Tax dodging by corporations

In this column David Hollanders discusses how excusable tax avoidance or fiscal planning is. He explains that tax dodging can be legal, but why it will never be moral.

Tax dodging by corporations: if not illegal, it is certainly immoral

Nobody likes paying taxes and companies are no exception. So one part of running a company is minimizing tax payments. The finance-textbook of Berk and DeMarzo shows how leverage reduces tax payments. Interest-payments are tax-deductible and the resulting tax-reduction is thus called the interest tax shield (ITS). Of course the larger the ITS, the lower government tax revenues are. This in turn leads to higher taxes elsewhere, higher government deficits or lower public expenditure.

One can however not blame companies for taking advantage of tax deductibility of interest-payments, just like one cannot blame citizens for deducting mortgage-interest payments. Some corporations however go much further than maximizing the ITS. They exploit tax loopholes, breaking the spirit if not the letter of the law. An example is Starbucks. The BBC reported that in 2013 “Starbucks, for example, had sales of £400m in the UK last year, but paid no corporation tax. It transferred some money to a Dutch sister company in royalty payment ”. So how can Starbucks make profits but not pay taxes? It has a small office in the Netherlands (in Dutch:”brievenbusmaatschappij”), set up for no other purpose than to avoid taxes. The mother company of Starbucks in the UK pays “costs” (the royalty payments) to their  Dutch office; these costs are fabricated and only exist on paper. This artificially reduces profits in the UK to approximately zero (and increases profits in the Netherlands). The Netherlands has a special (low) tariff for royalty payments. The profits are channelled back to the UK, and are not taxed there, for they have been taxed already in the Netherlands, albeit at a (very) low rate. Et voila: zero taxation. Starbucks is not the only company to avoid taxation in their mother county in this way: Google and Amazon are other examples. The other way round, the Netherlands was named a tax haven by Obama in 2009 (other tax havens included Bermuda and Ireland).

So is such tax avoidance –or fiscal planning as Starbucks and the likes call it- excusable? One can argue that such tax-dodging is legal and that the social responsibility of businesses –as Milton Friedman (in)famously remarked- is to increase profits. But this conveniently ignores the real issue. There are several activities that may be profitable but that many people nonetheless feel companies should not engage in, such as child labour, weapon-sales to dictators and polluting. While child labour is not the same as tax-dodging, it shows that businesses do have responsibilities. And one of these is to pay taxes, like everybody else in society. These taxes are used to finance –among other things- educating the future workforce and building dykes and roads –all benefitting companies. But, some would counter, isn’t tax-dodging legal and therefore excusable?

In fact, it can be argued that tax avoidance is illegal as it entails implicit government support for large businesses –that can afford the high up-front legal costs-, which is illegal in the EU. But even if legal, it is noteworthy that large businesses are lobbying for special tax arrangements –they are not just taking advantage of existing rules, they are influencing the rule-making process. But even if corporations would refrain from lobbying, it is close to impossible to formulate tax-rules that cannot be bent by corporate lawyers, who make a living out of, well, bending the rules. And this brings us back to the real issue. Small companies and households cannot afford an army of lawyers and lobbyists to eliminate their taxes. But taxes need be paid by someone. Whatever large companies are not paying, the rest of us is paying extra. If not illegal, that is certainly immoral.