The Power Politics of International Tax Cooperation - Why Luxembourg and Austria are Bound to Adopt Automatic Exchange of Information on Non-Resident's Interest Income

Theories of tax competition predict that small countries competing with large countries benefit, as they find it relatively easy to substitute revenue lost in a tax cut with revenue gained from incoming foreign tax base. If small countries can only lose from tax cooperation, why are Luxembourg and Austria bound to agree to a revised EU Savings Tax Directive that will oblige them to automatically provide information on foreign account holders’ interest income to residence countries? Putting emphasis on the neglected issue of power, I show that Luxembourg and Austria were first coerced into bilateral agreements on automatic exchange of information by the United States, which then activated a most-favored nation clause contained in the EU Directive on Administrative Cooperation in Tax Matters. As a result, the two countries were under a legal obligation to also extend greater cooperation to EU partners.