Health warning 1: I don't
make any distinction between the words "evasion"
and "avoidance" with respect to taxes in this
article. Such semantics are the preserve of
private bankers, accountants and tax consultants;
in my world the two words are the same. This
article isn't about a legal point of view but
rather a logical, humanistic point of view; hence
such distinctions don't have any place here.
Health warning 2: This
article discusses the operations of a number of
globally well-known companies many of whom offer
services I have personally enjoyed (Google, Apple)
; others whose services I have availed but not
necessarily enjoyed (Vodafone, Starbucks) and
lastly companies whose products or services I
haven't personally availed ("Big Pharma").
Throughout, I have
attempted to remain as
objective as possible when offering opinions but
it is important to consider my views in this
context of being both a consumer and a writer.
Health warning 3: This
article sings praises for tax evasion by companies
for reasons that are explained hereon. However,
nothing here should be construed as a defense of
tax evasion by citizens of any country - which I
find morally repugnant and running counter to the
implicit treaty that one signs when deciding to
live and work in any particular country. I am,
however, all in favor of people who emigrate for
tax reasons. [1]
It has been an
entertaining few weeks for the financial media,
what with a scandal or two erupting daily in
Europe about companies allegedly evading taxes
(see notes below about various companies so named
and shamed). An extraordinary focus on the
operations of global giants such as Starbucks,
Vodafone, Google and Apple has meant that such
allegations have resulted in politicians of all
hues raising an outcry on these companies
profiteering or worse evading taxes.
Rather than outright fraud though, the
companies are accused of using accounting
legerdemain to minimize taxes in various
jurisdictions, in effect transferring profits to
places where taxes are lower. The issue at hand is
transfer pricing - a strategy followed mainly by
multinational companies wherein they charge
royalty payments such as for marketing and
distribution of brands, payments for intellectual
property and research and development expenses
among other things - to group companies in places
where taxes are much lower.
So for
example, a company sells $100 of product in a
country, say Country A, against which it incurs
direct costs (of materials and labor) of $50; so
it has a nominal profit of $50 on which, all other
things being constant, lets say it owes taxes of
30%, or $15. Of course, selling a product or
service developed somewhere else means that the
company incurs expenses elsewhere: let's say that
it has costs of $50 in that development center,
located in Country B say Switzerland or Singapore.
Absent any revenues in Singapore or
Switzerland (and these are small countries), you'd
then have the company as a group, losing money:
profit after taxes in Country A is $35; while it
loses $50 in Country B for a grand loss of $15.
This is of course wrong from any accounting or
shareholder perspective; ideally there would be a
charge of $50 from Company B to Company B (an
intra-group transfer), which would mean that the
group loses no money and pays no taxes.
The counter argument of course goes that
the above example is all well and good in theory
but in practice most companies abuse the system of
transfer pricing to minimize taxes. This becomes a
particularly emotional argument at the current
juncture of yawning budget deficits and low
economic growth prospects in Western countries
such as the UK, US and the various countries of
Europe.
The generic left-wing argument
goes thus: companies are reducing their tax burden
in the developed world while benefiting from the
superior infrastructure - legal, human and
operational - that was at least partly paid for by
the government whose money they are now stealing.
With higher tax payments from these companies, the
argument goes, deficits in the West wouldn't look
quite so bad and therefore there would be less
hardship on the common folks who otherwise face
cuts in government services and a higher tax
burden themselves.
These arguments are
seductive - admittedly like many of the ones made
by the left that call upon lofty social principles
- but invariably are wrongheaded and
counter-intuitive when all facts are considered.
The primary argument in favor of tax
evasion is that companies are collections of
investments, innovations and competitive factor
costs (be it capital investments or simply better
employees). Funded by private capital sources
ranging from high risk (equity) to low risk
(bonds), companies are charged with generating an
acceptable return on capital for the level of
business risk they absorb.
That makes them
vastly different from governments, which are
essentially intermediary entities between
productive and less-productive parts of society.
Funded by taxes raised from the productive parts
of society or a monopoly on natural resources,
governments spend money on maintaining the social
fabric of countries. These are simple but not
necessary simplistic formulations of the
difference between the two.
Now
governments certainly have a bunch of social
functions including in the provision of defense,
security, healthcare and other areas where private
sector solutions may not generally reflect social
realities against the economic background. The
waste of governments also produces a number of
useful innovations - such as the the creation of
the Internet in the 1960s by the Defense Advanced
Research Projects Agency in the United States -
all of which end up benefiting society at large.
These are however accidents. In general,
governments run too expensively to properly
transmit the revenues raised from one set to
citizens to benefit another set of citizens -
"leakage" in other words.
Companies also
leak money on vanity projects and ill-advised
acquisitions among other things, but they are
quickly punished by various stakeholders - banks
charge them more for lending, employees leave and
equity investors run for the door. In theory,
government inefficiency is also punishable in the
same ways - markets should charge them more for
lending, citizens should emigrate and so on.
However, modern realities are different -
in the case of Europe, we have seen many a country
suffer from the markets' adverse reaction, but
they haven't really changed as a result: Greece is
still running yawning deficits, while Spain and
Portugal remain reconstituted but not
restructured. US governments at the federal and
state levels have benefited from the exit of
investors from Europe, and in effect have gotten
away with their own crimes, for now at least.
(America's relative position in the
hierarchy of sovereign bankruptcy has been
misconstrued by many - including those of the Paul
Krugman school - to the notion that there is no
debt crisis in the country now. That is a mistake,
which will come to light soon enough).
The
point is that governments spend too much because
there is no accountability in reality,
particularly in the democratic context where more
spending equals more popularity at the booth
(exhibit 1: the recent US presidential elections).
Contrast that with companies wherein excess
spending means less profit for shareholders and
soon enough a market punishment for either lower
earnings or mal-investments.
So what do
companies do with the money they steal from
governments in the form of lower taxes than is
rightfully owed?
This is the second major
area of support for companies to pursue tax
evasion actively. Companies usually pay dividends
to shareholders that is then taxed by governments
in the hands of individuals. As tax rates for
individuals are usually higher than those for
companies, this means no leakage in the system as
a whole (as whatever is "saved" in tax by the
company is handed over to shareholders as well).
What if there are no dividends - from the
likes of Google or Apple? These companies do two
things with their money - they reinvest in the
form of capital and jobs to pursue new innovations
(which brings more jobs - and therefore taxes -
immediately, and also improve productivity later).
Both of these benefit society at large, and
therefore cannot be construed as leakage -
particularly when we also consider that at least
for short-term profit generation, the corporate
model is unequalled by any governments.
So
the message to European governments - and in
particular those of France, Italy, Spain and the
UK - is simple: ignore companies diverting taxes
from your countries. Instead, lower your overall
corporate tax rates so that companies do not feel
the need to escape taxes particularly when weighed
against the negative publicity associated with
these actions.
Then take a hard look at
your own spending and figure out what would the
optimal course if you were running a company
instead of a government.
Notes: 1. French actor
Gerard Depardieu this week being one example,
renouncing his French citizenship in favor of a
move to neighboring Belgium. See Actor
Renounces His Citizenship in Snit Over French Tax
Burden, New York Times, December 16,
2012. For various articles on companies
mentioned here and their tax dealings, see: 2.
Starbucks: see here.
3. Google: see here.
4. Apple: see here. 5.
Vodafone: see here.
and this
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