Nicholas Apergis, Professor of Economics, discusses the ways that big businesses avoid paying taxes, the consequences of them and what governments can do to limit these actions.
Based on various reports from international economic institutions, the gap between the rich and the poor has grown over the recent years, with a massive increase in wealth at the top, while the total wealth owned by those at the bottom is falling. Since 2015, the richest 1% have more wealth than the rest of the world combined (Keeley, 2015). Such extreme economic inequality has been fuelled by an ‘epidemic’ of tax evasion and avoidance that has reached an unprecedented scale. While millions across the world live in poverty, rich companies, exploiting the secrecy provided by tax havens, are continuing to dodge their taxes, depriving the poorest groups from being able to provide vital services.
New information has been released that almost one in five of the UK’s biggest companies paid not a penny of corporation tax in 2018 (This is Money, 2018). More specifically, based on details of the tax paid by 69 of the FTSE 100 group (i.e., the largest companies on the stock market), such details are not published in their annual reports, while the remaining 31 refused or failed to respond to repeated requests to disclose their tax payments. Overall, tax havens have become a defining feature of the global financial system.
Methods for tax evasion
Domestic and multinational companies can use various schemes to avoid paying taxes in cases where they make vast revenues. There are several ways that corporations avoid paying taxes, or manage to earn tax subsidies. More specifically:
1. Foreign Subsidiaries
Companies are using tax loopholes to save money, including finding ways to shift their profits to foreign subsidiaries in countries with lower tax rates, a practice known as an offshore tax-shelter. Usually, companies do not have to pay taxes on income earned abroad until that income is repatriated from abroad. That tax, however, can be deferred indefinitely if the income is held abroad indefinitely. This money held abroad can be borrowed against and even used to invest in domestic assets.
Another way is through accelerated depreciation. The relative degree of freedom in tax laws has allowed companies to alleviate the cost of their capital equipment (e.g., machines, buildings) at a faster pace than it actually wears out. This allows a company to declare less income and defer paying taxes until later years, and as long as the company continues to invest, the deferral of taxes can continue for an indefinite amount of time.
3. Stock Options
Giving out stock options to employees as a part of their compensation is another avenue that has helped companies to reduce their total tax bill. When the options are exercised, the difference between what employees pay for the stock and its market value can be claimed for a tax deduction.
4. Industry-Specific Options
Finally, certain industries, such as oil and gas drilling, alternative energy, and film production, are privileged by the federal tax code to receive certain tax breaks.
A big question is why taxation is important. One perspective is that less tax paid to the government by corporations implies more for individuals, who are best placed to make appropriate use of it, and thus contribute to the economy. That may work well for rich nations and wealthier segments of society. But when it comes down to poor countries, they have another situation to deal with: the political pressures from rich countries. There are a number of impacts on developing/emerging countries:
- Secret bank accounts and offshore trusts encourage wealthy individuals and companies to escape paying taxes
- The ability of big corporations to structure their trade and investment flows through paper subsidiaries in tax havens provides them with a significant tax advantage over their nationally based competitors. In practice this biased tax treatment favours the large business over the small one, the international business over the national one, and the long-established business over the start-up. It follows, simply because most businesses are smaller and newer than those in the developed world and typically more domestically focused, that this in-built bias in the tax system generally favours big/multinational businesses over their domestic competitors.
- Banking secrecy and trust services provided by global financial institutions operating offshore provide a secure cover for laundering the proceeds of political corruption, fraud, embezzlement, illicit arms trading, and the global drug trade.
- The offshore economy has contributed to the rising incidence of financial market instability that can destroy livelihoods. Offshore financial centres are used as conduits for rapid transfers of portfolio capital in to and out of national economies which can have a highly destabilising effect on financial market operations.
How should governments be reacting? Strategies to improve the tax system
- Hiring more highly skilled enforcement personnel and investing in technology. Improvements in information technology can equip tax authorities to better enforce the tax laws. Advanced data analytics is becoming an increasingly important component of tax enforcement, but to use those tools effectively and securely, the tax policymakers will need modern technology.
- Fresh legislation to increase funding for tax enforcement.
- Greater information reporting is needed, such as information regarding payments to and between businesses.
- Better bank information reporting.
- More importantly, the tax returns of all large companies should be made publicly available. They should be filed with tax authorities at the same time as audited annual accounts. In this context, tax returns mean the full tax computation for each legal person subject to corporation, capital gains and other taxes. This computation can show how accounting profits are converted to taxable profits, while it may well be supported by a number of detailed schedules and notes and advice received from accountants and other tax advisers. As a result, tax returns would need to provide detailed information about intragroup and related party transactions.