Taxation is generally understood as a core sovereign function of the state, albeit ‘constrained to a limited extent’ under various international and supranational rules, including European Union (EU) law, World Trade Organization (WTO) law bilateral tax treaties and (possibly) customary international law.1 In this context, tax competition is usually presented as an exercise of sovereignty, or sovereign right, of by tax states. On the other hand, as explained in Chapter 10, the cooperation of states with other states, in an international order of states, is also an exercise of sovereignty. Therefore, a concept of ‘sovereignty’ on its own cannot explain very much about how states behave in the international tax context. The more fundamental issue concerns in what circumstances tax competition, or tax cooperation, would be beneficial or detrimental for tax states or for global welfare.

Policy discussions about the corporate tax often begin with the fundamental question: Why tax corporations?1 Reuven Avi-Yonah observed that corporations are ‘everywhere’ and ‘nowhere’ in economic and social life.2 The corporation is treated as a separate taxpayer in most income tax laws. Yet, like other intermediary business and investment vehicles, it is a legal fiction or construct. A corporation cannot bear the economic burden of a tax: a theory of ability to pay cannot be directly applied to a corporation.3

Tax law constitutes the boundaries of charities, the market and the state in a ‘jumbled mixed economy’.1 Charities are a subset of the broader not-for-profit sector, sometimes called the ‘third sector’ to distinguish it from the market and the state. The charitable tax exemption discussed here sets the border of the tax state with the charitable sector, while its political, or ethical, justification recognises, as Evelyn Brody suggests, that charities are in a sense ‘co-sovereign’ with the state.2

The Treaty of Westphalia of 1648 divided up the territory of Europe into nations, generating ‘a political imaginary that mapped the world as a system of mutually recognizing, sovereign territorial states’.1 The successful assertion of tax jurisdiction was a critical element of the ‘organizing logics’ of the nation state.2 In the eighteenth century, Adam Smith considered taxation to be essential to make Britain a ‘great nation’ in an international order of other nations. By the twentieth century, the nation state operated in what Nancy Fraser termed the ‘Keynesian-Westphalian’ frame,3 built on a market economy and a ‘tax and welfare state’ that was actively interventionist in the economy and had a core role of redistribution. Taxation was territorially and economically bounded, and claims for intervention in the market and for distribution were mostly internal, or domestic, claims on the state.

Tax policy refers almost universally to principles of equity, efficiency and simplicity, with modifications in definition and emphasis in different contexts.1 These three principles originate in four Maxims of taxation developed by Adam Smith early in the era of the tax state: equity, certainty, convenience and efficiency.

The long history of taxation in empires, kingdoms and nations has been studied by legal, economic and political historians.1 The history of the ‘tax state’, or a government that is dependent on the power and capacity to tax, is much shorter – at most, about 250 years. A ‘tax state’ is established when a sovereign is able to raise sufficient tax revenues to consolidate, stabilise and centralise government based on this source of finance.2

People in wealthy countries live in a state that is defined by the power to tax and dependent on taxation to fund government, which we call a ‘tax’ state.1 Most of the member states in the Organisation for Economic Co-operation and Development (OECD) are tax states. This book discusses taxation law and policy in the economic, social, legal and political context of tax states and explores the many challenges faced by these tax states in the twenty-first century.

The tax state of the twentieth century succeeded because it harnessed tax revenues from workers. The application of income taxes on wages, social security taxes levied on workers and employers, or even broad-based consumption taxes was impossible before the existence of a mass labour market delivering wages higher than subsistence level. When waged work became widespread in the industrialising economies of the twentieth century, governments gradually overcame barriers to successful taxation of labour income.

In the Maxims of Adam Smith, extracted in Chapter 4, the requirement of certainty (Maxim II) was considered by Smith to be the most important, even more important than equity. In eighteenth-century Britain, Smith was concerned about preventing arbitrariness and limiting the coercive power of the sovereign. Smith was also much concerned about the convenience of taxation. He strongly criticised the taxes of his time for exposing taxpayers to ‘much unnecessary trouble, vexation and oppression’ and being ‘so much more burdensome to the people than they are beneficial to the sovereign’. He said some taxes were payable at an ‘inconvenient’ time, while applauding other taxes levied when the taxpayer would have the funds to pay.1 Finally, Smith expressed concern about abuse of power by tax inspectors, bemoaning the ‘frequent visits and the odious examination of the tax-gatherers’, with their expensive ‘perquisites’ and the temptation through their office to ‘insolence’ and corruption.