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The Negotiations of a Tax Agreement between Switzerland and Germany

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Misha Nagelmackers-Voinov

V. Domestic Constraints and Shrinking Win-Set: Effects on Double-Level Negotiations

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  • 171 Peter B. Evans, Op. cit., p. 401.

1After analyzing official sources and documents, information gathered during interviews with direct participants to the negotiations, interest groups as well as media reports, this research examines the dynamics of the negotiations that led to the buildup and then collapse of a tax agreement with Germany, once at the domestic ratification level. It this section, we turn to academic research to contextualize the case and test the theory viewpoint. This section looks at the importance of the balance of power and reveals how domestic constraints and a shrinking win-set can affect double level negotiations. It also offers an illustration of how governments can shape domestic politics by using international debates while still facing conflicting interests along the increasingly blurred line of domestic and international interests. It also touches upon the failure of international negotiations that may come from actors misreading their own domestic political or ratification processes rather than the result of incomplete information from parties about each other’s political or ratification process. Most of all, it shows how “politically constructed ideologies” and stereotypical views171 – in this case the definition of “fair” taxes or the concept of “privacy” – make it nearly impossible to reach an agreement.

  • 172 Robert Putnam, “Diplomacy and Domestic Politics: The Logic of Two-Level Games,” International Organ (...)
  • 173 Andrew Moracsik, “Integrating International and Domestic Theories of International Bargaining”, Int (...)
  • 174 Ibid., p. 17.

2Scholars traditionally decompose the process of negotiation in two stages: Level I (bargaining between the negotiators, leading to a tentative agreement) and Level II (separate discussions within each group of constituents about whether to ratify the agreement).172 When Putnam published his “two-level game” theory on international negotiation, he brought new insights to political science, in three essential respects.173 As a theory of international bargaining, it offered a framework to analyze complex patterns of interdependence. Then, it emphasized that the statesman was the central strategic actor. Finally, his strategies reflected a simultaneous “double-edged” calculation of constraints and opportunities on both the domestic and international boards; domestic policies could be used to affect the outcomes of international bargaining, and international moves might be solely aimed at achieving domestic goals.174

  • 175 Ibid., p. 15.

3Thus, statesmen are assumed to pursue two “superimposed” objectives that can be summarized as “manipulating domestic and international politics simultaneously.”175 They are constrained both by what their counterpart to the negotiations can accept as well as by what her domestic constituencies can ratify.

4Referred to as the set of all possible agreements that could be ratified at the domestic level and that capture the notion of domestic constraint, the win-set is the “space” in which the negotiator has to manoeuver in order to get an agreement. This is achieved though political debate and ratification. The greater the autonomy from domestic pressure, the larger the win-set; adversely, the greater the autonomy from domestic pressure, the weaker the bargaining position.

  • 176 Robert Putnam, Op. cit., p. 438, 440.

5Regarding the impact of the win-set’s size, two hypotheses were made176 by Putnam. The first one implicitly assumed uncertainty and imperfect information: the smaller the win-set, the higher the chances the negotiations will break down, either because of the absence of common win-set, or the failure of the domestic ratification process, or even the change of win-set during negotiations due to new domestic constraints (elections, change of government…).

6The second implied that each party had a clear idea of each other’s win-set, and thus almost perfect information: in this case, a small win-set is a bargaining advantage. Having a clear idea of each other’s win-set is certainly possible in respect to the main substance (nucleus) of a win-set, in a theoretical framework. However, in reality, in an increasingly interlinked and interdependent world, the precise outlines of a win-set might remain somehow fuzzy. These remaining grey zones evolve in highly complex environments, influenced by many combinations of information as well as interlinked domino effects.

1. Domestic Constraints and Domestic Political Power

7According to Putnam, a negotiator – whose aim is to optimize his or her domestic and international positions – can strike a better bargain when subject to domestic constraints, for instance by using the position of her domestic constituent to obtain more concessions from the foreign country.

  • 177 Jongryn Mo, “Domestic Institutions and International Bargaining: The Role of Agent Veto in Two-Leve (...)

8Parties to a negotiation could decide to voluntarily impose domestic constraints on themselves domestically, by granting veto power to an agent, and use this constraint as a bargaining tool at the international level.”177 In this scenario, the negotiator is assumed to have the power to design a ratification procedure. The domestic agent does not have to be a legislature and could be an interest group, an agency or any committee that can exercise de facto a veto power over an international agreement.

  • 178 Ibid., p. 915.

9The agent veto’s power will therefore reduce the kind of proposal the foreign country can make and also increase opportunities for informational exchanges between parties. “The use of the agent veto affects the way information is transmitted during the negotiations.”178 This tends to demonstrate that greater domestic constraints do not automatically decrease the probability of ratification or the size the win-set.

  • 179 Jongryn Mo, “The Logic of Two-Level Games with Endogenous Domestic Coalitions,” Journal of Conflict (...)
  • 180 Ibid., p. 415–416.

10Jongryn Mo179 extended Putnam’s conclusion regarding domestic constraints, by determining that a bargaining outcome might well depend on the distribution of domestic political power between the negotiator and her domestic constituents. When the “domestic constituent’s political power is in the medium range, the negotiator can benefit from an increase of his political power. […] As the domestic constituent’s political power increases (or when the foreign country seeks its support), the other party to the negotiation must make more concessions, whereas the negotiator does not. Thus, an increase in political power of (the negotiator’s) domestic constituent has only beneficial effects.”180 In our case, the initial idea that was used as a starting point for tax cooperation came from the financial industry itself; it suggested a solution that successfully passed the corridors of power, to finally – after debate and adaptation – be adopted as a valid working position for international negotiations. This truly “bottom top” approach gave strong support to the Swiss negotiator, as the projected content of the agreement came from an industry – although not totally homogenous – that itself happened to benefit from strong political power.

2. Ratification and the Balance of Power

  • 181 Robert Putnam, Op. cit., p. 448.

11The size of the win-set depends on the Level II political institutions and the ratification process.181 The Swiss ratification process – and its system of optional or mandatory referendum system – could theoretically increase the bargaining power of negotiators. But the timing of the German ratification – in the context of general elections – might have increased the bargaining power of the German negotiators as general elections were de facto an “indirect” ratification of the agreement, considering the importance of the tax cooperation issue in the electoral campaign. This is purely theoretical as the agreement was adopted by Parliament in Switzerland but not submitted to referendum; in Germany, the tax cooperation agreement did not pass the Bundesrat – but the party defending its ratification still won the general elections.

  • 182 Peter B. Evans, Op. cit., p. 415.

12“Does the inclusion of a larger proportion of the population among the enfranchised (democracy) reduce the size of the win-set and thereby increase the difficulty of entering into agreement?”182

13According to Peter B. Evans, “procedures help determine the balance of power among different domestic groups and between the chief of government (COG) and constituents, but ratification procedures still remains determined by the balance of power”.

3. The Cost of No-Agreement

  • 183 Robert Putnam, Op. cit., p. 443.

14The lower the cost of “no-agreement”, the smaller the win-set: no-agreement often means status quo. Domestic constituents will tend to support or oppose an agreement, independently of its content, but depending on the price of a no-agreement. This is particularly the case when constituents’ preferences are more heterogeneous and an agreement will bear unevenly on them.183 In the negotiations preparing a tax cooperation agreement between Switzerland and Germany, the price of a no-agreement was quite different depending on the actors at play. For instance, for the Swiss chief negotiator, no-agreement with Germany meant a loss of credibility, domestically and internationally. Even much so as Switzerland was hoping to sign an agreement with a major European country in order to break the united front against Switzerland, with the OECD and the EU. In addition, the chief negotiator had just been appointed and much was expected from him. The impact of a no-agreement was quite different amongst the Swiss financial institutions, depending on their business strategies; the front was far from united amongst the big Swiss banks, foreign banks, private banks, cantonal and regional banks, as well as other financial actors such as insurance companies.

15In Germany, the government clearly supported an agreement: it would bring new income to the Finance Minister and settle a long-standing issue with Switzerland. However, no-agreement meant status quo for the Länder who would not, they felt, benefit as much as the central government from the tax cooperation with Switzerland. In addition, the ideological concept of “fair” taxes became the main issue during the German general elections: it was the only topic Chancellor Merkel was attacked on during the entire election campaign. Therefore, the SPD, as opposition party, chose “no-agreement” and status quo as its main strategy.

4. Sources of Power for Domestic Constituents

  • 184 Ellis Krauss, quoted in Andrew Moracsik, Op. cit., p. 22.
  • 185 Peter B. Evans, Op. cit., p. 401.

16“Domestic constituents do not merely respond passively to potential agreements negotiated between the governments, but instead seek to manipulate (and are manipulated by) government leaders and agencies. Their influence on international negotiations depends importantly on strategic considerations”184 about the two-way links between negotiators and constituents on both sides of the international tables, and tacit and explicit trans-governmental alliances. “Final outcomes will fundamentally depend on domestic interest groups” because of their role during the ratification process.”185

  • 186 Fred C. Iklé, How Nations Negotiate, New York, Harper and Row, 1964, p. 191–192.
  • 187 Cédric Dupont, Domestic politics and International Negotiations: Comparative Models of Strategic Be (...)

17Not all constituents participate in every ratification process and if they do, their participation varies, depending on their type and the issues at stake. These variations also have an impact on the size of the win-set. One would expect players to anticipate their own domestic ratification process as well as the other player’s. Some scholars186 suggest that players act according to a bottom line that shifts and is revised as the bargaining evolves. However, and as pointed out by Dupont,187 this bottom line cannot relate to domestic ratification constraints as they are not easily shifted – except when this minimum anticipation can relate to other domestic constraints such as elections, particular economic interests or the effect of a sudden crisis on public opinion. Finalizing an agreement on tax cooperation during general elections, in a global context of a major economic crisis, was a near to impossible challenge for Germany. By comparison, the tax agreement with the United Kingdom, which did not take place during elections, was ratified without a major domestic debate, despite the fact that the country was facing a similar economic crisis as other European countries.

  • 188 Robert Putnam, Op. cit., p. 445.
  • 189 Ibid., p. 446.

18Organized interest groups can be very active, “reducing the effective size of the win-set.188 “The group with the greatest interest is likely to hold the most extreme position.”189 In the present case, the SPD candidate Peer Steinbruck represented the domestic pressure group with the greatest interest. The negotiator was then faced with trade-offs, for instance by helping an “anti” potentially become a “pro” or “pro-ish”. The fact that representatives of a number of “swing-vote” Länder or Finance Ministers visited Switzerland in the weeks running up to the German Bundesrat vote was probably part of the efforts to support a positive vote in Germany. It might well be that discussions regarding the long standing conflict around the Zurich Airport, might also have been thrown in the discussions as a sweetener.

5. Issue Linkage or Synergistic Linkage

  • 190 Ibid., p. 447.
  • 191 Andrew Moracsik, Op. cit., p. 25.

19If the negotiator can steer opposition as well as answer her preferences, she might create an opportunity and open new policy options previously thought beyond domestic control. This transnational issue linkage or synergistic linkage190 will alter the feasible outcome at Level II – and internal reforms will be achieved if supported by an external partner. The negotiator can therefore gain influence in a number of ways, not only by acting autonomously within the domestic win-set but also by linking an important domestic measure to an attractive international agreement or vice-versa.191

20In this respect, Switzerland and its diplomats faced criticism regarding “banking privacy” for decades. Following increasing international pressure, in the 1970s, Swiss banks decided to promote a self-regulated “Convention de diligence” (Exercise in due diligence). In the 1990s, the Swiss Parliament voted an anti-laundering law and ordinance. In March 2009, the Swiss government withdrew its reservations on the application of art 26 OECD to non-residents; later, it agreed on a possible agreement on automatic exchange of information when it becomes an international standard. One can only think that Cantonal Finance Directors might also wish for this standard to become applicable to their own “customers”, Swiss residents. This might be pure fiction, the result of a conspiracy theory – or the result of a situation where, the Swiss government, “unable” to conduct internal reforms, has used the pressure of external partners (OECD, G20, EU…) to conduct domestic reform.

  • 192 Andrew Moracsik, Op. cit., p. 29.
  • 193 Andrew Moracsik, Op. cit., p.29.

21Conversely, as a transnational agreement emerges, domestic constituents might pressure the government to adopt new policies, improving the prospects of international cooperation. Constituencies at Level II will cut across the Level I divisions and become an ally to the other country’s negotiator. Polities aimed at foreign countries are common – such as “raising the cost of no-agreement to key constituents on the other side.”192 The negotiator “can also target linkages or side payments by offering specific benefits to particularly powerful domestic constituencies or swing groups in a foreign country […]. Another tactic is to use reverberation, which occurs when actions by one country alter the expectations about an agreement held by domestic groups in a foreign group.”193

6. Increasing Mutual Win-Sets

22“State strength” is a complex issue because of the different levels of information and the formal ratification the agreement must go through.

  • 194 Robert Putnam, Op. cit., p. 451.
  • 195 Robert Putnam Op. cit., p. 452.

23The negotiator faces an important tactical dilemma regarding the size of her opponent’s win-set which, in turn, highly depends on her own strategies. “Each Level I negotiator has an interest in helping the other to get the final deal ratified.”194 Negotiators will normally strive to reinforce one another’s position with their respective domestic constituents, as their popularity increases their mutual win-sets. However, Level I negotiators are often misinformed about Level II politics abroad.195 Working on the basis of wrong assessments will affect their appreciation of their opponent’s win-set and support tactics that end up being counterproductive.

7. Manipulating the Size of the Win-Set: Strategic Communication

24In order to get important domestic constituents or interest groups on board, the Level I negotiator can open, or be urged to set up, direct channels of communication – by establishing formal or informal expert commissions or consultations with various interest groups. Including domestic interest groups will “force” constituents to face the implications of their claims, while at the same time managing their expectations. Such was the case in Switzerland, when the Swiss Bankers Association, the Swiss Private Bankers Association and other trade associations were closely associated to the initial steps regarding mapping the contents of a possible agreement, its agendas and counterparts to its support (access to the EU market).

  • 196 Andrew Moracsik, Op. cit., p. 15.
  • 197 Robert Putnam, Op. cit., p. 454.

25“Diplomacy is a process of strategic interaction in which actors simultaneously try to take account of and, if possible, influence the expected reactions of other actors, both at home and abroad.”196 Win-set and information are therefore tightly linked in negotiations. For instance, when information is complete, either the win-set becomes smaller or domestic constraints tighten. “Much ambassadorial activity – wooing opinion leaders, establishing contacts with opposition parties […] is engaged to reach out to constituents and ease domestic constraints.”197 Communicating the cost of status quo and benefits of an agreement – reverberation of international issues on domestic politics – can shift the interests of a country and change minds. And as information can put a negotiation back on track… it can also totally derail it.

  • 198 Cédric Duont, Op. cit., p. 13.

26Citizen’s familiarity with issues relating to ongoing negotiations is an important aspect of the ratification process in Switzerland, due to its particular “referendum” process. The population can be actively involved in a number of ratification processes, as different ratification routes are available. Because of this, international negotiations have long been part of Swiss current affairs and therefore, the national and international media will report and debate on issues that are of interest to the domestic and international governmental agenda, to influence, educate, prepare or manage public opinion. Depending on the interests at stake, the media will constitute a tactical factor for interest groups; moreover, foreign players will equally approach any domestic or foreign constituent in order to present their position, and “try to enhance their bargaining position through outside play.”198

8. Using the Size of the Win-Set to Manage your Career

  • 199 Robert Putnam, Op. cit., p. 457.
  • 200 Gerhardt Stoltenberg, Wall Street Journal Europe, 2 October 1986, as quoted in C. Randall Henning, (...)
  • 201 James D. Morrow, Op. cit., p. 405–407.

27Theoretically, a negotiator’s preferences could be different from her constituents’. Her “agenda can be politically rewarding if [she] is seeking popularity;”199 she can facilitate domestic policy moves that would otherwise be infeasible internally; or she can pursue a personal conviction that serves the country’s best interest. “The limit of expanded cooperation lies in the fact that we, as democracies, need to secure electoral majorities at home.”200 Morrow201 incorporated the electoral incentives of negotiators in a negotiation’s framework; as economic conditions deteriorate, the preferences of the electorate changes – and so does the international bargaining outcome. Furthermore, “politicians care more about the benefits realized when they are in office than when they are out of office and will discount future benefits according to the probability that they will return to office.”

  • 202 Cédric Dupont, Op. cit., p. 20.
  • 203 Andrew Moracsik, Op. cit., p. 30.

28As described by Cedric Dupont,202 the negotiation process can be considered as a strategic interaction between rational players where actors behave as individuals. These individuals reflect their interests through their preferences either by “enhancing a domestic position, a capacity to mobilize an optimal response to international imperatives, regardless of domestic factors, or her personal policy preferences linked to past political history or personal idealism.”203 These negotiators, as individuals with preferences and interests, can act as agents (reflecting the median interest of his domestic constituents), doves (closer to the opposing win-set) or hawks (further than the opposing win-set).

8. The Win-Set and the Ticking Clock

  • 204 Cédric Dupont, Op. cit., p. 49.

29Timing might be a crucial preference factor that was partly overlooked by Putnam. An agreement is better today than it might be tomorrow as it starts delivering benefits immediately and avoids further costs.204 If both players are roughly placed under the same time preference, no player has any particular advantage over the other on this specific time resource. However, it can be of importance to only one actor, who might just be controlling the domestic political checks. And what if renegotiation was possible after a ratification failure, due to strategic voting?

  • 205 Iida Keisuke, “When and How Do Domestic Constraints Matter?” Journal of Conflict Resolution 37(3), (...)

30It is assumed that domestic constraints benefit both the negotiator and his domestic constituents. Could it be that the veto agent or the agent that ratifies the agreement tries to influence the agreement by changing his preference, if renegotiation is possible?205 Some domestic constituents might feel an incentive to reject an agreement even if the agreement is a clear improvement compared to status quo, because a possible future renegotiation might be possible in the future. If an agreement on tax cooperation is renegotiated with Germany, it might be interesting to analyze how this second negotiation changes the players’ win-sets, tactics and preferences.

  • 206 Andrew Moracsik, Op. cit., p. 27.
  • 207 Peer B. Evans, Op. cit., p. 412.

31“Statesmen have a great deal of control over the initiation of negotiations and the setting of a negotiation agenda; less control over the domestic conditions over which the ratification vote is taken; and no direct control over the final vote itself.”206 “The success or failure of agreements depends upon their impact on pre-existing structures of interest, both national and transnational”. Stateswomen “may be the most prominent players of two-level games, but other players’ agendas often triumph nonetheless.”207

9. The Filter of Ideologies

  • 208 Keisuke (Iida), “Analytic Uncertainty and International Cooperation,” International Studies Quarter (...)

32In non-crisis negotiation, it is assumed that both players are aware of each other’s resources through many informal preparatory talks or former negotiations – but this paper also stresses that players might lack information on beliefs and preferences of each other’s public opinions. Information on political process (elections…) or domestic political ratification process (informal ratification from interest groups, followed by formal ratification through Parliament and possibly through popular referendum, depending on the topic or if a popular initiative has been launched) might be difficult to assess. To the extent that failure of international negotiations may come from actors misreading their own domestic political or ratification processes rather than incomplete information from parties about each other’s political or ratification process.208

  • 209 Andrew Moracsik, Op. cit., p. 3.

33During the Great Depression, and despite a common crisis, domestic forces in various countries torpedoed negotiations that took place at the London 1933 World Economic Conference. This was partly due to “divergence of economic ideologies on the part of national central bankers, and the obstinacy of the French peasantry”209 – it ultimately led to the outbreak of World War II.

34The “true” nature of things – in the economic or political system – are not known. Policy makers are assumed to believe in different models of the world, to which they simply adhere. Let’s suppose that a country A believes in a “punitive” taxation policy with deep conviction of its fairness, this would be equivalent to having complete information in the game theory framework. Country B, however, believes in a “collaborative” taxation policy. Country B would not believe that Country A has complete information, but rather that it is simply wrong. When both sides firmly believe in very contrasting views of the world, it is not surprising that cooperation is a challenge.

Notes

171 Peter B. Evans, Op. cit., p. 401.

172 Robert Putnam, “Diplomacy and Domestic Politics: The Logic of Two-Level Games,” International Organization 42 (Summer 1988), p. 436.

173 Andrew Moracsik, “Integrating International and Domestic Theories of International Bargaining”, Introduction to International Bargaining and Domestic Politics: Double-Edged Diplomacy , Peter B. Evans, Harold K. Jacobson & Robert D. Putnam, University of California Press, 1993, p. 16.

174 Ibid., p. 17.

175 Ibid., p. 15.

176 Robert Putnam, Op. cit., p. 438, 440.

177 Jongryn Mo, “Domestic Institutions and International Bargaining: The Role of Agent Veto in Two-Level Games,” American Political Science Review 89(4), 1995, p. 914–924.

178 Ibid., p. 915.

179 Jongryn Mo, “The Logic of Two-Level Games with Endogenous Domestic Coalitions,” Journal of Conflict Resolution 38(2), 1994, p. 402–422.

180 Ibid., p. 415–416.

181 Robert Putnam, Op. cit., p. 448.

182 Peter B. Evans, Op. cit., p. 415.

183 Robert Putnam, Op. cit., p. 443.

184 Ellis Krauss, quoted in Andrew Moracsik, Op. cit., p. 22.

185 Peter B. Evans, Op. cit., p. 401.

186 Fred C. Iklé, How Nations Negotiate, New York, Harper and Row, 1964, p. 191–192.

187 Cédric Dupont, Domestic politics and International Negotiations: Comparative Models of Strategic Behavior in Non-Crisis Negotiations, University of Geneva, 1994, p. 18.

188 Robert Putnam, Op. cit., p. 445.

189 Ibid., p. 446.

190 Ibid., p. 447.

191 Andrew Moracsik, Op. cit., p. 25.

192 Andrew Moracsik, Op. cit., p. 29.

193 Andrew Moracsik, Op. cit., p.29.

194 Robert Putnam, Op. cit., p. 451.

195 Robert Putnam Op. cit., p. 452.

196 Andrew Moracsik, Op. cit., p. 15.

197 Robert Putnam, Op. cit., p. 454.

198 Cédric Duont, Op. cit., p. 13.

199 Robert Putnam, Op. cit., p. 457.

200 Gerhardt Stoltenberg, Wall Street Journal Europe, 2 October 1986, as quoted in C. Randall Henning, “Macroeconomic Diplomacy in the 1980s: Domestic Politics and International Conflict Among the United States, Japan, and Europe,” Atlantic Paper No. 65, New York: Croom Helm, for the Atlantic Institute for International Affairs, 1987, p. 1.

201 James D. Morrow, Op. cit., p. 405–407.

202 Cédric Dupont, Op. cit., p. 20.

203 Andrew Moracsik, Op. cit., p. 30.

204 Cédric Dupont, Op. cit., p. 49.

205 Iida Keisuke, “When and How Do Domestic Constraints Matter?” Journal of Conflict Resolution 37(3), 1993, p. 418.

206 Andrew Moracsik, Op. cit., p. 27.

207 Peer B. Evans, Op. cit., p. 412.

208 Keisuke (Iida), “Analytic Uncertainty and International Cooperation,” International Studies Quarterly 37, 1993, p. 431-457.

209 Andrew Moracsik, Op. cit., p. 3.

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