A constructive proposal on tax


Tax is a serious topic. It is serious because because taxes pay for the infrastructure, security,  healthcare , education and social safety nets that our economies and our welfare depend on. It is serious because raising funds through general taxation rather than relying rely on aid or natural resource rents is what makes for accountable government. And it is serious because robust, effective and well enforced taxation rules are crucial for fair competition and to avoid distorting and discouraging economic activity.

Tax dodging has become a big issue of public debate. For non-tax-experts (of which I am one) our mental map of the territory tends to look something like this:

Here be loopholes

On one hand are companies and individuals that follow the rules and pay all the taxes due. On the other side are companies and individuals that evade taxes through illegal means. And in the badlands in the middle are tax avoiders – companies and individuals that stretch the rules and exploit loopholes to get around paying a fair amount of tax without actually breaking the law.  

Tax is a rule-of-law issue –  governments should only  take people’s money  through transparent rules, fairly applied.

But this does not mean that as long as a company has not been found guilty of breaking the rules by a court, then all can be assumed to be ok.

If companies are operating in the grey-area of tax loopholes; finding clever ways to go against the spirit of  the law while staying within its letter, then the rules need to be tightened. If lack of enforcement capacity means they are able to evade tax rules with impunity, then tax inspectorates need to be strengthened. If the tax rules have not kept pace with the way that global trade and investment, and digital economy has developed then they need to be updated.

The argument so far is  fairly uncontroversial  –  responsible business, citizens, governments, the tax profession and those concerned with international development  are all broadly on same side; in favour of clear, efficient, well enforced and democratically agreed rules.

The devil is in the detail though, and beyond here the debate gets a bit technical, and seriously prickly. Its not just that  it is a complicated subject with real tensions, uncertainties and trade-offs. The public and expert debates have become disconnected in a way that has allowed misunderstandings and misreading to abound, both within and outside of organisations. As I have written about before,  the research organisation Global Financial Integrity (GFI) crunches IMF data to estimate how much the practice of reinvoicing exports through tax havens costs countries. This forms the basis of many ‘big numbers’ about tax avoidance. Their methodology (which is not able to assess transfer mispricing within multinational companies) came up with a figure of  $1- 4 billion per year lost to governments in Africa (up to 2006) The Africa Progress Panel (which includes great people like Bob Geldof, Kofi Annan and Graca Machel and was supported in its research by Kevin Watkins, now head of the ODI)   misread another piece of GFI analysis and inflated the estimate (up to 2010) to $38 billion per year. A recent report by Action Aid took  the Africa Progress Panel number, added  another unrelated figure to stated  that tax avoidance is costing African governments $64 billion a year.  GFI say their original number is a conservative estimate, and is due to be updated, so it certainly should not be taken as the ‘right’ answer, but the other two numbers quoted are pure misunderstandings with no methodological foundations.

Similarly, often the companies that hit the headlines as exemplars of tax avoidance turn out to have  plain vanilla explanations  for their  low tax bill, for example when big investments in new equipment and plant are written off through capital allowances  (Npower) or when the compensation that employees receive in the form of share options is included as a business expense (Twitter), when an international company centralises some of its operations (Starbucks roasting coffee in  Holland) or when a company just doesn’t make much profit altogether (Amazon).  In other cases, headlines of  companies exploiting  ‘tax loopholes’ turnout to be companies using a law as it was intended, but where campaigners would like the law changed (e.g. Vodafone’s sale of Verizon  and Barclays and HSBC accused of ‘underpaying’ tax by $2.6 billion).

Tax results do not always align with our moral intuititions. It is not always immoral or a sign of dodgy dealings for a huge company to be paying less tax than the small trader next door. A company that spends more on lobbying than corporation tax is not necessarily up to no good ( I know, it is hard to say that without sounding like you are definitely in league with the Evil Empire, but nevertheless it is true). Working out the fair division of profits across countries is not a trivial problem when people, inventions, investment, materials and goods can move around and combine in strange and new ways (and moving and combining these resources in new and strange ways is exactly what we want companies to do, not least to build the trillions of dollars worth of green power and water infrastructure needed to square the climate change-prosperity circle).

Conflating ordinary business practice with aggressive tax avoidance does not help us to understand what is going on, where the problems are or how best to respond to them. What we need is a grown-up, informed,  non-partisan analysis of the issues and data (for example – How can we make sense of the high profile tax scandal cases? What are the priorities for strengthening tax revenues in least developed and emerging economy countries? What are the best estimates of the costs of different kinds of tax avoidance? What would be the potential benefits, costs and risks of proposed international  measures such as country-by-country reporting? Is unitary  taxation a serious proposition? How do offshore financial centres impact on development, and how can this be improved?).

Without this kind of assessment we non-tax experts – which includes politicians,  international development experts, campaigners and funders, as well as regular citizens, are in danger of misinterpreting data, and  being driven by inchoate anger and the momentum of the narrative to support policies which we haven’t really been able to assess.

The state of divided debate reminds me of the field of business and human rights, before John Ruggie was appointed as UN Special Representative in 2005. His mandate was created when debates over proposed ‘Norms on Business and Human Rights’ broke down in deep division between governments, companies and advocacy organisations. His work started modestly with the initial task of ‘identifying and clarifying’ things, through consultations with all concerned. He drew on legal experts and sought to build up a robust evidence base and work out a way forward based on principled pragmatism. He discarded long-used terms (like ‘sphere of influence’) which turned out to be not all that useful and set out clear definitions for the ones he did use. He eventually developed the  Protect, Respect and Remedy framework which sets out human rights responsibilities for business and government. Not everyone was 100% happy with the compromises involved, but most agree that it represented a hard-won step forward in dealing with the difficulties of regulating corporate impacts across international boundaries.

My constructive proposal is that we need a similar process of principled, pragmatic, fact-based enquiry and consensus building on the matter of corporate and government responsibilities in taxation.

The International Bar Association’s Human Rights Institute (IBAHRI) has taken a step in this direction, creating a Task Force on Illicit Financial Flows, Poverty and Human Rights  with a mandate to conduct research and consultations. Their first report is thoughtful, and was carried out in the spirit of the Ruggie mandate.  They identified four areas of particular  concern; transfer mispricing, the negotiation of overgenerous tax holidays and incentives, inadequate taxation of natural resources and the use of offshore investment accounts and asked many good questions, for example;

  • What are the boundaries between legitimate tax planning, illegitimate tax avoidance and illegal tax evasion?
  • Is there a legitimate role for secrecy jurisdictions in the context of an interconnected global economy?
  • What international laws, policies and mechanisms are required to address tax abuses in the 21st century?
  • How do tax abuses prevent developing countries from raising sufficient resources to alleviate poverty and meet the needs of their citizens?
  • How are human rights relevant to these tax matters?

But their analysis doesn’t get much beyond a balanced but inconclusive reporting of  of divergent opinions, and they end up falling into the same trap with the big numbers as the other reports mentioned, confusing estimates of illicit capital flows with tax losses, and misattributing them to corporate transfer pricing. They don’t manage to come up with a strong definition on the core question of what is tax abuse,  but fall back on the circularity of identifying it with “behaviours that are of  greatest concern to stakeholders interviewed”.

Part of the problem I think is that the human rights lens is not in itself useful for untangling the tax debates. It gives moral gravity to the basic statements of why taxation is a serious business, but does not offer an analytical means to determine the difference between tax abuse and legitimate tax planning, or to work out the economic costs of poor tax systems, and the potential impacts of reforms. For that you need  tax specialists and economists.

I would love to see a follow up to the IBARHI report which involves a few willing tax advisors, companies and tax campaigners, together with economists and human rights lawyers working together in good faith to find common ground of concepts and data which would enable a more informed public debate. The task force could seek to tie down clear common definitions and categories, for example between ordinary-tax-planning-that-no-one-serious-contests and ordinary tax planning-based-on-a-law-that-someone-would-like-changed (there may be snappier titles here…), aggressive tax avoidance, exploitation of complex tax loopholes, and exploitation of poor enforcement (such as lack of transfer pricing rules). Which terms are  useful as a basis for analysis and action, and which are not? How do they help us understand the big numbers and tax scandals that are driving concern?  How does what we know about specific areas of tax abuse relate to the various policy recommendations to address it? And what might be their impacts?

For people who have been working on these issues for ages, this may be a frustrating ask.  It could just be a delaying tactic by people who want to cause a diversion to scupper reforms.   Group loyalties on all sides are strong and if particular big numbers or cases have become a core part of the narrative then correcting errors or admitting uncertainties looks like an own- goal to be avoided.

It is tempting just to ignore people asking pedantic questions, or accuse them of sticking up for tax avoiders.

On the other hand, the tax reform issue is part of the agenda of a broader movement for ‘open government’  which calls for more data and shared analysis,  to enable informed public debate and effective accountability.  Expert organisations,  civil society and the media,  with all the trust we invest in them have a responsibility, not just to compete for our limited attention spans through a race-to-the-bottom of  juicy but unreliable narratives, but to help us understand the complexities and trade-offs of the issues we are called to make judgement on.

Feel free to use my comments page as a sign-up sheet!

4 Responses to “A constructive proposal on tax”

  1. Hopefully GFI – or someone else – will come up with some new estimates of tax revenues lost as a result of illicit financial flows soon! Seems like a priority to me. Would be interesting to know if anything like this is underway.

  2. File me under “interested”

  3. How refreshing to see someone start a discussion about tax reform without the initial misstep of ideology or hyperbole. Bravo!

    In this spirit, here are a few points which will hopefully further the discussion.

    Reality 1) Politicians need to maximize in a sustainable manner the amount of tax revenue they collect in order to TRY to pay for entitlement programs which were put in place by themselves and predecessors. They will do this out of a sense of responsibility and/or a desire to be re-elected. As a result of the Prisoner’s dilemma, countries will compete with each other for sources of tax revenue and job creation. US politicians don’t get rewarded for helping other countries to the detriment of their own;

    Reality 2) The “tax equation” is “taxable income/capital gains” times “income/ capital gains rate” equals “taxes paid”. Quoting rates ( whether income or capital gains) in isolation is meaningless and misleading. The significant indicator is “tax paid”;

    Reality 3) In a progressive tax system like the US or UK the top 1% of taxpayers (aka. Golden Geese) pay over 1/3rd of the total personal taxes paid. This is true even though this group tends to pay more than other groups at capital gains rates. As a result of globalization these Golden Geese are no longer bound to remain in a given tax regime in order to make and maintain their wealth. Countries actively recruit and compete for these Golden Geese, by making their jurisdiction more tax friendly than others. Therefore income/ capital gains tax revenues will drop in jurisdictions which the Golden Geese deem as taxing too heavily. Increasing taxation on this group (aka “tax the rich”) will increase these departures and accelerate the loss of total taxes collected. (Note: For real life example look at Eduardo Saverin and the record number of American expatriations);

    Reality 4) International companies that deliver unique services delivered directly to devices ( eg Google and Twitter) are not as easily corporately taxed as companies which deliver standardized tangible goods either at retail outlets (eg Starbucks) or through courier/ mail (eg Amazon). With 3D printing becoming widespread and cheap; more tangible goods companies will be ones delivering programs on-line. This also makes it more difficult to apply VAT (ie consumption taxes) taxes on more and more goods. Therefore “Fair Tax” proposals will generate a dwindling amount of tax as this trend continues (Note: Puts those silly 3D food printing pioneers in a new light doesn’t it!)

    Reality 5) Financial transactions are quickly and easily moved between jurisdictions and not easily taxed. Therefore “Robin Hood” tax proposals are DOA, since any country trying to implement such a program will find a rapid loss of their financial markets to jurisdictions which do not implement such a tax. (Note for a real life proof look at the immediate loss of financial markets in the 11 EU countries which recently put in a financial transaction tax to the other 20 odd which did not);

    The sooner politicians of all stripes recognize (and educate the voters about) these realities the more chances that they will be able to get their tax revenues stabilized and maximized and therefore get the long-term support of the voting public.

  4. 4 Maya

    Update: Action Aid have let me know that they have amended the Barclays report, mentioned above.

    The original report said:

    The Africa Progress Panel estimates that lost taxation is costing sub-Saharan Africa US$63 billion every year.This lost tax, if paid and targeted effectively, would be enough to reach the UN’s millennium development goals of universal primary education and universal healthcare, with enough money left over to upgrade Africa’s entire road network, boosting regional trade and local development

    The amended report says:

    The Africa Progress Panel estimates that illicit financial flows from sub-Saharan Africa amount to US$63 billion every year. The tax revenue lost as a result of these flows, if paid and targeted effectively, would raise billions of
    dollars each year in the pursuit of global goals on hunger and education.

    Kudos to them for making the correction .

    It is now more accurate (the estimate does relate to illicit financial flows), but it is still not meaningful in relation to tax revenues or Barclays. The IFFs estimate includes drug smuggling, terrorist financing and proceeds of corruption (not things we usually try to tax), and does not assess anything about the impacts of ‘treaty shopping’ which is what Action Aid’s beef with Barclay’s customers in Mauritius is.

    It seems like it is being treated it like a typo rather than a serious correction of something which they previously thought was true (i.e. that there is a pot of money sitting there which could pay for primary education and universal healthcare, and upgrade Africa’s entire road network, and that this is the way to get at it).

    I do think it is more serious than a typo, and it is not just a problem of this report, or of Action Aid.

    To use a medical analogy, it is like saying “Did we say dyslexia is killing 370 million people every year? Sorry, we meant 370 million people have diabetes, either way the cure is the same, lets just get on with it”

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