Conceptualizing Epistemic Power: The Changing Relationship Between Economic Policy Paradigms and Academic Disciplines

3.1 The 1993 Reform: Effectiveness, Neutrality and Competitiveness

The late 1980s was a transformative period for international corporate tax policy (Genschel & Schwarz, 2011; Swank, 2016). In the words of one interviewee, “supply-side economics gained ground in the United States, which led to the push to lower marginal tax rates” (Interview, 2019a). This inspired a wave of tax reforms in the Nordic countries (ibid.), influencing the Finnish overhaul. A member of the 1991 working group was tasked with drafting a memo based on similar working groups in Sweden and Norway (Viherkenttä, 2019). As this expert noted, “Sweden and Norway were the key sources of inspiration, but Denmark also featured [in the discussions]” (ibid.). However, the general emphasis toward the creation of a competitive tax system emanated from the United States. The previous interviewee continues, “I spent quite a lot of time studying the Reagan tax reform […] which had a two-fold impact on our efforts. First, […] the decision to combine low tax rates with a broad tax base offered inspiration for other countries. Second, the U.S. example provided an important source of encouragement and confidence[.]” This notion lends support to the transformative ideational impact of US 1986 tax reform as a global catalyst for the “movement without precedent” in tax policy convergence (Steinmo, 2003).

Before 1993, the Finnish corporate tax regime incorporated a complex system of deductions, reserves and a differential treatment for different forms of capital income. This created ample opportunities for tax avoidance (Andersson, 1993). The 1993 reform separated the taxation of labor and capital income, introducing a proportional 25% tax rate for capital and corporate income. Deductions and reserves were streamlined and the tax base was broadened. The reform called for streamlining capital income taxation with a uniform treatment of different forms of income, catering to the needs of international capital flows, in line with the Nordic examples (PMO, 1991). The goal was to increase economic efficiency and neutrality and boost firm-level investment (PMO, 2011b). The unified 25% tax rate for corporate and capital income was seen as means to these ends. In some respects, the reduction of deductions and reserves can be seen as a tool to increase the neutrality of the tax system. However, in the words of one of our interviewees, neutrality can be interpreted as

a rather neoliberal argument, driven by an idea that the state should not offer deductions or other incentives in order to steer the overall direction of the national economy […] This could be contrasted with a Keynesian view of the state, which strives to regulate corporate activities, for example, through deductions (Honkanen, 2019; also Steinmo, 2003, p. 224).

However, the Finnish corporate tax system had admittedly become complicated. Deductions and reserves had mushroomed without a proper assessment of their inter-linkages, consequently shrinking the tax base and tax revenues. The paradigmatic shift to Reaganite ideas was perceived as an opportunity to start with a clean slate, with no competing, comprehensive alternatives in sight. The 1991 financial crisis was a unique, catalytic moment for such a shift as the biggest economic crisis any OECD country had experienced since the 1930s (Mayes, Halme, & Liuksila, 2001). Hence, in the words of one interviewee, “no one believed that we could have navigated out from the recession by tinkering with the details. The recession may have provided a political window of opportunity to adopt the model” (Interview, 2019g).

The 1991 report highlighted the importance of the international race to the bottom, as “there are countries even in Europe (e.g., Luxembourg) with which it is nearly impossible to compete” (MoF, 1991, p. 6). This remark mirrored the international political landscape of the time: while global economic governance was about to enter its golden decade after the end of Cold War, the political imagination and impetus for curtailing the race to the bottom was missing in the new “free-market” atmosphere. Together with the crisis mentality that had captured the public mindset, the Reaganite–Nordic examples provided “moral-political backing” for a politically sensitive reform with a major distributional impact (Viherkenttä, 2019). Hence, using counter-factual reasoning, it would have been inconceivable to think that a pro-regulatory approach would have gained a hegemonic position in the prevailing policy atmosphere.

The resulting report lacked a list of references, referring only occasionally to previous governmental working groups. Its authority relied on the personal influence of the authors. In the words of one of the lawyers of the 1991 group, who also served as civil servant in the Ministry of Finance, “academic scholarship played a limited role. We were not really doing academic research, but rather assessing how similar reforms had been conducted in other Nordic countries” (Viherkenttä, 2019). This can be seen to reflect the idea of legal scholarship as an interpretative and also comparative science. However, this notion also underlined the fact that evidence-based policy-making had not yet emerged as a meaningful agenda. These factors effectively enabled Chicago-style tax policies to enter the traditionally statist Nordic context without economistic calculations, which was typical for the Chicago-influenced law and economics approach of the time. The fact that the epistemic backing of the underlying ideas came from highly abstract and anti-statist Friedmanian economics (Fourcade, 2009) was not an issue, since the epistemic credibility of the reform relied on authority of the law professors who designed it.

In a way, the 1991 report continued the Nordic tradition of legalistic tax policy design aligned with the mainstream economics view of the role of taxation, but in a context where Keynesian ideas had become unfashionable and empirical basis of economic analysis had been succumbed by abstract modeling. As the mainstream thinking in tax economics shifted to Reaganite ideas, so did the Finnish corporate tax policy (fourth factor). This tendency to follow the international economic consensus helps to understand why lawyer-dominated tax policy formation shifted so quickly away from the earlier dirigiste approach (Campbell & Pedersen, 2014), even in a process steered by lawyers. In a way, this was a textbook example of a paradigm shift (Hall, 1993). Yet, focusing solely on policy paradigms would hide important aspects on how they were mediated in the national context (c.f., Helgadóttir, 2016). Further, the ways in which this mediation occurred created path dependencies for the future reforms.

3.2 The Early 2000s: Adapting to the International Regulatory Agenda

In the mid-1990s, Finland was recovering from a devastating recession, while converging its laws with the European Community rules. This shift necessitated eliminating customs duties, which was compensated by increasing the corporate tax rate first from 25 to 28% in 1996, and to 29% in 2000 (Kaseva, 2014). The overall course of the Finnish tax policy remained stable, steered by a small group of influential lawyers. Altogether six of the eight authors behind the 1991 report were lawyers, as was the group’s chairperson. These experts wrote key textbooks and legal commentaries and their interpretations shaped legal adjudication. They also contributed frequently to the hearings of the parliamentary tax committee (Pekkanen, 2019).

The next major assessment of the Finnish corporate tax system was published in 2002 by a working group commissioned by the Ministry of Finance (MoF, 2002). The lawyer-dominated group included a chairperson, six members, and three secretaries. The report marked a growing international interest in tax governance. By this time, the deregulatory agenda that characterized global economic governance in the early 1990s had become balanced by growing concerns over harmful tax competition. In this new context, many of the ideas were drawn from or reflected against international policy processes, such as the OECD’s initiative against harmful tax competition and the EU’s Code of Conduct Group on Business Taxation.

While the 2002 report included significant economistic aspects, its argumentation was strikingly pluralist. On the surface, this was surprising, given that there had not been any major changes in the composition of the epistemic expertise behind Finnish tax policy. The report acknowledged that the characteristics of an ideal tax system—such as neutrality, predictability and fairness—can conflict with each other. The authors carefully considered how Finland could combine attracting international investment with commitments to abstain from harmful tax competition. Corporate tax rate cuts were seen as means toward this end, in line with the 1993 reform. The report also discussed potential leakages and their remedies (regarding, for example, intra-firm financial arrangements). It criticized economistic tax research for unrealistic assumptions and for neglecting the use of holding company arrangements to shift profits. Finally, the report noted that the results of the studies on tax elasticity (see Section 3.3.) differed wildly depending on the methodology.

The 2002 report can be interpreted at least partly as a national manifestation of the Europe-wide rebuttal of the most extreme aspects of the Reaganite tax agenda. In the mid-1990s, a wave of social democratic governments across the EU found inspiration, for example, from Krugman’s (1994) influential criticism of tax competition (Radaelli, 1999). The transformation of the conceptions of tax competition inspired attempts to harness the economistic idea of tax neutrality to advance policies against harmful tax competition both in the EU and the OECD. In the early 1990s, this kind of international juridical-regulatory agenda had been missing. After its emergence, influential tax lawyers were well-equipped to follow these discussions and the recommendations that surfaced internationally. This development reflects Fourcade’s (2006) notion that the transnational expansion of economistic ideas does not necessarily occur uniformly. When making this argument, Fourcade points to the complex and possibly contradictory influences arising from American consulting firms and universities. In contrast, we highlight such asymmetries between different functions and departments of major IOs that steer global economic governance.

In the academia, the new regulatory initiatives inspired a wave of research in legal studies and social sciences (e.g., Radaelli, 1999; Weiner & Ault, 1998). Hence, the changing international tax policy consensus in the IOs and the academia facilitated its national diffusion (Farrell & Quiggin, 2017). The key lawyers drew simultaneously from two major epistemic sources, i.e., the economics literature of the time and the new IO-centered policy agenda. Reaganite ideas had been increasingly questioned within economics, and the IO-centered policy agenda further amplified these dissenting voices. Again, the changing international disciplinary and policy-level consensus (fourth and fifth factors) impacted national policy. In the early 1990s, this shift centered around the rise of the Reaganite tax policy, whereas the agenda against harmful tax competition of the early 2000s was a more trans-disciplinary and fragmented affair. Importantly, the episode also highlights how IOs can directly influence the scope and focus of legal studies.

3.3 From Lawyers to Economists: The Triumph of Impact Assessments

The epistemic community behind the Finnish tax policy shifted after the 2005 tax reform. One of the key professors, Edward Andersson, retired in 1999. Another prominent professor, Kari Tikka, died in 2006, with a two-fold impact on tax scholarship. First, in the words of one interviewee, the expertise of prominent legal scholars was lost “[w]hile at the same time there were many more tax economists than in the past, when the quality of tax scholarship in economics was, at best, modest” (Viherkenttä, 2019). Secondly, academic tax scholarship changed direction after the departure of these law professors. “The focus of these new professors has been to a great extent in international tax law […] and in indirect taxation. A major [epistemic] gap emerged” (Pekkanen, 2019).

The gradual departure of prominent lawyers coincided with the growing use of quantitative impact assessments. The Finnish government had already initiated several projects for improving legislative work through impact assessments in the 1990s (Ilmakunnas, Junka, & Uusitalo, 2008). This work culminated around 2004–2007 in several reports issued by the Ministry of Justice and the Prime Minister’s office, which recommended using quantitative estimates “that can be complemented with qualitative studies” (Ministry of Justice, 2004, p. 16; NAO, 2011). These reforms resonated with the work that the OECD had conducted since 1997 (NAO, 2011). In its 2003 country report, the OECD (2003, p. 58) noted that ex ante regulatory impact analyses “need to be sharpened so as to enhance the quality and effectiveness of regulations.” These projects strengthened the role of quantitative impact assessments at a time when far-reaching cost-cutting programs had hampered the legislative capacity across ministries (NAO, 2011). An epistemic gap emerged, which economists soon occupied: expertise was needed in quantitative impact assessments, and lawyers typically did not excel in this area. The decision to establish the new Working Group in 2008 was a milestone, as most of its participants had degrees in economics. The project was led by under-secretary Martti Hetemäki from MoF, who both chaired the working group and its secretariat.

The world often changes remarkably faster than disciplinary boundaries, creating potential gaps between bodies of knowledge that feed into policy-formation (Seabrooke, 2014). These gaps are likely to be filled with some forms of expertise in a process where policy-level path dependencies and the self-perception of experts may reinforce each other (Dezalay & Garth, 2011). Hence, we need to pay attention to the emergence of ruptures and scientific contestations related to addressing and filling the gaps. Economists saw the Working Group as a way to improve the theoretical and empirical robustness of the Finnish tax policy. One of our economist interviewees (who contributed to the 2010 report) contrasted the 2002 and 2010 expert group reports by stating that the former “had a homespun flavor, with somewhat weak argumentation. It did not really manage to tackle the real problems of our [tax] system” (Interview, 2019b, emphasis added). The conceptions of policy-relevant knowledge were shifting, which also influenced the perceptions of the past work.

These two reports conveyed a radically different approach to how tax policy should be studied: through legal reasoning, or by relying on international tax-related economics literature. To illustrate this, Table 1 compares how the 2002 and 2010 reports used international policy processes as reference points for their recommendations.

Table 1 highlights the reliance of the 2002 report on the authority of international tax policy organizations, whereas the 2010 report sought advice from economics literature. The first report included altogether 46 references. There were only a few references to theoretical economics literature. About 20% of references (N = 9) pointed to ECJ resolutions, whose importance had grown with a number of Court decisions on national income tax systems’ compatibility with the EU law (Menéndez, 2009). Other references pointed to statistical sources or reports from working groups or IOs. The 2002 report effectively incorporated a juridical approach to tax reforms, stressing the importance of aligning tax policy with international standards. In contrast, out of 138 references in the interim report of the 2010 group, 125 were written by economists or published by institutes that relied primarily on economics (such as the economics department of the OECD). In other words, at least 90% of the works cited were economistic. The report also drew from 49 memos, mostly based on economics literature. This disciplinary shift aligned the 2010 report with the topical discussions in the economics tax literature, in line with a similar trend in Norway (Christensen, 2018). Concerns related to international coherence of the national-level policy issues or intra-firm tax avoidance were marginalized.

The OECD also noted this shift. In its country review, the Paris-based organization maintained that the Finnish public administration had traditionally relied on a “sense of formalism and legalism which still permeates social, business and political affairs” (OECD, 2010, p. 19). However, the review (pp. 21–22) argued that Finland now had “frameworks in place that contribute to the achievement of an evidence-based decision-making culture”, citing regulatory impact assessments as a prime example. However, the review noted that these efforts lacked coherence, and called for even more systematic impact assessments and cost-benefit analyses. In the following year, the Prime Minister’s Office published a report on improving and mainstreaming the use of impact assessments throughout the government (PMO, 2011a), which has remained a governmental priority throughout the 2010s.

In other words, the extent to which politicians rely on expertise shifted (first factor), coinciding with changes in the composition of relevant expert groups (second factor), and the shift in the underlying disciplinary basis (third factor), contributing to a shift in the utilization of the research and recommendations produced by IOs (fifth factor). While the IO-centered agenda against harmful tax policy continued evolving, the changing disciplinary basis effectively blocked its main dissemination channel to Finnish tax policies—favoring instead analyses produced by the economist departments of these same IOs. This notion underlines the importance of focusing on the exact mechanisms involved in policy diffusion and transfer (Marsh & Sharman, 2009). Even if the government would have wanted to facilitate policy diffusion in this area, the lack of epistemic structures that would have enabled such a policy diffusion would have hindered such endeavor.

Finally, the change in the composition of Finnish tax law professors facilitated a shift within tax law scholarship from national corporate taxation to international questions, which further heightened the relative importance of economists in the design of national tax policy (second and fourth factor). This shift effectively cemented the epistemic shift from lawyers to economists. Even if politicians would have wanted to redirect epistemic power to lawyers, they may not have found equally talented candidates to fill these expert posts. This could have also lowered Finland’s standing in the OECD’s assessments. Further, there were signs of a disciplinary shift in the utilization of economics research (fourth factor), given how the report relied increasingly on theoretical economics literature. This reflects the idea of economic models as “transmission devices” between economic paradigms and policy programs (Heimberger, Huber, & Kapeller, 2020). However, as we will argue below, the real significance of this shift became only evident in the final stage of our analysis.

3.4 The 2014 Reform and the Quarrel over Dynamic Effects

The 2010s saw a further extension of the epistemic shift from lawyers to economists, which completed the long-term transformation from legalism to economism in the Finnish corporate tax policy. First, the growing reliance on economics in policy-making enabled anchoring policy proposals on economics literature. The normalization of this practice contributed to a situation where the MoF’s leadership was able to bypass their own Tax Department to advance a major corporate tax cut. Second, the normalization of the use of economics enabled designing tax policy with future-oriented estimates that relied on assumptions drawn from the economic theory.

Prime Minister Katainen’s government began its term in early 2011. The governmental program reflected the 1990s consensus: by “lowering the corporate tax rate by one percentage point to 25%, private sector employment will improve growth and investment opportunities” (PMO, 2011b, p. 16). These alignments were operationalized (and slightly exceeded) in 2012, with a tax rate of 24.5%. However, the government soon decided that the economic crisis necessitated further action. This paved the way to the drastic reform of 2014, which reduced the corporate tax rate from 24.5 to 20%. There was an urge to do something “big” as a signal to the markets and for bolstering the competitive advantage (Interview, 2019c). This can also be interpreted as a defensive measure to curb the registering of Finnish corporations to regional low-tax regimes, such as Estonia (Interview, 2019d; Kortela & Maunu, 2014). The decision was politically contentious for a six-party government with deep ideological rifts. In the words of an insider, the tax cut “was an undesirable expense for the political left, and the smaller the cost, the easier it was to settle on the reform” (Interview, 2019c). The static downward impact on tax revenues was estimated at 960 m€. The preparatory work began in late-2012 in a process directed by Hetemäki, who also steered both the 2010 expert group and its secretariat. It was the first major corporate tax reform to rely on the 2010 expert report that drew from international economics literature, with additional calculations prepared by an economics research center (VATT) instead of the lawyer-dominated Tax Department of the MoF. Third, the reform was justified by the anticipated dynamic effects of tax cuts.

Indeed, the key controversy related to the anticipated dynamic effects of the 2014 reform. During the budget framework negotiation, the MoF, politicians and the VATT assumed that the beneficial behavioral effects of the tax cuts would broaden the corporate tax base through increased employment and investment, which would mitigate the budgetary impact (Kortela & Maunu, 2014). The government expected that broadening the tax base would help to cover more than half (50–62%) of the annual revenue loss. The inclusion of presumed behavioral impact remains unprecedented. The MoF and the VATT utilized a dynamic, applied general equilibrium model in their calculations, without specifying a timeframe for dynamic effects. This approach was highly controversial even within the MoF. High-ranking civil servants found meaningful short-term impact unlikely (Maunu, 2014). The estimates relied on studies of tax elasticity of corporate tax reforms. Several preparatory memos refer to a 2008 review article written by Ruud de Mooij and Sjef Ederveen (VATT, 2013). Given the importance of this article for the policy, as well as for the shift in the disciplinary base, we turn to discuss its contributions.

After reviewing 427 studies, de Mooij and Ederveen (2008) suggest that 4.5 percentage point drop in corporate tax rate would result in a self-financing rate of 62% through broadening the tax base. The article identified five sub-components for this effect: changes in the (1) the corporate legal forms; (2) the profit-shifting patterns of multinationals; (3) debt-capital ratios; (4) size of the existing foreign direct investment, and, (5) the amount of inward investments. The relative size of these components was estimated through a literature review. The contents of these sub-components were only vaguely debated in public, even though they involved highly controversial assumptions. First, two-thirds of the dynamic effects were seen to result from the shifts of transboundary “hot money”, or, from changes in the legal form of existing economic activity. These effects are prone to react to corresponding changes in other jurisdictions. Second, the long-term effects on economic growth and employment are meagre, as the governmental Economic Policy Council (2014) also noted. Even the relationship between profit-shifting patterns and corporate tax rate is much more complex than anticipated (Finér & Ylönen, 2017). Profit-shifting is influenced by a variety of factors such as tax treaties and the capacities of tax authorities. Many commentators found the international estimates unreliable and questioned whether they could be meaningfully applied in the Finnish context (Interview, 2019d, 2019f).

The de Mooij and Ederveen article also saw the level of corporate tax rate as key variable in determining economic activity, which reflects the contested idea of the Laffer curve (Morgan, 2021). The article infers predictions on investment activity based on a pre-determined set of causal mechanisms that impact the cost of capital. However, empirical literature suggests that investment decisions are influenced by a myriad of reasons beyond tax rates, such as productive possibilities, market size, resources and the political and macroeconomic stability (OECD, 2007; Stiglitz, 2019). The type of investment most responsive to the level of corporate taxation seems to be highly mobile portfolio investment (IMF, 2014).

These uncertainties notwithstanding, this single article occupied a central role in governmental discussions on the budget framework. The article was important not only at the preparatory level, but also within the government. An expert with close knowledge of the negotiation process explains that the article was in “briefcases when the decision was made, it was reviewed and browsed during the process. […] If I need to name one study that was on the desks at the time, this was it” (Interview, 2019c). In the words of a lawyer interviewee, “[economistic] tax theoretical considerations gained too prominent position in tax policy. Expertise in economic theory is, in principle, desirable, but it may sideline competition-related issues and the practical effects of the reform” (Interview, 2019g). This interviewee also noted, “perhaps there is a growing need to give policy proposals a seemingly scientific form to lend them credibility.” Hence, politicians “sometimes refrain from advancing reforms that might generate positive results according to practical knowledge of the issues at hand” (ibid.). Furthermore, politicians tend to favor quantitative assessments, even when they are highly uncertain (Kortela & Maunu, 2014).

The government’s Economic Policy Council stated that dynamic effects are negligible or nonexistent, and that including them in the budget process undermined its goals (Economic Policy Council, 2014). The National Audit Office (NAO, 2014, p. 24) also criticized the MoF for ignoring how business cycles influence the anticipated dynamic effects. The preparatory materials issued by the MoF and the VATT partially acknowledge these caveats. However, Hetemäki explained that “international academic consensus is that the dynamic effects cover as much as 70% of the costs of the tax cuts. Given that we know that tax reforms affect firm behavior, disregarding this knowledge would hamper well-informed decision making” (quoted in Suominen, 2013, emphasis added). This estimate is exaggerated even compared to the upper-scale estimates by de Mooij and Ederveen (62%). Social democratic finance minister Jutta Urpilainen also referred explicitly to the 50% self-financing rate without further qualifications (Yle, 2015).

The incorporation of economic theoretical considerations resulted from a broader shift in the conceptions of what constitutes policy-relevant knowledge. In this process, the window of opportunities for tax policy was subsumed under the neoclassical theory of taxation, illustrating how the use of scientific disciplines is open to interpretation (Ban, 2016). The inclusion of dynamic effects signals a strengthening of the economistic paradigm of tax policy (fourth factor). The technical nature of the underlying analyses further solidified the expert position of economists, given that very few politicians know how to interpret theoretical economics literature. A single meta-review gained a central place in a major policy process, but the disciplinary constellation that guided evidence-based policy-making masked deep uncertainties in the underlying calculations. This resonates with the recent scholarship on the political aspects of quantitative indicators and estimates (Fourcade, 2010; Mügge, 2020).

The quarrel over dynamic effects concluded the shift from legalism to economism. Utilizing counterfactual reasoning, this shift would not have been possible without the preceding steps that fixed the other components that were necessary for the mainstreaming of such rationalities. For example, an expert group dominated by lawyers would not have had the technical expertise required for assessing of such estimates. Moreover, if the prevailing ideas of evidence-based policy-making would not have embraced the use of quantifiable estimates, the introduction of dynamic effects would have been much riskier, highlighting the inter-dependence of disciplinary shifts that drive tax policies.