.-Can., Tax Treaties (CCH) ¶ 1903.03 [hereinafter. U.S.-Canada Treaty].
125. See supra text accompanying notes 15-16.
126. One commentator observed: [I]ncome tax treaties are bilateral documents attempting to survive in a thrivingly multilateral world. Apart from the fact that treaty-shopping rules do not work very well in this environment, the treaty negotiators and interpreters must try to cope with the bewildering complexities arising from the burgeoning growth of partnerships, joint ventures, "alliances," "cooperation agreements," and other arrangements that are "pass-through" entities for U.S. tax purposes, foreign tax purposes in one or more countries or both. David R. Tillinghast, Tax Treaty Issues, 50 U. MIAMI L. REV. 455-56 (1996).
127. For a discussion on the ability of the existing bilateral tax treaties to distort trade and investment under NAFTA, see Brian J. Arnold & Neil H. Harris, NAFTA and the Taxation of Corporate Investment: A View from Within NAFTA, 49 TAX L. REV. 529, 577-79 (1994).
128. See id. at 580.
129. The existing Member State tax treaties do, however, contain provisions ameliorating this effect. For example, the U.S.-Mexico Treaty contains a provision establishing that, if the United States agrees to a dividend withholding rate of less than 5% in a treaty with another nation, then that rate will apply in the United States-Mexico context as well. See supra note 101.
130. Additionally, the increased mobility of capital may put pressure on governments to find a less mobile tax base such as labor. Increased cooperation will likely be necessary to relieve this pressure, which may in turn encourage increased regressivity in the Member State tax systems.
131. I use the term "tax harmonization" to mean the deliberate convergence of the tax systems of the Member States through formal negotiations. It does not include the inadvertent convergence of tax systems that may take place due to tax competition or one government following the policies of another. Although this second form of noncooperative behavior may lead tax systems to become more "harmonious" in the sense that they become more similar, this Article is concerned with the question of whether or not the governments of the Member States should come to some formal agreement concerning the uniformity of their tax systems.
132. See WILLIAM A. KLEIN & JOSEPH BANKMAN, FEDERAL INCOME TAXATION 76 (10th ed. 1994).
133. For a comparative description of tax reform in the mid-1980s among the Member States, see John Whalley, Foreign Response to U.S. Tax Reform, in Do TAXES MATTER? 286 (Joel Slemrod ed., 1990).
134. A detailed description of the tax systems of the Member States and the differences between these systems is beyond the scope of this Article. For a description of the different Member States' tax regimes, see Arnold & Harris, supra note 104, at 532-38.
135. The differences among the tax rules of the Member States is more obvious at the personal income tax level since workers generally cannot relocate to lower personal income tax jurisdictions, permitting the countries to maintain divergent personal income tax policies.
136. See Boadway & Bruce, supra note 44, at 69 (reviewing the corporate income tax systems of Canada and the United States and indicating that the systems have converged partly as a result of the need to maintain attractiveness to mobile capital).
137. See Roger H. Gordon & Eduardo Ley, Implications of Existing Tax Policy for Crossborder Activity Between the United States and Mexico After NAFTA, 47 NAT'L TAX J. 435, 443 (1994) (concluding that Mexican and American tax laws are now similar and, although NAFTA would likely increase cross-border activity, this "should not generate much immediate pressure to rethink domestic tax policy in either country"; however, the article notes that certain existing provisions such as the tax treatment of leasing and indexing taxable income to inflation in Mexico will distort the location of economic activity).
138. For a description of the corporate shareholder tax structures of the Member States, see Arnold & Harris, supra note 104, at 586-90 (describing distortions caused by die different corporate-shareholder tax regimes of the Member States).
139. John P. Steines, Jr., Commentary, Income Tax Implications of Free Trade, 49 TAX L. REV. 675, 689 (1994).
140. Along with this decentralization trend, it is likely that the states and provinces will become more concerned with threats against their taxing authority posed by NAFTA. See Amy Hamilton, Threat of GATT, NAFTA to State Taxing Powers Analyzed at Florida Tax Seminar, TAX NOTES INT'L, Feb. 9,1996, at 28-7.
141. See Francois Vaillancourt, Subnational Tax Harmonization, Canada and the United States: Intent, Results, and Consequences, in CANADA-U.S. TAX COMPARISONS 323 (John Shoven & John Whalley eds., 1992).
142. See IQBAL, supra note 18, at 12.
143. Rates ranged from 44% to 69% in 1995 as a percentage of basic federal tax. See infra tbl. 2.
144. The average subnational sales tax (including state, cities, and counties) in the United States in 1995 was 8.17%. See Deborah Lohse, Average Sales Tax Rates, WALL ST. J., Jan. 24, 1996, at Al.
145. The average for state payroll taxes was 2% in 1993. See IQBAL, supra note 18, at 5.
146. Most Canadian provinces have a tax collection agreement with the federal government for corporate and personal income taxes and have generally forgone the right to choose their own income tax base and apportionment formulary. See M. Daly, Tax Coordination and Competition in Canada: Some Lessons for the European Community, in Ruding Committee, supra note 5, Annex 9A ("In the case of Canada, therefore, the benefits of tax harmonization (together with federal equalization payments) have, up to now, been considered by the provinces to be sufficiently great to persuade them to forego a large degree of their sovereignty in tax matters.").
147. See Arthur J. Cockfield, A New Corporate Minimum Tax for Ontario, 23 TAX MGMT. INT'L 345 (1994) (explaining that Ontario's provincial government implemented a minimum corporate tax as a result of a public perception "that some corporations were not paying their fair share of taxes").
148. See CHEN & MCKENZIE, supra note 18, at 25 ("We also examined METRs [marginal effective tax rates] across provinces and sectors within Canada and found that the variation in [these rates] across provinces is quite pronounced. This suggests that the tax system encourages an inefficient allocation of capital across the provinces.").
149. See, e.g., Utz, supra note 99, at 768 (indicating that growing state tax burdens within the United States may influence the "rolling recessions" that afflict one region of the United States and then another).
150. See Joann E. Weiner, Tax Coordination and Competition in the United States of America, in Ruding Committee, supra note 5, Annex 9C (stating that the independence of state tax policies "arises from the federal nature of the [U.S.] system. States vigorously protect their sovereignty over tax policy. The inability of the [U.S.] Congress to impose uniformity in multistate taxation, despite apparent benefits of uniformity to both taxpayers and tax administrators, reflects the strength of this sovereignty").
151. See Vaillancourt, supra note 118, at 331 (arguing that even if the federal tax systems of Canada and the United States were completely harmonized, the differences in the subnational tax systems would continue to distort resource allocation between, and within, the two jurisdictions).
152. See H. David Rosenbloom, Sovereignty and the Regulation of International Business in the Tax Area, 20 CAN.-U.S. L. J. 267, 269 (1994).
153. For a discussion of the problems associated mui the current transfer pricing rules, see infra text accompanying note 148. Subsequent discussion of formulary taxation in this Article is based on McDaniel, supra note 34, at 691, 706-09. See also Robert S. McIntyre & Michael J. McIntyre, Commentary, Using NAFTA to Introduce Formulary Apportionment, TAX NOTES INT'L, Apr. 5, 1993, at 851.
154. Critics suggest that formulary methods are arbitrary because they allocate profits without any sound relationship to market conditions or the facts surrounding the transaction. For discussions of the debate surrounding the implementation of international formulary apportionment, see Reuven S. Avi-Yonah, The Rise and Fall of Arm's Length: A Study in the Evolution of U.S. International Taxation, 15 VA. TAX REV. 89, 147-59 (1995); Sylvain Plasschaert, An EU Tax on the Consolidated Profits of Multinational Enterprises, 37 EUR. TAX. 2, 3-10 (1997); John Turro, The Battle Over Arm's Length and Formulary Apportionment, 65 TAX NOTES 1259 (1994).
155. Critics suggest that formulary methods are arbitrary because they allocate profits without any sound relationship to market conditions or the facts surrounding the transaction. For discussions of the debate surrounding the implementation of international formulary apportionment, see Reuven S. Avi-Yonah, The Rise and Fall of Arm's Length: A Study in the Evolution of U.S. International Taxation, 15 VA. TAX REV. 89, 147-59 (1995); Sylvain Plasschaert, An EU Tax on the Consolidated Profits of Multinational Enterprises, 37 EUR. TAX. 2, 3-10 (1997); John Turro, The Battle Over Arm's Length and Formulary Apportionment, 65 TAX NOTES 1259 (1994).
156. Critics suggest that formulary methods are arbitrary because they allocate profits without any sound relationship to market conditions or the facts surrounding the transaction. For discussions of the debate surrounding the implementation of international formulary apportionment, see Reuven S. Avi-Yonah, The Rise and Fall of Arm's Length: A Study in the Evolution of U.S. International Taxation, 15 VA. TAX REV. 89, 147-59 (1995); Sylvain Plasschaert, An EU Tax on the Consolidated Profits of Multinational Enterprises, 37 EUR. TAX. 2, 3-10 (1997); John Turro, The Battle Over Arm's Length and Formulary Apportionment, 65 TAX NOTES 1259 (1994).
157. NAFTA-wide formulary apportionment has been criticized for, among other things, increasing compliance and enforcement burdens, creating the technical problem of defining "unitary enterprise," and ignoring the difficulty of approximating existing revenues and of using standard formulas where industry practices vary. See John S. Brown, Commentary, Formulary Taxation and NAFTA, 49 TAXL. REV. 759, 761-67 (1994).
158. The unitary enterprise, however, would file a tax return using the income determination rules of each NAFTA Member State. The determined income (or loss) would then be apportioned to each country pursuant to the agreed-upon formula. Each country's tax rate would then be applied to the taxable income apportioned to that country. See McDaniel, supra note 34, at 714.
159. See Alvin C. Warren, Jr., Commentary, Alternatives for International Corporate Tax Reform, 49 TAX L. REV. 611 (1994); see also Brown, supra note 132, at 767 ("In practice, the [several] states [of the United States] have never agreed on a standard apportionment formula, and there is no reason to expect otherwise from the NAFTA countries .... Given the complexity and the economic interests at stake, it is highly unlikely that consensus could be reached.").
160. See, e.g., Avi-Yonah, supra note 131, at 154 (indicating that the United States pursued its own interests when it developed its new profit split regulations, which include the cost of developing intangibles, since this cost is likely to be incurred in the United States).
161. In Europe, the Ruding Committee rejected formulary taxation for a number of reasons: "Firstly, and foremost, allocation is suitable only if States have reached an advanced degree of integration, such as common currency, common company law, common accounting standards and common expertise in the tax administrations." Ruding Committee, supra note 5, ch. 5; see also McDaniel, supra note 34, at 734-37 (addressing criticisms of the Ruding Committee and finding it highly desirable that corporate tax rates of countries in a common market be harmonized to achieve the benefits of the free trade zone).
162. See Richard M. Bird, Commentary, A View from the North, 49 TAX L. REV. 749, 750 (1994) ("To twist and paraphrase a famous sentence of Gertrude Stein ('A rose is a rose is a rose'), however, a free trade area is not an economic union is not a federation is not a unitary state.").
163. See id. at 749.
164. As explained previously, these two forces have been described as the "double movement of history." See POLANYI, supra note 2, at 76. This approach comports with that of international relations theorists who believe that, within the global economy, there are still opportunities for the development of governance mechanisms at the international level that neither undermine national governance nor hinder the creation of national strategies for international control. See, e.g., PAUL HIRST & GRAHAME THOMPSON, GLORMJZATION IN QUESTION 170 (1996).
165. The tax authorities of the Member States currently hold trilateral meetings regarding compliance issues. See Kathleen Matthews, U.S. IRS and Practitioners Discuss International Compliance Issues and 1996 Legislation, TAX NOTES INT'L, Feb. 10, 1997, at 475, 477.
166. This Tax Working Group could resemble the current NAFTA Working Group on Trade and Competition which is charged with reporting within five years on aspects of the relationship between competition laws of the Member States and trade within NAFTA.
167. Unlike most negotiations between countries, which are handled by diplomats, tax treaty negotiation is routinely conducted by governmental tax experts.
168. In Europe, the Ruding Committee found that, despite an extensive network of bilateral tax treaties among the member states of the European Union, their disuniformity led to economic distortion of the European market. The Committee suggested that the member states adopt a common tax treaty policy to combat these distortions. See Ruding Committee, supra note 5, ch. 10.
169. Many of the differences among the tax treaties can, however, be arbitraged away through "treaty shopping." For example, a Canadian investor who plans to invest in Mexico can take advantage of more favorable benefits in the U.S.-Mexico tax treaty by setting up a flow-through entity (for tax purposes) in the United States. The ability of sophisticated tax arbitrage strategies (and accompanying waste of resources) to circumvent the bilateral nature of tax treaties, however, only highlights the appropriateness of a multilateral model.
170. But see Rosenbloom, supra note 129, at 268 ("Although there is near unanimity at the level of principle [concerning the negotiation of multilateral tax treaties], in practice and administration it is virtually impossible to pass beyond the bilateral level.").
171. See Arnold & Harris, supra note 104, at 578-79 (recommending that tax treaties in North America be negotiated with a view to harmonizing the provisions of the treaties to the maximum extent possible and arguing that it is preferable, if not necessary, for these negotiations to be conducted on a trilateral rather than a bilateral basis); see also McDaniel, supra note 34, at 739 ("The NAFTA countries need to have a coordinated tax treaty policy with non-NAFTA countries whether or not [a formulary taxation] system is adopted.").
172. See Avi-Yonah, supra note 131, at 92.
173. One criticism leveled at the arm's length method is that it does not reflect economic reality since intrafirm transfers are not the same as those among nonaffiliated groups. See, e.g., Plasschaert, supra note 131, at 7.
174. The United States and the, most recent version of the OECD guidelines developed a more flexible approach toward arm's length pricing in which, although the traditional transactions-based method continues to be favored, a profit-based formula can now be adopted (i.e., comparable profits derived from similar uncontrolled companies). See id. at 5. For a review of the OECD guidelines, see Robert E. Culbertson, A Rose By Any Other Name: Smelling the Flowers at the OECD's (Last) Resort, TAX NOTES INT'L, Aug. 4, 1995, at 150.
175. The tax authorities of Canada and Mexico already use, at times, a profit-based method in order to come to a solution with respect to transfer pricing disputes. But see TURNER, supra note 42, at 18 ("It is suggested that, while detailed legislation may be attractive from a purely domestic perspective, it may not allow for the degree of judgment and flexibility required in an international context"). Draft legislation was introduced in Canada in 1997 to, inter alia, increase the required amount of documentation used to substantiate transfer prices. See Steven Audereth, Canada Proposes Transfer Pricing Bill Requiring More Documentation, Harsh Penalty, U.S. TAX'N INT'L OPERATIONS, Sept. 8, 1997.
176. For American issues, see Thomas C. Louthan, Building a Better Resolution: Adapting IRS Procedures to Fit the Dispute, TAX NOTES INT'L, Oct. 28, 1996, at 209. For Canadian issues, see Scott Shaughnessy, Spotlight on APAs in Canada, TAX NOTES INT'L, Dec. 4, 1995, at 232. For Mexican issues, see Albertina M. Femandez, Mexico Issues First Maquiladora APA, TAX NOTES INT'L, Nov. 13, 1995, at 218.
177. For American issues, see Thomas C. Louthan, Building a Better Resolution: Adapting IRS Procedures to Fit the Dispute, TAX NOTES INT'L, Oct. 28, 1996, at 209. For Canadian issues, see Scott Shaughnessy, Spotlight on APAs in Canada, TAX NOTES INT'L, Dec. 4, 1995, at 232. For Mexican issues, see Albertina M. Femandez, Mexico Issues First Maquiladora APA, TAX NOTES INT'L, Nov. 13, 1995, at 218.
178. For American issues, see Thomas C. Louthan, Building a Better Resolution: Adapting IRS Procedures to Fit the Dispute, TAX NOTES INT'L, Oct. 28, 1996, at 209. For Canadian issues, see Scott Shaughnessy, Spotlight on APAs in Canada, TAX NOTES INT'L, Dec. 4, 1995, at 232. For Mexican issues, see Albertina M. Femandez, Mexico Issues First Maquiladora APA, TAX NOTES INT'L, Nov. 13, 1995, at 218.
179. The revised protocol between the United States and Canada sets up a mutual agreement procedure to resolve disputes under the tax treaty. See U.S.-Canada Treaty, supra note 101, ¶ 1903.26. The U.S.-Mexico tax treaty also contains provisions dealing with mutually agreed dispute resolution procedures. See U.S.-Mexico Treaty, supra note 101, art. 26. The Canada-Mexico tax treaty also establishes mutual agreement procedures. See Canada-Mexico Treaty, supranote 101, ¶ 34,709.
180. See Convention 90/436/EEC on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises, TAX NOTES INT'L, Apr. 24, 1995, at 78.