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Does Strategic Forbearance Explain EU Deference to FATCA?

Posted on Jan. 24, 2022
Robert Goulder
Robert Goulder

This week we dabble in cross-disciplinary thinking. The proposition is that wisdom from other social sciences can help explain some of the odd things we encounter in the tax world — specifically regarding EU governance.

Strategic forbearance has been gaining intellectual traction in recent years, thanks in part to the writing of Alisha Holland, an associate professor at Harvard University whose 2016 paper on the topic won a prize from the American Bar Foundation.1 An oversimplification of her thesis is that institutions vested with great power (typically large governments) may achieve desired objectives and advance their standing by purposefully not deploying those powers in the intended manner. That forbearance is likely to have adverse consequences on the private parties who would have benefited from governmental action. Collateral damage is the price of institutional inaction.

It can be useful to think about the things that strategic forbearance is not. The concept is distinct from dilatory tactics, in which a governmental body reckons that delay is preferable to acting swiftly. It’s also distinct from the caution that naturally occurs when one party to a conflict declines to exercise power because of retaliation concerns.

Here the focus is on what Holland describes as the deliberate underenforcement of law. It suggests a setting in which a political body holds a unique and valuable power yet refuses to use it in situations that beg for its application. The implication is that more can be gained by not deploying the power in question, which seems paradoxical to centuries-old political instincts. Why would Niccolò Machiavelli encourage his prince to attain political clout, at considerable expense, only to keep it under wraps? In more contemporary terms, what good is power if you don’t use it?

A recent academic paper rifted on Holland’s thesis to critique the behavioral patterns of the European Commission. In December 2021 R. Daniel Kelemen of Rutgers University and Tommaso Pavone of the University of Arizona released a working draft of their forthcoming paper on supranational forbearance, which tries to explain why the commission has grown sheepish on infringement proceedings.2 The paper just as easily explains why the commission has emerged as a defender of the U.S. government’s Foreign Account Tax Compliance Act. It’s tempting to label the commission as an unwitting protector of the FATCA regime, but the designation might not be accurate. Brussels seems to know exactly what it’s doing.

The point here is to circle back to the collateral damage. What greater good is served by Europe’s supranational forbearance toward FATCA, and who loses out when the commission declines to ask tough questions about U.S. data protection standards?

Nonfeasance as Misfeasance

Constitutionally, the commission has two basic responsibilities, according to Kelemen and Pavone:

  • to serve as the primary engine of European integration; and

  • to serve as guardians of the EU treaties.

Nothing about these roles is meant to be mutually exclusive; they are intended to be complementary functions. Yet evidence suggests that pursuit of the first objective necessitates increased moderation as to the second.

The idea that the commission, over time, is bringing fewer infringement proceedings against EU member states might come as a surprise to those of us in the tax profession. Hardly a week goes by when Tax Notes readers aren’t presented with a range of analyses and opinions on recent infringement proceedings involving large corporate taxpayers. The state aid probes have made sure of that. But that caseload stands as an exception to the general rule of diminished activity.

The numbers don’t lie. Between 2004 and 2018 the volume of infringement inquiries brought by the commission fell by 67 percent.3 The number of infringement proceedings referred to the EU courts fell by 87 percent. The commission has grown decidedly less activist during the last decade and a half.

The presumptive explanation is that EU leaders detected a weakening in support for tighter EU scrutiny of local practices. The member states were OK with being told how to behave, but only to a limited degree. This was spotted even before the Brexit referendum and the migrant crisis that arose out of the Arab Spring. It forced an unwelcome choice for EU leaders: They could prioritize enthusiasm for continued EU integration or strict enforcement of EU law, but not both. They responded by making the unpopular elements of EU treaty law less offensive. Kelemen and Pavone put it as follows:

The Commission’s political leadership became worried that its vigorous law enforcement was antagonizing member states and jeopardizing already precarious intergovernmental support for the EU and the Commission’s agenda, so it sought to assuage national governments via forbearance. . . . Essentially, the Commission worked to safeguard its political role as the engine of integration by partially sacrificing its legal role as the guardian of the Treaties.4

According to Kelemen and Pavone, this forbearance occurs because the EU officials charged with enforcement are not insulated from political pressure. From the rule-of-law perspective, this conduct creates a void that no other player in the EU roster can fill. Under article 258 of the Treaty on the Functioning of the European Union, the commission alone is responsible for bringing infringement actions. The European Parliament has powers — more than it used to — but they’re limited in scope and no replacement for what the commission should be doing.

The EP can veto a trade pact or budget proposal, but it struggles to exert broader influence. Critically, the EP can’t launch infringement probes or directly refer transgressions to the EU courts. This reflects Brussels’ democratic deficit. Power lies predominantly with unelected commissioners rather than elected members of Parliament.

All of which gets us to FATCA. The U.S. data collection regime depends on a network of intergovernmental agreements. Without these treaty-like agreements, there is no formal mechanism for the necessary account holder information to be conveyed from foreign financial institutions to the U.S. government. No IGAs means no data exchange. As previously discussed, these IGAs have a looming problem with the EU’s General Data Protection Regulation (GDPR).5 The judgments in Schrems I and Schrems II are highly relevant regarding whether U.S. data protections — such as they are — are equivalent measures for GDPR purposes.

Each member state has a national data protection agency charged with making sure the country’s domestic data protection practices are compliant with GDPR obligations. The role of these national bodies is key to upholding the integrity of the GDPR regime, which assigns them a power of direct intervention. That is, upon discovering a possible GDPR violation, the national data protection agencies are not limited to an advisory or investigator role. They are expected to do more than merely refer matters to state prosecutors; they have their own prosecutorial competency. Article 58 GDPR empowers them to initiate legal proceedings against data processors, as appropriate, including both private and public sector entities. (GDPR does not give a pass to state-administered data processors, such as tax administrators.) In short, if a country’s revenue body is dropping the ball on data protection, it’s the duty of these national data protection agencies to respond, including direct intervention through the courts.

In theory, the national agencies are structurally independent of the governmental units they oversee. Their degree of actual independence is less certain, which explains why we don’t observe them applying much scrutiny over public sector bodies. At the EU level, they are collectively monitored by the European Data Protection Board, whose mission statement calls for “ensuring the consistent application of European data protection rules across the EU.”

Evidence shows that the board itself is susceptible to supranational forbearance. It has the jurisdiction, subject matter competency, and resources to launch a major probe into member states’ IGAs with the U.S. government. Given the publicity accompanying the Schrems cases, which cast serious doubt on U.S. data protection practices (in a setting other than tax administration), you’d think that organized scrutiny would naturally follow. That’s not what occurred. The board passed, instead choosing to invite the member states to review the matter themselves — which is a license for doing nothing at all.

That’s hardly a formula for EU-wide consistency. What kind of a mess would occur if the French data protection agency concluded that its IGA is defective, while its German counterparts determined their IGA is GDPR-compliant? That’s unlikely to occur because nobody expects the national agencies to take the task seriously, if they critique the IGAs at all.

There are names for what is going on. In the United States, we call it passing the buck. In academic circles, we’re now calling it supranational forbearance. The resulting collateral damage (inevitable with purposeful underenforcement of the law) is that European taxpayers don’t possess meaningful GDPR rights when it comes to anything that relates to the cross-border exchange of tax information among tax administrators.

This level of inaction has a trajectory. If it continues long enough, a de facto standard will be established. Over the years, it will become clear that the GDPR is subject to an unwritten carveout for the network of IGAs that give life to the FATCA regime. That would be fine if the hands-off treatment flowed from constitutional or statutory language, reflecting the designs of democratically elected assemblies. It does not. Nothing in the GDPR says that tax administration generally, or FATCA specifically, merits preferential treatment.

Pillar 1 Wants In

As an aside, it’s worth thinking about how these IGAs became a source of binding U.S. law in the first place. They’re bilateral treaties for practical purposes, but they were never ratified by a two-thirds majority of the Senate, which is what you might expect given a reading of the U.S. Constitution’s Article II ratification clause. Nor were the IGAs approved as executive-legislative agreements, which would have taken the form of revenue bills originating in the House of Representatives adhering to the ordinary process. That would require a simple majority approval in each chamber.

The IGAs were sustained as executive agreements, plain and simple. Congress had no say over their approval. The same is true for the tax information exchange agreements the government has signed over the years with a handful of jurisdictions deemed unworthy of treaty-partner status.

Some will argue that approval of the IGA network, as a series of executive agreements, should be noncontroversial because the structural need for those pacts could be reasonably inferred from FATCA itself, which Congress passed a few years earlier. That is, no sound reasoning would have Congress obstruct implementation of its own statutory creation. That view might be generous in assuming an internal consistency on the part of lawmakers, but so be it.

There are implications for the OECD inclusive framework. If the IGAs can secure approval as executive agreements, bypassing Congress entirely and then successfully fending off legal challenges in federal court, then why shouldn’t the same treatment be available for the pillar 1 reforms? One way to keep reluctant senators from spoiling the party is to not give them an opportunity to do so.

That said, there’s a reason pillar 1 is not a good candidate for the executive agreement process. It doesn’t mirror the situation we had with IGAs because there’s no preexisting statute from which the subject matter is intuitively derived. To the contrary, the pillar 1 proposals substantially deviate from the provisions of the IRC relating to jurisdictional taxing rights and profit attribution. Tempting as it might be, the proposed OECD-level reforms are different enough from IGAs that they shouldn’t be formalized without congressional involvement.

FOOTNOTES

1 Alisha C. Holland, “Forbearance,” 110(2) Am. Pol. Sci. Rev. 232-246 (2016).

2 R. Daniel Kelemen and Tommaso Pavone, “Where Have the Guardians Gone? Law Enforcement and the Politics of Supranational Forbearance in the European Union,” SSRN, Dec. 21, 2021.

3 Before this period, the frequency of commission-led infringement proceedings and judicial referrals was on the rise. From 1978 to 2004, infringement probes increased from 95 opened matters per year to 1,952, marking a 20-fold increase. For the same span of years, the number of commission-led referrals to EU courts increased from 15 per year to 259, for a 17-fold increase. See Kelemen and Pavone, supra note 2, at 4.

4 Kelemen and Pavone, supra note 2, at 3.

5 For related analysis, see Robert Goulder, “Does FATCA Have a Schrems Problem?Tax Notes Int’l, Dec. 7, 2020, p. 1391. See also Goulder, “Does FATCA Have a General Data Protection Regulation Problem?Tax Notes Int’l, Nov. 30, 2020, p. 1245.

END FOOTNOTES

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