Cost-benefit analysis puts corporate tax avoidance in perspective

The growing crackdown on tax avoidance risks ushering in a broader suppression of international tax competition, harming the interests of all taxpayers.

An inevitable consequence of economic globalisation is that supply chains and financial linkages have become dispersed across geographic space, and producers now strive to provide customers with quality goods and services, at affordable prices, on a global scale.

With individual countries maintaining powers to autonomously impose taxes on different bases and with different rates, opportunities emerge for multinational corporations to not only structure their economic and financial affairs to secure general efficiency gains, but to avoid some punitive taxes.

In recent months some tax avoidance schemes adopted by major companies have received widespread media attention, with coverage typically portraying tax avoidance as an evil which “unfairly” starves governments of revenue and slugs non‑avoiding taxpayers with additional imposts.

In September the union‑backed Tax Justice Network NGO released a report asserting that tax avoidance by ASX 200 companies was rife, claiming that 84 per cent of the companies paid less in tax than implied by the 30 per cent corporate tax rate.

The TJN went further,  saying that one in ten of these companies were paying no tax at all, with tax avoidance practices costing the federal Treasury $8 billion in lost revenues.

More recently, it has been reported that hundreds of companies, including those headquartered in Australia, and even the federal governmentʼs own Future Fund, no less, avoided tax by channelling financial transactions through low‑taxing Luxembourg.

These reports may have dominated front‑page headlines in recent weeks, and in one fell swoop tainted the reputations of some of our major producers, but the claims of industrial‑level avoidance of taxation obligations have been hotly contested.

The TJN study has been heavily criticised for failing to take into account the territorial aspect of Australian corporate tax laws, in which only the earnings of multinational companies that are generated by Australian activity, and not from  anywhere else,  are liable to Australian company tax.

Indeed, it is nonsensical to claim that foreign earnings should also be represented as an “avoided tax” that companies have elected not to pay, as the TJN appears to have suggested.

Nor did the study recognise that trusts don’t attract tax liabilities, whereas the holders of their securities pay tax on interest and other earnings received, thus avoiding the problem of “double taxation”.

Another blind spot of the TJN analysis is that the effective rate of tax paid by a given company may not necessarily be the same as the statutory rate for a variety of legitimate reasons, including through the treatment of tax credits and offsets, timing issues presented by the use of accrual accounting standards, and so on.

The claims of so‑called massive tax avoidance in Luxembourg also does not appear to hold much watergiven that, at the very least, the funds invested by companies in that low‑tax country will eventually be subjected to taxes paid by shareholders (either through dividend taxation or capital gains taxes).

So, the recent reports and attention‑grabbing headlines are essentially grounded in, at best, a fleeting understanding of taxation laws and principles but, even if the corporate tax avoidance claims are true, is it strictly the case that wrongdoing has been committed?

For a start, there is a world of difference between tax avoidance, involving the application of existing legal provisions, including tax loopholes, to reduce tax liabilities, and tax evasion, involving engagement in illegal activities, such as fraud, to reduce taxes.

There has been no serious suggestion, at least to date, that the tax avoidance activities of firms operating across borders have entailed criminality.

Another point that should be raised is that the coverage given to recent tax avoidance matters, or allegations of them taking place, has not been presented from an economic perspective weighing up the relative costs and benefits of avoidance, to the avoiding taxpayer, other taxpayers, and governments.

It could be presumed that those engaging in tax avoidance acts construe such activities as providing a net benefit to them, even if it takes some effort to avoid taxes, although in the case of large firms there seems a growing risk of a loss of reputation resulting from such activity.

The assertion is often made that corporate tax avoidance costs the non‑avoiding taxpayer through higher tax burdens, but other factors must be considered when rendering a final judgment.

For example, the taxes avoided by the firm are funds that could be used, instead, to invest and expand business operations, representing gains to shareholders and those situated within the broader economy.

In high‑taxing countries vulnerable to avoidance activities there may be some deprivation of revenue experienced by government, but that may present a silver lining in terms of less subsequent expenditures on unproductive undertakings.

Further, any costs of tax avoidance borne by high‑tax countries could be offset, at least in part, by gains in tax revenue and general economic activity within low‑taxing countries, the benefits of which could spill back over into high‑tax countries in the form of, say, more goods and services trades.

The fact is high‑tax countries present just  as strong a motive for international tax avoidance as the existence of low‑tax countries, including tax havens, but we are not hearing the anti‑avoidance activists and commentators calling for lower, even flatter, income and capital taxes globally.

Inspired by the sensationalist headlines, the emerging policy agenda for a clamp down on tax avoidance should be seen for what it truly is: a ploy by indebted countries, with overgrown public sectors, to hoover up more cash from productive people and enterprises, stifling tax competition in the process.

It is most unfortunate that Australia, with much to gain in reducing its own hefty company and personal income taxes, is so actively entertaining the avoidance crackdown obsession by the political representatives of economically flabby and high-taxing Europe.

We seem to forget the march toward greater tax competition by advanced economies, from the early 1980s to  before the global financial crisis, played a major role in encouraging productive entrepreneurship by the top end of town, as well as promoting upward mobility for those on low to middle incomes.

In  their quest to stamp out tax avoidance, Western countries are merely aiming to compulsorily extract revenue from taxpayers more easily, and threatening to drag the rest of the world into a situation where international competition to lower taxes  is no longer the norm.