“Rules are rules, but rules are meant to be broken.” Taken from a Guardian article dated 18 March 2004, these are not the words of an anti-capitalist anarchist, but come from an interview with a business tax partner of a major global accounting business. The interviewee was commenting on UK Chancellor Gordon Brown’s recent budget proposals, and went on to say that “no matter what legislation is in place, the accountants and lawyers will find a way around it.”
Confronted with evidence of incitement to criminality, the accounting firm in question hastily sought to distance itself from its partner’s comments, but in reality tax practitioners around the world have been engaged in subverting national tax regimes for decades, and hold firmly to the view that nothing – but nothing - should stand in the way of making profits.
Knowingly or otherwise, such behaviour is rooted in the thinking of the University of Chicago, made famous by the radical ideas of Nobel-prize winning economist Milton Freeman and his colleagues working in the area of corporate law. Addressing the issue of anti-competition violations, Professors Frank Easterbrook and Daniel Fischel wrote in the 1980s that company directors not only could, but should, violate rules in pursuit of profit. Rule violations, they argued, should be seen as ‘externalities’ and paying the associated fines and penalties is a normal cost of doing business. Whilst broader society might regard fines and penalties as deterrents against law-breaking, the self-styled ‘Chicago boys’ took the line that everything in the corporate world boils down to calculations of financial costs and benefits.
A recent US Senate enquiry examined how accounting firm KPMG has applied this logic to the tax
avoidance products which it markets to its global clients. In a series of emails released to the enquiry, a senior tax practitioner told his colleagues that even if regulators acted against their sales strategies, the potential profits greatly exceeded the possible penalties. ‘Our average deal’ one email noted, ‘would result in KPMG fees of US$360,000 with a maximum penalty exposure of only $31,000.’
Judging by the string of recent corporate scandals, the Chicago boys appears to have won the day. Corporate tax avoidance has become a major global industry, costing the US federal authorities an estimated US$170 billion annually and extending well beyond the world of delinquent companies like Enron, Worldcom, Tyco and Yukos. In April 2004 the US General Accounting Office revealed the startling fact that 61 per cent of American corporations paid no tax during the late 1990s, which period, it is worth bearing in mind, witnessed the longest bull market ever recorded. Recent research by UK-based Tax Research suggests that tax avoidance is endemic amongst FTSE100 companies, and according to chartered accountant Richard Murphy “is probably costing the UK government in excess of £20 billion annually in lost revenues.”
Whilst tax avoidance industry is damaging to the interests of developed countries, it poses a far greater problem for developing countries, where multinational companies and local elites can undermine the tax base with ease. Oxfam estimates the revenue losses to developing countries from harmful tax competition at US$50 billion annually and this figure does not take account of losses arising from the aggressive use of transfer pricing and thin capitalisation. The cumulative impact is immense, compelling many governments to borrow on the financial markets to fund revenue and capital expenditure that would otherwise be less expensively funded from tax revenues.
The problem of tax evasion and tax avoidance is at its greatest in some of the world’s poorest countries, particularly in Africa and Latin America. The weakness of the Bolivian fiscal system, highlighted in last year’s IMF review of that country, illustrates the extent of the problem. Facing a fiscal deficit of 8.8 per cent of the current budget, the Bolivian government tried in 2003 to change the tax code in order to recover €355 million in revenue arrears from tax evading business elites. This move was fiercely resisted by some members of the business community, many of whom – like their Brazilian and Argentinian counterparts - have illicitly moved their capital to the Cayman Islands and similar tax havens. Struggling with deteriorating public health and education services, the Bolivian government remains reliant on multilateral credits and grants from donor countries.
Avoiding the issue
Paying taxes is perhaps the most fundamental way in which private and corporate citizens can engage with the social contract. US judge Oliver Wendell Holmes hit the nail bang on the head when he argued, in 1904, that “taxes are what we pay for civilized society,” Nonetheless, tax minimization is widely regarded as one of the prime duties that directors perform on behalf of their shareholders. Compelled by the profit logic and by a legal principle which asserts that tax payers may organise their affairs in such a way as to pay the least possible tax under the law, tax advisers encourage directors to regard tax as a cost of doing business which, according to a senior tax partner of global firm Ernst & Young “a good manager will try to manage,” adding, for good measure, that “this is an essential part of good corporate governance.”
This assertion is questionable on two counts. First, tax is not a conventional cost of providing either goods or services and cannot be treated as such. By treating tax as a cost of production, businesses undermine the entire basis of the efficiency-maximising market economy. Second, good corporate governance does not expose a company to a subsequent risk that its tax planning strategies are illegal, leaving directors and shareholders exposed to risks of legal action. And anyway, how does such behaviour square with the CSR agenda, which is driven by demand for an ethical approach to doing business? It is not possible to be selective about the application of ethics to business conduct, and companies that function in this way reveal a major disconnect in their core organizational values.
Curiously the CSR debate, which has touched on virtually every other area of corporate engagement with broader society, has only recently begun to question companies in the area where their corporate citizenship is most tangible and most important – the payment of tax. Meeting at the European Social Forum in Florence, November 2002, a coalition of NGOs, academics, professionals and faith groups agreed to form the global Tax Justice Network to campaign against aggressive tax practices and harmful tax competition. With its international secretariat based in London, the Network is now engaging with the CORE Coalition and other stakeholders in the CSR debate to promote responsible tax practices and to advocate for global policy measures to overcome the systemic faults that have led to a situation in which multinational businesses can run rings around nationally based tax regimes.
According to Richard Murphy the signs are that the tide is turning against tax avoidance, not least because of concerns that sell-side analysts lack sufficient knowledge about tax affairs to factor this issue into their analyses, leading to a systematic over-valuation of many businesses. “A shift in political will,” he argues, “could leave such companies exposed to very substantial risks of downwards re-valuation.” This shift is already underway. Companies tendering for US federal contracts have already come under scrutiny in the Senate for their tax avoidance strategies, and, in response to what the Financial Times has described as the exponential growth in the use of tax havens, senior revenue officials from the US, UK, Canada and Australia agreed in Spring 2004 to co-operate in investigating aggressive tax practices by multinational companies. At a truly multilateral level, the United Nations General Assembly agreed in December 2003 to start the process of forming an inter-governmental commission involving its 191 member countries in developing new anti-avoidance measures.
Faced with what appears to be a substantial shift in the CSR agenda, company directors need to reappraise their attitude towards paying taxes, particularly when they operate in developing countries.
CSR standards are required in the area of taxation, amongst other things covering the publication of all necessary accounting information and the use of profits-laundering vehicles that operate without substantial economic purpose. CSR reports should list the countries in which the company trades, how much profit is derived from activities in each of these countries, and where these profits are booked for tax purposes, indicating any special purpose vehicles that are used, and the extent of tax avoidance arising from the use of ‘novel tax planning ideas.’ Only in this way can the relevant stakeholders, including governments, shareholders, employees and the general public obtain the data they need to determine whether the organizations that dominate the globalized economy are truly acting as good corporate citizens.
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