Income Tax Discrimination: Still Stuck in the Labyrinth of Impossibility
Graetz, Michael J., Warren, Alvin C., Jr., The Yale Law Journal
ESSAY CONTENTS INTRODUCTION I. EFFICIENCY AS THE NORM II. THREE EFFICIENCY STANDARDS FOR INTERNATIONAL TAX NEUTRALITY Ill. THE ASSUMPTION THAT TAXPAYERS CANNOT CHANGE RESIDENCE IV. THE NORMATIVE CASE FOR COMPETITIVE NEUTRALITY V. THE TAX LAW REQUIREMENTS OF COMPETITIVE NEUTRALITY VI. THE PROPOSED CONSTITUTIONAL VERSION OF COMPETITIVE NEUTRALITY VII. THE POSITIVE CLAIM FOR COMPETITIVE NEUTRALITY VIII. COMPETITIVE NEUTRALITY AS A WAY OUT OF THE LABYRINTH OF IMPOSSIBILITY CONCLUSION
The foundational treaties of the European Union establish a unique system of government. (1) In general, they leave decisions about how to levy income taxes and at what rates to the member states. If the member states agree unanimously--a rare occurrence indeed--the European Commission, Council, and Parliament can together issue income tax directives, but so far these few directives have been limited to rather technical matters. (2) Within Europe, as elsewhere, cross-border transactions involving income taxation are also governed by an extensive network of bilateral income tax treaties that, while reflecting many common principles, often vary in their details. (3)
In this context, the European Court of Justice (ECJ) is charged with ensuring, to the extent appropriate and practicable, that the member states' income tax laws do not interfere unduly with the "four freedoms" guaranteed by the Treaties: free movement of goods, (4) services, (5) labor, (6) and capital. (7) These freedoms of movement were intended to create an economic market relatively free of internal barriers, as well as greater social and political union within Europe.
There is considerable tension inherent in this structure, in which each member state retains a veto over European income tax legislation, including proposals that would promote the cohesion of the internal market, while the ECJ reviews the tax laws of the member states to ensure that they do not violate the Treaties' guarantees of free movement. The national income tax laws at issue vary across the Union, generally providing an important source of revenue and implementing national distributive and economic policy goals in light of each member state's economic and social conditions, as well as internal political dynamics and conflicts. Variations in income tax laws and rates across Europe affect taxpayers' decisions about where to work, live, and invest, as well as tax planning efforts about where to locate income and deductions to minimize income tax burdens. (8)
In the 1980s, the European Court of Justice began deciding income tax cases with an aim to strengthening the Union and to limiting the member states' ability to favor their own residents or to favor domestic over foreign investments? Although there is considerable doctrinal confusion in the decided cases, the essential construct used by the ECJ to achieve its goals is the concept of discrimination against cross-border transactions as compared to purely domestic transactions. (10) While a number of commentators, including us, have criticized these decisions as being incoherent in terms of tax policy, doctrinally confusing, sometimes conflicting, and constitutionally questionable in terms of democratic decisionmaking, those decisions have no doubt contributed to the economic, social, and political union in Europe?' In recent years, the European Union has expanded to twenty-seven members, enlarging the membership of the court and creating even greater diversity among the member states' economies and income tax laws. After that expansion and the rejection of a proposed European constitution, the court has become less aggressive in striking down aspects of member states' income tax laws, accepting justifications offered by the member states that in earlier times the court would have rejected. (12)
Competition in Europe has had a notable effect on income tax structures and rates in the member states. …