Politics
The curious business of taxation
Published 12 November 2007
Wages have stagnated, corporations contribute less to Treasury coffers as their profits grow ever vaster. What has gone wrong with taxation?
Something very odd has happened to the world economy in the past decade or so. With the march of globalisation, real wages have more-or-less stagnated in the developed world, yet returns to capital have shot up.
Moreover, as the benefits of growth have started to accrue more to capital-holders than to workers, the share of government revenue from corporate taxation has fallen.
Across the world, governments have found it more and more difficult to tax corporations, and so the tax burden has instead fallen squarely and heavily onto the shoulders of individuals.
Making sense of how and why this has happened is fairly straightforward. With the emergence of industrial capitalism in the late 19th and early 20th Centuries, governments in the developed world realized a balance had to be struck between the demands of the market and the demands of the broader society in which markets were located.
This realization came sooner in some places – as with Bismarck’s development of the welfare state in Germany in the 1880s.
In Britain, the process of taming the market started perhaps a little later, beginning with Lloyd George’s radical reforms as Chancellor in the early years of the last century, and reaching its zenith in the post-war settlement created by the Attlee Government of 1945-51.
What marked out this earlier stage of the relationship between markets and societies was that it all happened under the roof of one particular state.
A balance could be struck, therefore, between the demands of economic growth and of social protection, because the nation state was in a powerful position to impose whatever regulation it saw as necessary on corporations.
Now globalisation has shattered that balance.
Capital can move jurisdiction at will. The mechanisms of taxation and regulation that can be used by the state have grown useless and atrophied.
States cannot set the terms of operation for corporations that are free to relocate to more benign host countries.
The balance of power has slipped from democratic governments to globally mobile corporations, with states reduced to adopting beggar-my-neighbour policies of tax competition.
It is unsurprising, given this reallocation of political power, that the benefits of the world economy accrue increasingly to the owners of capital rather than to the providers of labour, and that the tax burden in countries like the UK falls disproportionately on individuals rather than corporations.
These problems were illustrated starkly last week, in the Guardian’s investigation into the economics of the world banana industry.
Del Monte, Chiquita and Dole sold over £400 million worth of bananas in Britain last year. Yet these three corporations between them paid only £128,000 tax in the UK.
To put things into perspective, the annual income to the UK Exchequer from taxation of banana companies is less than the income tax paid in a three month period by the Liverpool footballer John Arne Riise (if the copy of his wage slip that has been circulating on the internet is to be believed).
How do these companies manage to pay so little tax? Well, primarily, through the operation of complex webs of financial transactions known as ‘transfer pricing’, whereby semi-imaginary deals between different subsidiaries of the same company are used to move profits from one jurisdiction to another.
As the Guardian article illustrated, the tax avoiding behaviour of UK banana sellers are so Byzantine and complicated that, on its way from Latin America to our supermarket shelves, a bunch of bananas will have passed through virtual balance sheets in the Isle of Man, Ireland, Bermuda, Jersey and the Cayman Islands.
The combination of tax havens and transfer pricing allows large multinational corporations to set their tax rates more or less at will.
As things stand, of course, none of this is actually illegal. Traditionally, the distinction has been drawn between tax evasion, which is the illegal activity of evading one’s full tax liabilities, and tax avoidance, which is the legal activity of arranging an individual’s or corporation’s affairs, within the letter of the law, so as to minimise one’s tax exposure.
Unsurprisingly, it is hard to hold a clear line between the two, and many schemes of tax avoidance shade over towards the borders of tax evasion. Indeed, some writers on tax have coined the term ‘avoision’ to refer to those schemes which fall somewhere in the disputed borderlands.
Large corporations are concerned to avoid downright illegality, and so tend not to practice tax evasion.
But, as the banana example shows, large corporations have no need to get into straightforward illegality when their interests can be served so fully by avoidance strategies using transfer pricing and tax havens.
Tax avoidance is a despicable practice, for a number of reasons. Firstly, it is deeply anti-democratic. It frustrates the legislative intentions embodied in tax legislation, in favour of allowing the distribution of ownership in the economy to be determined by the machinations of tax avoiders themselves.
Secondly, tax avoidance ignores basic standards of fairness. Corporations can make money because they have access to our markets, and make use of our workforce, legal system and transport system. Basic fairness surely dictates that corporations therefore have responsibilities to society, and the very minimum of meeting those responsibilities should be meeting the full expectation of a corporation’s tax contribution?
Tax avoidance enables corporate tax avoiders to fail to live up to their side of the ‘social contract’.
As Richard Murphy, Director of Tax Research LLC, succinctly puts it: "Tax is not a cost to a company. It is a distribution out of profits. That puts tax in the same category as a dividend - it is a return to the stakeholders in the enterprise.
"This reflects the fact that companies do not make profit merely by using investors’ capital. They also use the societies in which they operate, whether that is the physical infrastructure provided by the state, the people the state has educated, or the legal infrastructure that allows companies to protect their property rights. Tax is the return due on this investment by society from which companies benefit." (‘Havens and have-nots’, The Guardian 7.11.2007)
Corporations earn their “social license to operate” insofar as they contribute to the general good of the societies in which they exist.
They can only do this when they contribute both towards the economic health of that society and to the democratic aims of that country’s government, through providing revenue to the state that can be used to pursue valuable social policies.
A corporation which shirks its minimal commitment to uphold the basic rules of society, including its taxation rules, fails to earn its justification for existing, and is in need of urgent reform.
I’ve said that the explanation of why corporations contribute so little to society is straightforward.
What is much more difficult is to understand how this situation can be changed. Once markets are global, the individual state has little room for manoeuvre in its efforts to grab social value from internationally mobile capital.
Indeed, it would seem that tax avoidance is the inevitable result of a co-ordination problem among competing firms. If your competitor is avoiding tax, then you will have to do so as well, if you are not to suffer a sizeable commercial disadvantage by comparison. Moreover, tax avoidance is incredibly wasteful: it consumes the efforts of thousands of high-energy, talented, imaginative people; and it does so for a destructive social end.
If tax avoidance could be structurally outlawed, then the enormous energy and imagination that goes into pursuing it could be redeployed to more genuinely productive occupations, and directed towards technical and managerial innovation, instead of just ‘cooking the books’.
There is, so to speak, something of a Prisoner’s Dilemma in operation. We would all be better off if this practice of tax avoidance could be eliminated, but it is individually rational for each corporation to engage in such practices. The questions to be faced, therefore, are why it might be that such practices are currently legally permissible, and how we might bring it about that such practices could be stopped.
This, it seems to me, is one of the most pressing political issues of our day. How can we re-empower our collective institutions, given their powerlessness in the face of globally mobile capital?
From the problems of tax avoidance to the problems of the ‘sub-prime’ mortgage market, what we see everywhere is a failure of regulatory power by states when facing rampant corporate and financial interests that value quick profits over social progress or even long-run economic stability.
When society and the market are no longer “under one roof” these sorts of problems emerge. There are two ways in which they could be brought back under the same roof. One is a retrograde policy of closed-borders and protectionism, which would attempt to re-localize markets. This approach is likely to throw away the material gains of globalization along with its problems of capital mobility.
The forward-looking approach is instead to look for transnational regulatory mechanisms, operating at an EU level (in the first instance) or eventually perhaps even at a global level. Through this approach, we might hope to keep the material benefits of globalization, whilst rebalancing the relationship between corporate power and the power of democratic governments and our collective institutions.
Politicians of all parties should be addressing this agenda with much more energy than we have seen.
Moreover, shifting the tax burden away from individual income from work, and towards the owners of capital, is a policy that could be highly popular, and surprisingly easy to sell.
People could be brought around to an agenda of clamping down on corporate tax avoidance if they were told that it meant that they could pay less personal tax if only corporate scroungers and tax-cheats paid their fair share.
In the long run, we need a better global financial architecture. In the shorter term, a raft of specific policies could be pursued, hopefully in co-operation with other nations. Firstly, we need better public information.
Companies should be required by law to publish in full their tax payments in every jurisdiction in which they operate, so that individual citizens and voters can see whether those companies are good corporate citizens or scrounging cheats.
Secondly, we need to clamp down on tax havens, especially those in our own back yard, like Jersey and the Isle of Man. If need be, consideration should be given to refusing legal recognition to corporate entities based in tax havens.
Thirdly, we need to move towards international accounting practices that rule out the most shameless examples of financial hocus-pocus such as ‘transfer pricing’.
Moreover, we need to clamp down very hard indeed on accounting firms that market the more exotic forms of tax avoidance schemes, by subjecting them to much tougher regulatory legislation. (If a softer approach does not work, then perhaps we should consider legislative measures that could lead to a few senior accounting partners being banged-up for a few years, pour encourager les autres.)
Most of all, democratic states need to take the power back before things it's too late.
What this will involve is the reorientation of tax laws so that they take more account of where real economic activity takes place, rather than being too bamboozled by the formal paper structures of imaginary subsidiaries and bogus holding companies.
More aggressive regulation, pursued at a European level, could provide more government income whilst reducing individual tax burdens.
Best of all, perhaps, all those clever and ingenious corporate accountants who spend their working days devising ever more complex ways of defrauding their fellow citizens could instead expend all that ingenuity and intelligence on doing something more productive instead.
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