A Constitutional Moment in Cross-Border Taxation

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University of Nairobi




The complex pattern of formal and informal rules that governs the taxation of cross-border transactions tends to be thought of as rigidly path dependent. (Rixen, 2011) In truth, the Classification and Assignment Constitution has repeatedly undergone sudden changes initiated by influential actors. A failure to acknowledge the power wielded by a handful of states and organizations nurtures an evolutionary myth of cross-border taxation, but a close examination reveals traces of intelligent design, with repeated interventions altering the course of its development.

A century ago a material constitution coalesced around an elegant but flawed algorithm providing for the "classification and assignment of specific categories of income to source or residence" to allocate taxing rights among states. (Graetz & O'Hear, 1997, p. 1074) To determine which state can impose tax on a cross-border transaction, this approach enumerates a menu of taxable income items—such as dividends, interests and royalties—(classification) and then allocates each item to either a home or host state (assignment). Decades later, after World War II, thousands of bilateral double tax treaties emerged to form an intricate bill of rights to that constitution. The startling rise of the treaties widely perceived as hallmarks of stability reveals a surprisingly dynamic material constitution.

Despite the absence of any formal amendment mechanism, the Classification and Assignment Constitution has been remade more than once. Employing constitutional concepts deeply engrained in its legal culture, the United States has mastered the art of both initiating change and preventing it. U.S. policymakers have alternately transformed the Classification and Assignment Constitution and preserved it much as they do with the U.S. Constitution. Understanding the U.S. perspective on wielding constitutional power reveals an important opportunity for long-marginalized states. Simply put, it shows how constitutional power can be seized with nothing more than an idea.

Section 2 introduces the concept of a material constitution. It explains how U.S. policymakers have entrenched norms that have provided stability in the taxation of cross-border transactions over the past century despite the absence of any formal international tax governance structure. It then describes how the resulting constitutional order allows it and others to exercise power to alter that constitutional order.

Section 3 shows that at constitutional moments change can be initiated, revealing how the Classification and Assignment Constitution has been amended. Offering examples ranging from the creation of the Controlled Foreign Corporation a half century ago to the recent European state aid cases, it illustrates the process through which constitutional amendments can be proposed and, on rare occasions, completed.

Finally, section 4 highlights implications of this constitutional order for marginalized states. It urges bold action of the type that Justice Marshall once took to transform the role of the U.S. Supreme Court, granting it primacy in a suddenly remade constitutional order. Reshaping a material constitution, as every U.S. lawyer learns in their earliest days of legal training, requires no formal control at all.

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