In his second blog for us, Alex Cobham explains how corporate tax avoidance doesn’t only rob countries of much needed revenues and exacerbate inequality, it actively undermines the social contract between states and citizens. But we – as citizens – have a role to play in bringing about change.
Some time before the financial crisis, I wrote a paper outlining the importance of tax (PDF), above all for developing countries. The paper coined the phrase, ‘the 4Rs of tax’. The most obvious two are revenue (the money raised for governments to spend on e.g. public health and education); and redistribution (the ability to contain inequality and ensure the gap between top and bottom incomes does not become damagingly wide).
Tax is also used for re-pricing, the ability of governments to encourage or discourage particular activity by changing relative prices, for example by increasing the price of tobacco or reducing that of children’s clothing.
Arguably the most important R of tax, however, is also the least obvious: representation. The more that governments rely on tax for their expenditures, the more – over time – they are likely to be representative of their citizens and accountable to them.
The famous saying that tax is “what we pay for civilized society” does not only refer to the basic costs of organising ourselves in a less brutal way than survival of the fittest. It also reflects the importance of tax as the glue that holds together the social contract between states and citizens, and ultimately between individuals in choosing to live together by some common rules.
This is what companies are dodging – not just the payment of money, but the collective social responsibility that we all share. At the same time as they benefit most (financially) from the rules and institutions that make their markets work, these companies are dodging the reciprocal contribution.
Worse than that, evidence from experimental economics shows that our own tax compliance depends on the extent of redistribution (whether we think taxes are spent to help the poorest), and on our perceptions of compliance by others.
The more that high-profile taxpayers dodge their responsibilities, the further will compliance in general fall. This is why some countries find themselves in a vicious circle in which nobody pays tax because, well, nobody pays tax. ‘Why should I be the only mug?’
What of companies’ common defence that avoidance is legal, unlike tax evasion? As Google said recently, “our present structure is compliant with the tax rules in all the countries where we operate”.
This is surely true, but in fact is a further insult. When the law seems powerless to prevent things like the Bermudan and Irish structures that resulted in minimal UK tax being paid last year, the wider perception of the tax system as legitimate is put in question.
So corporate tax avoidance doesn’t just mean that somebody else has to pay; it tugs on the thread which holds together the social contract. For poorer countries, this can mean critical failures - to fund health systems to reduce infant mortality (PDF), for example, or to reduce the inequalities that blight development progress.
But it also undermines the emergence of an accountable, representative politics on which all human development must ultimately be founded.
So what can be done to make corporate tax more than purely voluntary?
Increasingly, a common sense consensus is emerging among experts who lean both to the corporate side and to the tax justice side, that the current global system is broken.
The answer, many now think, lies in approaches that distribute the taxing rights on corporate profits according to the location of their real economic activity.
To make that work, of course, we first need the transparency about MNE operations that country-by-country reporting would provide. (As an aside: it’s unfortunate, though perhaps also indicative of the need for cultural change, that the London-based body responsible for such international accounting standards is itself under investigation for – er – tax issues…)
Practical change will come when there is cultural change: when companies find that they lose money if they get a reputation for failing in their responsibilities to the societies in which they profit; and when politicians face real pressure to live up to their rhetoric on transparency.
All of that starts with citizens. What will you do today?
Alex Cobham is a development economist who appears in Stealing Africa. He is writing purely in a personal capacity.