In November, Australia will host the G20 meetings in Brisbane. Included in an overly ambitious agenda is international tax avoidance or, as the OECD (Organisation for Economic Co-operation and Development) has labelled it, "base erosion and profit shifting". This is an important debate. Unfortunately, business has been somewhat reluctant to engage in the issues and faces a period of prolonged tax policy uncertainty.
Anti-business activists have already prepared the ground within Australia by producing a report that alleges that many large Australian companies pay little or no corporate income tax at rates well below the 30-percent statutory rate. The newly elected centre-right government is prosecuting the case with some vigour, with Treasurer Joe Hockey arguing that companies must both comply with the tax law and pay their fair share of taxes. In times gone by, complying with tax law was paying a fair share of taxation.
In Australia, at least, big business pays a very fair share of income tax. According to OECD figures, Australian businesses paid 19.7 percent of total tax revenue in company income tax in 2011, compared to an average of 8.7 percent for the OECD as a whole. In short, there is no reason for the Australian government to believe that it is being short-changed in its company-tax receipts.
Nonetheless the issue is on the agenda, and many governments are keen to be seen to be doing something. The European Union — a member of the G20 in its own right — and the OECD, in particular, have been very vocal in this area.
Big-government advocates, including government itself, have been able to generate a campaign of misinformation around company tax through anti-business prejudice and rational ignorance. All this has combined to create a series of tax myths — those beliefs that the public "knows" to be true, yet are entirely misleading, if not false. One of those tax myths is that business doesn't pay a "fair share" of tax. Another myth is that declining company-tax rates result in reduced company-tax revenue. Between the early 1990s and 2006 — immediately before the Great Recession — company-tax revenue within the OECD had increased as a percentage of total tax revenue.
Anti-business sentiment is cyclical. Rational ignorance is a bigger problem for business. Many voters find taxation to be boring and highly complex. In this environment it becomes easy to propagate the fiscal illusion that the tax burden is lower than it actually is or that government adds more value than it actually does.
Take for example the difference between cost accounting, financial accounting and tax accounting. Cost accounting generates information for management; financial accounting generates information for investors; while tax accounting generates information for the tax authorities. Already some readers are bored. Yet attempting to calculate effective tax rates from financial accounting data can lead to very misleading inferences as to how much tax companies actually pay.
That is exactly what anti-business activists have been doing in Australia. Despite the fact that annual financial statements reconcile financial accounting with tax accounting, those activists have managed to create so much public indignation that the Australian Senate has announced an inquiry into company taxation. The fact that accounting information is put to different uses for different purposes should be understood by any high school student; yet politicians and bureaucrats either struggle with that notion, or they deliberately obfuscate this point.
In the first instance, then, the prima facie evidence that companies engage in base erosion and profit shifting is an accounting illusion. While corporate-tax revenue fluctuates with the business cycle, there is no evidence that the trend in revenue has declined, at least not for the OECD overall. At a time when corporate-tax rates have fallen, stable revenues would suggest the corporate-tax base has expanded and has not been eroded as is claimed. It is true that companies do not pay nearly as much tax as various governments would like them to spend, but that too isn't evidence of any wrongdoing. The company-tax system raises as much revenue as it is designed to raise. If governments want more money from the company-tax system, they should pursue those policies that would result in higher levels of company profitability.
Companies do tend to structure their affairs in such a manner as to minimise the amount of tax that they pay. This perfectly legal strategy has led UK Prime Minister David Cameron to argue that he was opposed to "aggressive" tax avoidance, and he favoured "tax transparency". The problem with Cameron's position is that it isn't clear that any of the companies usually singled out as engaging in "aggressive tax avoidance" are being non-transparent. The famed "Double Irish Dutch Sandwich" tax strategy does not rely on bank secrecy to operate. Capital mobility, national investment incentives and the existing international tax architecture all contribute to what is now labelled "profit shifting".
A telling fact is that those nations that do have general anti-avoidance or anti-abuse provisions in their tax law seldom use those provisions against large multinationals or, as happened recently in Australia, lose in the courts. While claiming that aggressive tax avoidance occurs, governments don't take action under existing laws to curb that behaviour. Although that could change, it is yet another sign that the corporate-tax system raises as much revenue as it is designed to raise.
What is really happening is that governments don't like competition. In particular, they don't like the competition that manifests itself within their own international tax cartel. The fact is that companies around the world are subject to the laws that governments have written themselves. Governments have also voluntarily entered into tax agreements with other nations that bind international transactions and multinational corporations. In establishing an international tax cartel, governments have both written the rules and divided up the global income-tax share amongst themselves. As economists have long known, cartels are as unstable as participants have incentives to cheat. Some members may lower their prices to gain market share.
So it is with taxation. Some governments have lowered their tax rates to gain economic activity. The UK, for example, is itself lowering corporate-tax rates in order to attract multinational corporations. In responding to those incentives, many law-abiding tax-paying citizens and companies get to be labelled "tax cheats". As if being fully compliant with the law of the land were somehow immoral.
When pushed, some politicians argue that it isn't tax competition per se that concerns them, but rather tax havens are the problem. Yet this argument doesn't survive scrutiny. The public perception of tax havens is very different from the mundane reality. So-called "tax havens" tend to be respectable and well-managed economies. Australian activists, for example, have been condemning those well-known fiscal "fleshpots" Hong Kong, Malaysia and Singapore as being tax havens. The fact of the matter is that there are good reasons why any company with an international presence would locate in Hong Kong, Malaysia and/or Singapore. Activists, bureaucrats and politicians might not know that. They seldom have any actual business experience or understanding of business practices. Some may never have held a job in the private sector.
To argue that routine business decisions constitute tax avoidance, and even evasion, requires those activists, bureaucrats and politicians to second-guess those decisions. There can be no doubt with the benefit of hindsight, and a lack of appreciation for business risk and uncertainty, that many bureaucrats and politicians think that they would make much better decisions than business people ever do. Yet the state of public finances tends to suggest otherwise.
Then there is the fact that at some level almost all nations are tax havens for some economic activity. The United States is probably the biggest tax haven in the world — somewhat ironic for a nation that aggressively pursues its own citizens' worldwide income. The UK has long been a residential tax haven for wealthy foreigners. Any country that provides any tax concession to foreigners becomes a tax haven. So it boils down to politicians wanting to offer incentives for investment in their own country, while restraining others from doing just that.
So we have members of a very unhappy international tax cartel meeting soon, with some members hoping to change the rules. Luckily the biggest player, the United States, is unlikely to agree to any significant rule changes. After all, many of the companies regularly singled out as tax cheats are American multinationals. It isn't clear why the US government will agree to having American companies pay more tax to foreign governments.
Despite all the fire and brimstone promised at the G20 meeting — and domestic Australian politics — the international tax cartel will continue under much the same rules as before. Unfortunately that opens multinational corporations up to the prospect of protracted litigation where individual nations employ their own existing tax rules, or introduce new rules, in an attempt to gain more tax revenue. These fiscal shakedowns are likely to become common as tax complexity reduces legal certainty and allows governments to raise revenue through the threat of legal action, and companies settle the claims rather than litigate. The US government has managed to raise $125 billion over the past five years by fining US banks for various regulatory breaches. We may see that sort of behaviour on a grander scale. The international business community faces a hard choice: Greater legal certainty will come at the price of much higher levels of taxation.
It is well known that legal uncertainty depresses economic prosperity. So, too, do high levels of taxation. In an environment where economic growth has been anaemic, and is forecast to remain anaemic, bureaucrats and politicians should be concentrating on reducing those risks and lowering the tax burden rather than attempting to increase both.
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